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, 1997
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to _________
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
(Address of principal executive offices) (Zip Code)
(610) 878-7800
(Registrant's telephone number, including area code)
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 48,215,224 shares
Class Outstanding at October 24, 1997
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
PAGE
----
Part I - Financial Information:
Item 1. Consolidated Financial Statements 3
Consolidated Balance Sheets - 3
December 31, 1996 and September 30, 1997 (unaudited)
Consolidated Statements of Operations - 4
Three and Nine Months Ended September 30, 1996 and 1997
(unaudited)
Consolidated Statements of Cash Flows - 5
Nine Months Ended September 30, 1996 and 1997 (unaudited)
Notes to Consolidated Financial Statements 6
Item II. Management's Discussion and Analysis of 11
Financial Condition and Results of Operations
Part II - Other Information:
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 18
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
DECEMBER 31, SEPTEMBER 30,
ASSETS 1996 1997
- ------ ------------ -------------
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents, including
restricted cash of $204 and $311
respectively $ 11,954 $ 5,193
Short term investments 43,063 16,805
Accounts receivable, net of allowance for
uncollectable accounts of $558 and $556 13,921 6,689
Inventories 13,863 11,050
Other current assets 3,913 10,593
-- --
--------- ---------
Total current assets 86,714 50,330
--------- ---------
Property, plant and equipment, net of
accumulated depreciation of $8,383
and $10,586, respectively 10,517 10,749
Patents, net of accumulated amortization of
$4,152 and $5,236 respectively 9,753 9,433
Long term deposits 3,822 4,035
Other 1,830 1,771
--------- ---------
25,922 25,988
--------- ---------
$ 112,636 $ 76,318
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long term
debt $ 790 $ 831
Accounts payable 15,127 4,071
Accrued compensation and related expenses 3,551 4,949
Deferred revenue 4,790 3,238
Other accrued expenses 5,380 5,476
--------- ---------
Total current liabilities 29,638 18,565
--------- ---------
LONG TERM DEBT 4,221 3,737
--------- ---------
OTHER LONG TERM LIABILITIES 6,270 3,835
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 3)
SHAREHOLDERS' EQUITY:
Preferred Stock, $ .10 par value, 14,399
shares authorized-
$2.50 Convertible Preferred, 103 shares
and 102 shares issued and outstanding 10 10
Common Stock, $.01 par value, 75,000 shares
authorized, 48,109 shares and
48,167 shares issued and outstanding 481 481
Additional paid-in capital 234,245 234,496
Accumulated deficit (162,229) (184,806)
--------- ---------
Total shareholders' equity 72,507 50,181
--------- ---------
$ 112,636 $ 76,318
========= =========
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,
-------------------------- --------------------------
1996 1997 1996 1997
-------- -------- -------- --------
REVENUES:
Product revenues $ 7,522 $ 1,933 $ 14,356 $ 42,151
Licensing and alliance 1,868 1,227 26,575 5,182
-------- -------- -------- --------
9,390 3,160 40,931 47,333
-------- -------- -------- --------
OPERATING EXPENSES:
Cost of UltraPhone revenues 8,755 2,181 16,652 37,912
Sales and marketing 1,216 1,362 3,132 5,553
General and administrative 2,627 2,870 8,080 9,508
Product development 5,888 5,469 15,054 18,171
-------- -------- -------- --------
18,486 11,882 42,918 71,144
-------- -------- -------- --------
Income (loss) from operations (9,096) (8,722) (1,987) (23,811)
OTHER INCOME (EXPENSE):
Interest income 892 745 2,963 1,768
Interest and financing expenses (55) (81) (132) (309)
-------- -------- -------- --------
Income (loss) before income taxes and
minority interest (8,260) (8,058) 844 (22,352)
INCOME TAX PROVISION (14) -- (3,519) (34)
-------- -------- -------- --------
Income (loss) before minority interest (8,273) (8,058) (2,675) (22,386)
MINORITY INTEREST 1 -- (890) --
-------- -------- -------- --------
Net income (loss) (8,272) (8,058) (3,565) (22,386)
PREFERRED STOCK DIVIDENDS (64) (64) (196) (192)
-------- -------- -------- --------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS $ (8,336) $ (8,122) $ (3,761) $(22,578)
======== ======== ======== ========
NET INCOME (LOSS) PER COMMON SHARE $ (0.18) $ (0.17) $ (0.08) $ (0.47)
======== ======== ======== ========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 46,709 48,167 45,922 48,148
======== ======== ======== ========
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,
----------------------------
1996 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (3,565) $(22,385)
Adjustments to reconcile net income (loss) to net
cash used for operating activities-
Minority interest in subsidiary 890 --
Depreciation and amortization 2,179 3,546
Other (145) (2,627)
Decrease (increase) in assets-
Receivables (9,491) 7,232
Inventories (3,728) 2,813
Other current assets (2,563) (6,680)
Increase (decrease) in liabilities-
Accounts payable 5,007 (11,056)
Accrued compensation (1,009) 1,398
Deferred revenue 12,822 (1,552)
Other accrued expenses 756 96
-------- --------
Net cash used for operating activities $ 1,153 $(29,215)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (increase) in short-term investments $ 3,639 $ 26,258
Additions to property and equipment, net of non-cash additions
of $0 and $352, respectively (4,746) (2,092)
Additions to patents (429) (764)
Other non-current assets (2,178) (404)
-------- --------
Net cash provided by investing activities $ (3,714) $ 22,998
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sales of Common Stock
and exercises of stock options and warrants $ 9,597 $ 251
Payments on long-term debt , including capital lease obligations (452) (795)
-------- --------
Net cash provided by financing activities $ 9,145 $ (544)
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 6,584 $ (6,761)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 9,427 11,954
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 16,011 $ 5,193
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 128 $ 107
======== ========
Income taxes paid, excluding foreign witholding taxes $ 389 $ 127
======== ========
The accompanying notes are an integral part of these statements.
5
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
1. BACKGROUND:
InterDigital Communications Corporation ("InterDigital"(R) or the
"Company"), a public corporation incorporated in the Commonwealth of
Pennsylvania, develops and markets advanced digital wireless telecommunications
systems using proprietary technologies for voice and data communications and has
developed an extensive patent portfolio related to those technologies. The
Company offers its customers, licensees and alliance partners what it believes
is unique access to both time division multiple access ("TDMA") and Broadband
Code Division Multiple Access(TM) ("B-CDMA"(TM)) proprietary digital wireless
technology and intellectual property.
The Company's principal product is the UltraPhone(R) system, a radio
telephone system providing businesses and households access to basic telephone
service through a wireless local loop. The UltraPhone system offers greater
flexibility and ease of installation than conventional wireline-based systems
and is designed to provide high transmission quality, capacity and spectrum
efficiency. The UltraPhone system, which incorporates the Company's proprietary
TDMA technology, is sold predominantly to foreign telephone companies to provide
basic telephone service to their customers, primarily in rural and near-urban
areas, where the cost of, or time required for, installing, upgrading or
maintaining conventional wireline telephone service supports selection of an
UltraPhone system. Sales of UltraPhone systems accounted for approximately 40%,
20% and 47%, respectively, of the total revenues of the Company during 1994,
1995 and 1996. Through September 30, 1997, the Company has sold over 345
UltraPhone systems worldwide, with aggregate UltraPhone Product Revenue totaling
over $200 million.
The Company and its alliance partners are developing a new air interface
technology and products, based on the Company's patented B-CDMA technology and
proprietary technology know-how. The initial phases of the development effort
are oriented towards development of wireless local loop products with
performance and cost characteristics applicable to a market segment distinct
from the Company's UltraPhone system. The Company has started to market its new
TrueLink(TM) wireless local loop product based on the Company's proprietary
B-CDMA technology. The Company obtained approximately $600,000 of Product
Revenue for the TrueLink(TM) product during the third quarter of 1997. These
sales included both ASICs and B-CDMA components sold to alliance partners for
their integration into pre-production products.
InterDigital Technology Corporation ("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 the
Company's extensive portfolio of TDMA, code division multiple access ("CDMA")
and other patented technologies. These efforts have resulted in patent license
agreements with a total of thirteen entities, and the recognition of $28.7
million, $67.7 million and $28.7 million of licensing revenue in 1994, 1995 and
1996, respectively.
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, 1997 and the results of their operations for the
three and nine month periods ended September 30, 1996 and 1997 and cash flows
for the nine month periods ended September 30, 1996 and 1997. 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
6
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, as amended, 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.
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 or that ITC's patents in suit are invalid. In one such action involving
Motorola, Inc., a Court of Appeals has partially overturned a U.S. District
Court decision by reinstating two claims that had previously been held invalid.
The Court of Appeals also affirmed the validity of three other claims, affirmed
the invalidity of nineteen claims, and denied ITC's request for a new trial as
to validity and infringement issues. ITC requested a rehearing in the Court of
Appeals, which request was denied. ITC has decided not to pursue an appeal to
the United States Supreme Court. In another action with Ericsson GE Mobile
Communications, Inc., its Swedish parent, Telefonaktieboleget LM Ericsson and
Ericsson Radio Systems, Inc. the Court has stayed the proceeding at the mutual
request of the parties until December 15, 1997. ITC is also involved in
administrative proceedings in which various parties have challenged the validity
of ITC's patents or patent applications, variously on either a pre- or
post-issuance basis.
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.
4. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
The Company considers investments purchased with an remaining 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,
1996 1997
----------- -------------
Money market funds and demand deposits $ 2,871 $ 3,466
Certificates of deposit 204 --
Repurchase agreements 1,457 1,726
Commercial paper 7,422 --
------- -------
$11,954 $ 5,193
======= =======
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, 1996 consisted
of $26.0 million in government-issued discount notes, $2.8 million in municipal
securities and $14.2 million in corporate debt securities. Short-term
investments available for sale as of September 30, 1997 consisted of $7.8
million in
7
government-issued discount notes, $2.4 million in municipal securities and $6.6
million in corporate debt securities.
5. MAJOR CUSTOMERS AND GEOGRAPHIC DATA:
Product Revenue:
In fiscal 1996, the Company's Philippine and Indonesian customers
represented 56% and 16%, of Product Revenues, respectively. For the three months
ended September 30, 1996, the Company's Philippine customer accounted for 77% of
Product Revenues. Starting in the quarter ended September 30, 1997, the Company
began shipping prototype units of the TrueLink (B-CDMA) product to its European
alliance partner. These shipments, which approximated $600,000, are recorded in
Product Revenues as the alliance partner is purchasing these units on a cost
plus profit basis. For the three months ended September 30, 1997, the Company's
Indonesian customer and its European alliance partner accounted for 43% and 31%,
respectively, of Product Revenues. For the nine months ended September 30, 1996,
the Company's Philippine and Puerto Rican customers accounted for 66% and 10%,
respectively, of Product Revenues. For the nine months ended September 30, 1997,
the Company's Indonesian customer accounted for 78% of Product Revenues.
Product Revenues by geographic area are as follows (in thousands):
Three Months Nine Months
Ended Ended
September 30, September 30,
1996 1997 1996 1997
---- ---- ---- ----
Domestic $ 581 $ 377 $ 1,521 $ 951
Foreign 6,941 1,556 12,835 41,200
-------- --------- --------- ---------
$ 7,522 $ 1,933 $ 14,356 $ 42,151
======== ========= ========= =========
Licensing and Alliance Revenue:
During the three months ended September 30, 1996, ITC recognized $754,000
related to agreements with Samsung Electronics Co., LTD. ("Samsung"), $800,000
related to agreements with Siemens Aktiengesellschaft ("Siemens") and $314,000
of royalty revenue from one licensee under ITC's TDMA related patents. The
Licensing and Alliance Revenues for the three months ended September 30, 1997
include $704,000 from Samsung and $523,000 of royalty revenue from one licensee
under ITC's TDMA related patents. During the nine months ended September 30,
1996, the Company recognized $22.3 million of revenue related to its agreements
with Samsung and $4.0 million from Siemens. During the nine months ended
September 30, 1997, Licensing and Alliance Revenues include $2.1 million from
Samsung, $1.6 million from Siemens and $1.5 million of royalty revenue from one
licensee under its TDMA related patents.
6. 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 not been considered as common
stock equivalents in the computation for the three and nine month periods for
1996 and 1997 since their effect is anti-dilutive.
Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share," which supersedes APB Opinion No. 15 "Earnings per Share", was issued in
February 1997. SFAS 128 requires dual presentation of basic and diluted earnings
per share (EPS) for complex capital structures on the face of the income
statement. Basic EPS is computed by dividing income by the weighted average
number of
8
common shares outstanding for the period. Diluted EPS reflects the potential
dilution from the exercise or conversion of stock options and other securities
into common stock. SFAS 128 is required to be adopted for year end 1997; earlier
application is not permitted. The Company does not expect any material change to
the current period presentation of EPS; there was no effect of this accounting
change on previously reported EPS for the three and nine months ended September
30, 1996.
7. INVENTORIES:
December 31, September 30,
1996 1997
----------- ------------
(In thousands)
Component parts and work-in-progress $ 11,640 $ 9,726
Finished goods 2,223 1,324
--------- -----------
$ 13,863 $ 11,050
========= ===========
Inventories are stated net of valuation reserves of $5.9 million and $6.5
million as of December 31, 1996 and September 30, 1997, respectively.
8. 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 provision for the three months ended September 30, 1996
consisted of a current state tax provision of $14,000. For the three months
ended September 30, 1997 there was no income tax provision. For the nine months
ended September 30, 1996, the income tax provision consisted of a 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, 1997 consisted of a
current state provision of $34,000. At December 31, 1996, the Company had net
operating loss carryforwards of approximately $100 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,
1997.
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, 1997. 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.
9
9. MYANMAR CONTRACT:
On May 16, 1997, the Company signed a contract with Myanma Posts and
Telecommunications (MPT) in the Union of Myanmar, for UltraPhone systems, B-CDMA
equipment and related telecommunications equipment. The value in the agreement
is $250 million, including UltraPhone systems, B-CDMA equipment, infrastructure
equipment and services, as well as capital costs for a manufacturing facility to
be built in Myanmar. The agreement calls for establishment of a joint venture in
Myanmar between InterDigital and MPT for local manufacture of UltraPhone systems
and other infrastructure equipment. In addition, the agreement provides an
option for the joint venture to manufacture InterDigital's B-CDMA technology
products. Implementation of the ministerial details of the agreement is subject
to certain Myanmar governmental approvals as well as finalization of the
financing documents.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FINANCIAL POSITION, LIQUIDITY AND CAPITAL REQUIREMENTS
Overview
The following discussion should be read in conjunction with the
Consolidated Financial Statements and notes thereto, contained elsewhere in this
document.
The Company's ability to derive revenue from product sales will be affected
by, among other things, the intensified competition for sales of wireless local
loop telephone systems and economic conditions in the Company's principal
markets. Competing products and technologies have proliferated and competitors,
many of which have significantly greater resources than the Company, are more
actively promoting their products in the Company's target markets. In spite of
this competitive environment, the Company increased UltraPhone system revenues
in 1996 compared to 1995 by over 50% to nearly $25 million and built 1996
year-end product backlog to $80.7 million including $43 million subsequently
removed from backlog for the Pakistan contract (See "Backlog"), from $20.0
million at December 31, 1995. These successes were achieved by lowering
UltraPhone system prices, offering the UltraPhone system in conjunction with
alliance partners, focusing on larger scale telecommunications infrastructure
programs and successfully marketing to the Company's existing customer base in
Indonesia. On large scale opportunities when commencement of product delivery
significantly lags contract negotiation and where deliveries are expected to
extend over a significant period of time, the Company is actively marketing the
UltraPhone system at sales prices which would generate little, if any, margin
based on the current cost characteristics of the system configurations being
proposed. In these 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 production costs prior to
delivery of the order, the expected positive effects on vendor pricing of
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.
The Company anticipates that, in order to maintain or increase its
UltraPhone order rate, 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 by amounts significantly greater than the selling price
reductions. The Company has experienced and may continue to experience
engineering delays in the introduction of new, more efficient, lower cost system
components and other new enhancements or features. 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, or that the Company
may not, in the future, choose to reallocate resources, in whole or in part to
other corporate uses.
The Company does not currently have a material backlog of product orders.
(See "Backlog".) Accordingly, the Company cannot predict with certainty when it
will begin shipping any significant orders, and the volume of production and
shipments prior to that time may not fully absorb fixed manufacturing costs,
which would negatively affect gross margins. Additionally, the Company signed a
contract with MPT which includes, in part, product orders, which are currently
not included in backlog. The contract amount includes UltraPhone systems, B-CDMA
equipment, infrastructure equipment and services, as well as capital costs for a
manufacturing facility to be built in Myanmar. Implementation of the ministerial
details of the agreement is subject to certain Myanmar governmental approvals as
well as finalization of the financing documents, and orders under the contract
will not be subject to production until such time as these events have taken
place. The Company currently believes that these events will take place during
the fourth quarter of 1997 or the first quarter of 1998.
11
In addition to the effects of varying selling prices and product material
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.
Liquidity
The Company had working capital of $31.8 million at September 30, 1997
compared to working capital of $57.1 million at December 31, 1996. The decrease
in working capital since December is due primarily to the operating cash needs
of the Company.
Demands on working capital in 1997 and beyond are expected to increase. The
Company expects to continue its B-CDMA technology development expenditures at
significant levels in order to commercialize its technology. Field trials have
been scheduled domestically and abroad. Additional expenditures are being
incurred for marketing and other activities and subsequent, substantial
additional expenditures will be required to support later stage development. The
Company presently intends that later stage development will result in a product
with limited mobility and, in the next stage, a technology enabling full
mobility. However, the Company has not yet committed resources or entered into
contractual commitments to develop mobility-based products. Engineering efforts
required to support the UltraPhone product have recently been expended at
significant levels as the Company continues its efforts to reduce the cost of
the UltraPhone product and increase its market share; future scopes of effort
will be based upon market conditions and the economic attractiveness of
competing usages of Company resources. Marketing, administrative and other costs
are expected to increase as well, as the Company seeks to more effectively
support its alliance and licensing program.
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-related 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. Also, the Company has ordered, and may continue to
order, inventory in support of anticipated shipments not currently supported by
shippable backlog (see "Backlog"). Should the Company incur a significant delay
in securing the applicable shippable backlog it would have a negative impact on
its cash resources.
Accordingly, absent significant increases in cash generated by operations,
the Company will, at some future date, require additional debt or equity
capitalization to fully support its technical and product development and
marketing activities and to fund its patent-related activities. The Company does
not presently maintain bank lines of credit. Further, there can be no assurance
that the Company will be able to sell additional debt or equity securities when
it needs to, or, if it can, that it will be able to do so on terms acceptable to
the Company.
The Company believes that its investment in inventories and non-current
assets are stated on its December 31, 1996 and September 30, 1997 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 use or technological obsolescence. With respect to
other assets, the Company believes that the value of its
12
patents is at least equal to the value included in the December 31, 1996 and
September 30, 1997 balance sheets.
Backlog
At September 30, 1997, the Company's backlog of orders for UltraPhone
telephone equipment and services was $888,000. All of the backlog is scheduled
to be delivered during the remainder of fiscal year 1997. Previously, the
Company included in backlog a $43 million order from Pakistan Telecommunications
Company Limited ("PTCL"). PTCL allowed the contract to lapse on July 17, 1997,
when it did not accept InterDigital's proposal to finance the order. The Company
continues to work through the issues associated with the contract but the
Company cannot say with any degree of certainty whether it will be able to
reestablish the agreement.
Additionally, the Company signed a contract with MPT for $250 million which
is currently not included in backlog. The contract amount includes UltraPhone
and B-CDMA systems, infrastructure equipment and services, as well as capital
costs for a manufacturing facility to be built in Myanmar. Implementation of the
ministerial details of the contract is subject to certain Myanmar governmental
approvals as well as finalization of the financing documents. In any event,
shipments during the remainder of 1997 may not occur and, if they do, will not
be significant due to lengthy materials procurement lead times.
At September 30, 1996, the Company's backlog of orders for UltraPhone
telephone equipment and services was $49.2 million which included an order from
the Company's Indonesian customer of $36.8 million and the balance of another
order from the Company's Philippine customer of $8.3 million. The backlog as of
September 30, 1996 has been restated to remove the Pakistan order.
Cash Flows and Financial Condition
The Company has experienced negative cash flows from operations of
approximately $29.2 million during the nine months ended September 30, 1997. The
negative cash flows from operations are primarily due to expenses incurred for
UltraPhone product engineering and marketing, B-CDMA technology development and
the Company's general and administrative activities.
Net cash flows from investing activities were positive for the nine months
ended September 30, 1997 due to the conversion of some of the Company's
short-term investments into cash or cash equivalents. Notwithstanding the above,
the amount of cash used in investing activities has, historically, been low
relative to cash used in operations.
During the nine months ended September 30, 1997, the Company experienced
negative cash flows of $544,000 from financing activities. The funds were used
for payments on long-term debt (including capital lease obligations) but were
partially offset by proceeds from the exercise of stock options and warrants and
the sale of stock through the Company's Employee Stock Purchase Plan.
Cash, cash equivalents and short-term investments of $22.0 million as of
September 30, 1997 includes $311,000 of restricted cash. The product accounts
receivable of $6.7 million at September 30, 1997 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, 1997, $1.3 million has been collected through October 24, 1997.
Inventory levels at September 30, 1997 of $11.0 million have decreased as
compared to $13.9 million as of December 31, 1996, reflecting the shipment of
inventory for the Indonesian order. Inventories at December 31, 1996 and
September 30, 1997 are stated net of valuation reserves of $5.9 million and $6.5
million, respectively.
Included in other accrued expenses at September 30, 1997 are professional
fees, consulting and other accruals as well as sales taxes payable.
13
Results of Operations - Third Quarter of 1997 Compared to the Third Quarter of
1996
Total Revenues. Total revenues in the third quarter ended September 30, 1997
decreased 66% to $3.2 million from $9.4 million in the third quarter ended
September 30, 1996. Product sales decreased in the third quarter of 1997 to $1.9
million from $7.5 million in the comparable quarter of 1996. During the third
quarter of 1997, the Company included in Product Revenue approximately $600,000
related to sales of prototype TrueLink product to its European alliance partner.
During the third quarter of 1997, the Company recognized $704,000 of
Samsung revenue that related to the B-CDMA technology development portion of the
agreement. The Company also recognized $523,000 of royalty revenue during the
third quarter of 1997 from one of its licensees. During the third quarter of
1996, the Company recognized $754,000 as part of the Samsung agreements,
$800,000 as part of the Siemens agreements and $314,000 of royalty revenue from
one of its licensees.
Cost of Product Revenues. The cost of Product Revenues for the third quarter of
1997 decreased to $2.2 million from $8.8 million for the third quarter of 1996,
primarily due to the decrease in Product Revenues. The Company had approximately
13% negative gross margin on product sales for the quarter ended September 30,
1997 as compared to a negative gross margin of 16% for the quarter ended
September 30, 1996. The Company has been successful in reducing the cost of the
UltraPhone product and has gained efficiencies in the manufacturing process. The
Company did not achieve Product Revenues sufficient to fully absorb
manufacturing overhead costs at standard, acceptable absorption rates. Included
in cost of Product Revenues 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 any manufacturing overhead
expenses the Company has incurred that are not absorbed into inventory based on
the low volume of production during the quarter.
Other Operating Expenses. Other operating expenses include sales and marketing
expenses, general and administrative expenses and product development expenses.
Sales and marketing expenses increased 12% to $1.4 million during the third
quarter of 1997 as compared to $1.2 million during the third quarter of 1996.
The increase is primarily due to an increase in activity levels including costs
associated with increasing activity related to the Company's B-CDMA based
product but was partially offset by decreased commission expense due to the
decrease in UltraPhone Product Revenues in the three month period of 1997.
General and administrative expenses for the third quarter of 1997 increased
9% to $2.9 million from $2.6 million for the third quarter of 1996. The increase
is primarily due to an increase in patent amortization expense related to the
buyout of the minority interest of InterDigital Patents Corporation ("Patents
Corp,") in September 1996 and an increase in corporate communications
activities.
Product development expenses for the third quarter of 1997 decreased 7% to
$5.5 million as compared to $5.9 million during the third quarter of 1996.
Included in the 1996 period is non recurring engineering charges of $875,000
related to UltraPhone product engineering partially offset by increased activity
levels.
Other Income and Expense. Interest income for the third quarter of 1997 was
$745,000 as compared to $892,000 for the third quarter of 1996. The Company had
lower average invested cash balances in the 1997 period as compared to the 1996
period. Interest expense for the quarter ended September 30, 1997 was $81,000 as
compared to $55,000 for the quarter ended September 30, 1996. The increase is
due primarily to the mortgage interest related to the Company's purchase of its
King of Prussia facilities in the third quarter of 1996.
14
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 no charge in minority interest in the third
quarter of 1996. During September 1996, the Company reacquired the minority
interest of Patents Corp. in exchange for shares of the Company's Common Stock
and will therefore no longer record a change in the Minority Interest liability.
Results of Operations - Nine Months Ended September 30, 1997 Compared to Nine
Months Ended September 30, 1996
Total Revenues. Total revenues for the nine months ended September 30, 1997
increased 16% to $47.3 million from $40.9 million for the nine months ended
September 30, 1996 primarily due to an increase in the amount of Product
Revenues partially offset by a decrease in Licensing and Alliance Revenues.
Product Revenues increased 194% during the nine months ended September 30, 1997
to $42.2 million from $14.4 million in the comparable period of 1996 primarily
due to the completion of shipments of the Indonesian order. Also included in
Product Revenues for the nine months ended September 30, 1997 is approximately
$600,000 related to sales of prototype TrueLink product to its European alliance
partner. License and Alliance Revenues for the nine months ended September 30,
1997 includes $2.1 million as part of the Samsung Agreements, $1.6 million as
part of the Siemens Agreements and $1.5 million of royalty revenue from one
licensee. Licensing and Alliance Revenues for the nine months ended September
30, 1996 includes $22.3 million as part of the Samsung agreements and $4.3
million as part of the Siemens agreements.
Cost of Product Revenues. The cost of Product Revenues for the nine months ended
September 30, 1997 increased 128% to $37.9 million from $16.7 million for the
nine months ended September 30, 1996. The Company incurred a positive gross
margin on Product Revenues of 10% for the nine months ended September 30, 1997
as compared to a negative gross margin of 16% for the nine month period ended
September 30, 1996. Included in cost of Product Revenues 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 half of 1996 and the third quarter of 1997, the
Company incurs substantial negative gross profit margins because production
costs are spread over only a limited number of units of production.
Other Operating Expenses. Other operating expenses include sales and marketing
expenses, general and administrative expenses and product development expenses.
Sales and marketing expenses increased 77% to $5.6 million during the nine
months ended September 30, 1997 compared from $3.1 million during the nine
months ended September 30, 1996. The increase is primarily due to increased
commissions expense, commensurate with the increase in Product Revenues and
increased levels of marketing and sales activities, including activities related
to the marketing of the Company's TrueLink product.
General and administrative expenses for the nine months ended September 30,
1997 increased 18% to $9.5 million from $8.0 million for the nine months ended
September 30, 1996. The increase in general and administrative expense is due
primarily to increased patent amortization expense related to the buyout of the
minority interest of Patents Corp. in September 1996 and higher corporate
communications activity levels.
Product development expenses increased 21% for the nine months ended
September 30, 1997 to $18.2 million from $15.1 million for the nine months ended
September 30, 1996. 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 continued development of the Company's UltraPhone product.
15
Other Income and Expense. Interest income for the nine months ended September
30, 1997 was $1.8 million as compared to $3.0 million for the nine months ended
September 30, 1996. The decrease is due primarily to lower average invested cash
and investment balances in 1997 compared to 1996. Interest expense for the nine
month period ended September 30, 1997 was $309,000 as compared to $132,000 for
the nine month period ended September 30, 1996. 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 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 September 1996, the Company reacquired the minority interest of
Patents Corp. in exchange for shares of the Company's Common Stock and will
therefore no longer record a change in the Minority Interest liability.
STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The foregoing Management's Discussion and Analysis and discussions of the
Company's business contain forward looking statements reflecting, among other
things, the Company's current beliefs, intentions and expectations as to its
objectives, including with respect to the development and commercialization of
its B-CDMA technology, objectives and potential for the Company's product
business, contract with MPT, contract with PTCL and backlog. Such statements are
subject to risks and uncertainties. The Company cautions the readers that
important factors in some case have affected and, in the future, could
materially affect the Company's actual results and cause the Company's actual
results to differ materially from the results expressed in any such forward
looking statement. These factors include but are not limited to: technical,
financial or other difficulties or delays in the development, production,
re-engineering, testing and marketing or sale of the Company's products; failure
to secure additional working capital; failure to fully and successfully
implement the alliance program; failure of alliance partners to meet the
Company's expectations; failure of other persons with a business relationship
with the Company to secure adequate financing, required frequencies or other
things necessary to fulfill their obligations to the Company; failure to perform
the Myanmar contract due to inability to secure acceptable financing, lack of
governmental or regulatory approval confirming implementation, U.S. sanctions or
other governmental prohibitions, failure of MPT to fulfill its obligations to
the Company, lack of continuous flow of financing, or other factors; unstable
foreign governments and legal systems and inter-governmental disputes; the
failure to reestablish negotiations or renegotiate a mutually acceptable
contract with PTCL; the effects of, and changes in, foreign trade, monetary and
fiscal policies, laws and regulations or other activities of foreign and the
United States governments, agencies and similar organizations; the difficulty or
inability to enforce contractual commitments abroad; demand for and pressures on
margin on the Company's products; and the availability of competitive products
superior on a perceived, relative or actual basis with the Company's products.
The Company undertakes no obligation to publicly update any forward looking
statements, whether as a result of new information, future events or otherwise.
16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As reported in the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1997, in July, 1997, the U.S. Court of Appeals for the Federal
Circuit partially overturned a U.S. District Court decision in the patent
infringement case between ITC and Motorola, Inc. by reinstating two claims that
had previously been held invalid. The Court of Appeals also affirmed the
validity of three other claims, affirmed the invalidity of nineteen claims, and
denied ITC's request for a new trial as to validity and infringement issues. ITC
requested a rehearing in the Court of Appeals, which request was denied. ITC has
decided not to pursue an appeal to the United States Supreme Court.
17
Item 6. Exhibits and Reports on Form 8-K.
(a) The following is a list of exhibits filed as part of this Form 10-Q:
Exhibit 10.33 Employment Agreement dated June, 1997 by and
between InterDigital Communications Corporation and
Joseph Gifford
Exhibit 10.34 1997 Stock Option Plan for Non-Employee Directors
Exhibit 27 Financial Data Schedule
(b) The following is a list of Current Reports on Form 8-K filed during
the third quarter of 1997:
None.
18
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 13, 1997 /s/ William A. Doyle, President
-----------------------------------------
William A. Doyle, President
Date: November 13, 1997 /s/ Keith R. Ruck
-----------------------------------------
Keith R. Ruck, Chief Accounting Officer
19