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 June 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 _________
_______________________________
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 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 46,437,793
- -------------------------------------- -------------------------------
Class Outstanding at August 8, 1996
<PAGE>
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
PAGES
-----
Part I - Financial Information:
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - 3-4
December 31, 1995 and June 30, 1996 (unaudited)
Consolidated Statements of Operations 5
Three and Six Months Ended June 30, 1995 and 1996
(unaudited)
Consolidated Statements of Cash Flows - 6
Six Months Ended June 30, 1995 and 1996 (unaudited)
Notes to Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13-23
Part II - Other Information:
Item 1. Legal Proceedings 24-25
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 27
<PAGE>
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
ASSETS 1995 1996
----------- -----------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents, including restricted
cash of $1,200 and $1,002 respectively $ 9,427 $ 20,306
Short term investments 55,060 62,322
License fees receivable 400 702
Accounts receivable, net of allowance for
uncollectable accounts of $340 and $432, respectively 2,757 5,397
Inventories 4,853 4,751
Other current assets 1,474 5,670
--------- ---------
Total current assets 73,971 99,148
--------- ---------
PROPERTY AND EQUIPMENT:
Land, Buildings and Improvements -- 4,031
Machinery and equipment 4,033 4,732
Computer equipment 3,734 4,464
Furniture and fixtures 1,540 1,743
Leasehold improvements 1,114 659
--------- ---------
10,421 15,629
Less-accumulated depreciation and amortization (5,969) (6,654)
--------- ---------
Net property and equipment 4,452 8,975
--------- ---------
OTHER ASSETS:
Patents, net of accumulated amortization of
$3,456 and $3,714 respectively 2,405 2,395
Other 2,339 5,032
--------- ---------
Total other assets 4,744 7,427
--------- ---------
$ 83,167 $ 115,550
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1995 1996
------------ -----------
(UNAUDITED)
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long term debt $ 430 $ 484
Accounts payable 4,313 6,681
Accrued compensation and related expenses 4,335 4,034
Purchase commitment reserve 855 505
Deferred revenue 1,597 9,198
Income and foreign withholding taxes payable 653 614
Other accrued expenses 2,780 2,920
--------- ---------
Total current liabilities 14,963 24,436
--------- ---------
LONG TERM DEBT 631 3,142
--------- ---------
OTHER LONG TERM LIABILITIES 1,323 758
--------- ---------
MINORITY INTEREST 3,810 4,732
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 3)
SHAREHOLDERS' EQUITY:
Preferred Stock, $.10 par value, 14,399 shares authorized-
$2.50 Convertible Preferred, 113 shares and 105 shares
issued and outstanding 11 11
Common Stock, $.01 par value, 75,000 shares authorized,
44,424 shares and 46,346 shares issued and
outstanding 444 463
Additional paid-in capital 212,310 220,932
Accumulated deficit (150,325) (145,750)
--------- ---------
Total shareholders' equity 62,440 75,656
--------- ---------
$ 83,167 $ 115,550
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- --------------------
1995 1996 1995 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES:
UltraPhone $ 6,145 $ 5,007 $ 11,456 $ 6,834
Licensing and Alliance 30,974 9,107 62,093 24,707
Contract Services 141 -- 445 --
-------- -------- -------- --------
37,260 14,114 73,994 31,541
-------- -------- -------- --------
OPERATING EXPENSES:
Cost of UltraPhone revenues 5,884 5,020 11,729 7,897
Contract service costs 259 -- 512 --
Sales and marketing 975 1,143 2,068 1,916
General and administrative 4,154 2,283 8,569 5,453
Research and development 2,028 4,835 3,854 9,166
-------- -------- -------- --------
13,300 13,281 26,732 24,432
-------- -------- -------- --------
Income from operations 23,960 833 47,262 7,109
OTHER INCOME (EXPENSE):
Interest income 821 956 1,224 2,071
Interest and financing expenses (443) (44) (610) (77)
-------- -------- -------- --------
Income before income taxes and minority interest 24,338 1,745 47,877 9,103
INCOME TAX PROVISION (1,831) (998) (3,307) (3,505)
-------- -------- -------- --------
Income before minority interest 22,507 747 44,570 5,598
MINORITY INTEREST (1,918) (4) (3,777) (891)
-------- -------- -------- --------
Net income 20,589 743 40,793 4,707
PREFERRED STOCK DIVIDENDS (68) (66) (134) (132)
-------- -------- -------- --------
NET INCOME APPLICABLE TO COMMON SHAREHOLDERS $ 20,521 $ 677 $ 40,659 $ 4,575
======== ======== ======== ========
NET INCOME PER COMMON SHARE $ 0.45 $ 0.01 $ 0.88 $ 0.10
======== ======== ======== ========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 45,475 48,572 46,195 47,931
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
For the six months ended June 30,
---------------------------------
1995 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 40,793 $ 4,707
Adjustments to reconcile net income to net
cash provided by operating activities-
Minority interest in subsidiary 3,818 891
Depreciation and amortization 836 898
Other 37 (80)
Decrease (increase) in assets-
Receivables 14,925 (2,942)
Inventories 1,128 102
Other current assets (481) (4,195)
Increase (decrease) in liabilities-
Accounts payable (6,030) 2,367
Accrued compensation 1,587 (301)
Deferred revenue 1,402 7,601
Other accrued expenses (7,991) (250)
Other long term liabilities -- 6,262
-------- --------
Net cash provided by operating activities $ 50,024 $ 15,060
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in short-term investments $(44,472) $ (7,262)
Additions to property and equipment, net of non-cash additions
of $100 and $2,866, respectively (669) (2,110)
Additions to patents (149) (248)
Other non-current assets (218) (2,881)
-------- --------
Net cash used for investing activities (45,508) (12,501)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sales of Common Stock
and exercises of stock options and warrants 12,076 8,621
Payments on long-term debt, including capital lease obligations (137) (301)
-------- --------
Net cash provided by financing activities 11,939 8,320
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 16,455 10,879
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,264 9,427
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 22,719 $ 20,306
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 16 $ 63
======== ========
Income taxes paid, excluding foreign withholding taxes $ 1,850 308
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE>
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 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") 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(R) 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. To date, the Company has formed two such broad business alliances,
with Siemens and 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 250 UltraPhone systems worldwide, with aggregate UltraPhone
telephone system revenues totaling over $140 million. UltraPhone product
revenues accounted for approximately 20% of the total revenues of the Company
during 1995 and approximately 21% of revenues for the six month period ended
June 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 the 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 August 8,
1996, the recognition of $28.7 million, $67.7 million and $24.7 million of
licensing and alliance revenue in fiscal 1994, 1995 and the six month period
ended June 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, 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.
7
<PAGE>
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 June 30, 1996 and the results of their operations for the three
and six month periods ended June 30, 1995 and 1996 and cash flows for the six
month periods ended June 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 six months ended June 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 including Motorola, 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 partners have challenged the validity of ITC's
patents. (See Part II, Item 1, Legal Proceedings.)
On November 7, 1994, a purported class action complaint was filed against
the Company and its former chief executive officer alleging certain violations
of the disclosure requirements of the federal securities laws. In July 1996, the
parties agreed to settle the litigation, subject to court approval, in
consideration of a future payment by the Company. Such payment will not be
material to the Company's financial position or results of operations.
(See Part II,
Item 1. Legal Proceedings.)
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.
8
<PAGE>
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, June 30,
1995 1996
---------- ---------
Money market funds and demand deposits $ 2,096 $12,671
Certificates of deposit 966 751
Repurchase agreements 3,955 1,897
Commercial paper 2,380 4,987
-------- -------
$ 9,427 $20,306
======== =======
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 June 30, 1996 consisted of $51.4 million in
government-issued discount notes and $10.9 million in corporate debt securities.
The aggregate cash, cash equivalents and short-term investments held by
Patents Corp. was $68.8 million as of June 30, 1996. Such funds can be made
available for uses related to UltraPhone activities, product development efforts
or other Company uses upon such funds being transferred to InterDigital pursuant
to contractual arrangements or in conjunction with a dividend declaration.
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 December 31, 1995 and March 31, 1996 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 December
1996, the expected date of completion of functional testing at the system
component level.
9
<PAGE>
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 to the alliance 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 quarter, 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
December 1998, 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 second
quarter of 1995, the Company's Russian and Indonesian customers accounted for
53% and 19% of UltraPhone product revenues, respectively. During the second
quarter of 1996, the Company's Philippine and Puerto Rican customers accounted
for 66% and 14%, respectively of UltraPhone product revenues. For the six months
ended June 30, 1995, the Company's Indonesian and Russian customers accounted
for 48% and 29% of UltraPhone product revenues, respectively. For the six months
ended June 30, 1996, the Company's Philippine, Puerto Rican and Myanmarian
customers accounted for 54%, 15% and 12%, respectively of UltraPhone product
revenues.
UltraPhone product revenues by geographic area are as follows (in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
1995 1996 1995 1996
---- ---- ---- ----
Domestic $ 608 $ 491 $ 1,365 $ 940
Foreign 5,537 4,516 10,091 5,894
--------- --------- ----------- ---------
$ 6,145 $ 5,007 $ 11,456 $ 6,834
========= ========= =========== =========
10
<PAGE>
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 six months ended June 30, 1996
include $21.5 million from Samsung and $3.2 million from Siemens. During the six
months ended June 30, 1995, ITC entered into royalty-bearing license agreements
with Pacific Communication Sciences, Sanyo, Mitsubishi and Hitachi, together
with its affiliate Kokusai, 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 $27.1
million, which was recognized as revenue during the six months ended June 30,
1995. An additional $8.0 million of revenue was recognized during the first half
of 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 computations for the three and six
month periods for 1995 and 1996 since their effect is dilutive. (See Item 6,
Exhibit 11 - Computation of Net Income Per Share.)
9. INVENTORIES:
December 31, June 30,
1995 1996
---- ----
(In thousands)
Component parts and work-in-progress $ 4,341 $ 4,244
Finished goods 512 507
--------- ---------
$ 4,853 $ 4,751
========= =========
Inventories are stated net of valuation reserves of $6.9 million as of
December 31, 1995 and June 30, 1996. In addition, inventory purchase commitment
reserves were $855,000 and $505,000 as of December 31, 1995 and June 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 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.
11
<PAGE>
11. 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 June 30, 1996 consists
of a current foreign withholding provision of $990,000, a current state tax
provision of $3,000 and a Federal Alternative Minimum Tax provision of $5,000.
The income tax provision for the three months ended June 30, 1995 consisted of a
current foreign withholding tax provision of $1.4 million, a current state and
local tax provision of $41,000 and a Federal Alternative Minimum Tax provision
of $420,000. The income tax provision or the six months ended June 30, 1996,
consists of a current foreign withholding tax provision of 3.3 million, a
current state tax provision of $114,000 and a Federal Alternative Minimum Tax
provision of $91,000. The income tax provision for the six months ended June 30,
1995, consisted of a current foreign withholding tax provision of $2.4 million,
a current state tax 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 June 30, 1996.
The net operating loss carryforwards as of December 31, 1995 are scheduled
to expire as follows:
2001 $ 2.5 million
2002 10.3 million
2003 18.2 million
2004 20.0 million
2005 11.9 million
thereafter 38.7 million
---------------
$101.6 million
===============
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 June 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.
12
<PAGE>
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. The Company expects such variability to continue during 1996 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 "Siemens Agreements". The Company continued its
implementation of the alliance program when it signed a series of agreements
with Samsung Electronics
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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, an indirect majority 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 August 8, 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
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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. While the Company
has appealed the decision and 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 $74.7 million at June 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 $21.5 million and receipt of $8.6 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 operating losses.
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Since the fourth quarter of 1994, the Company has generated cumulative operating
profits and substantially strengthened its cash position through its alliance
and licensing transactions. Proceeds from licensing transactions paid to ITC can
be made available for uses related to UltraPhone product marketing efforts,
product development efforts or other Company uses upon such funds being
transferred to InterDigital pursuant to contractual arrangements or in
conjunction with a dividend declaration.
Net proceeds of the Samsung agreements signed in February 1996, and which
became fully effective in May 1996, were approximately $29 million, all of which
were received by the Company by June 30, 1996.
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
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.
The Company relocated its Pennsylvania operations and support activities to
a new location within the King of Prussia, Pennsylvania area in December 1995
and purchased that facility in June 1996. The cost of the new facility was $3.73
million, which sum was partially financed through a $2.8 million institutional
mortgage loan.
In August 1996, the Company acquired a fifty (50) percent interest in an
office building located on Long Island, New York. The Company affected
the acquisition of the building through the creation of a New
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York Limited Liability Company, 60 Crossroads, L.L.C., in which the Company
holds a 50% interest. A local commercial real estate owner, developer and
building contractor holds the remaining ownership 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 has not, but may
in the future, finance some or all of its acquisition costs. The Company intends
to enter into a lease agreement with the limited liability company for the
building and adjoining property. The Company intends to use the building and
property as the principle site for its B-CMDA technology development and
commercialization efforts.
The Company believes that its investment in inventories and non-current
assets are stated on its December 31, 1995 and June 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 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 June 30, 1996 balance
sheets.
Backlog
At June 30, 1996, the Company's backlog of orders for UltraPhone telephone
equipment and services was $53.0 million, which includes the balance of one
order from the Company's Philippine customer of $13.1 million and another order
from its Indonesian customer for $36.8 million. Over $15 million of the backlog
is expected to be delivered during the second half of fiscal year 1996, with the
balance expected to be delivered during fiscal 1997. At June 30, 1995, the
Company's backlog of orders for UltraPhone telephone equipment and services was
$18.4 million.
Changes in Cash Flows and Financial Condition
The Company has experienced positive cash flows from operations during the
six months ended June 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 $21.5 million was recognized as revenue in
the six month period ended June 30, 1996. (See Note 6 of the "Notes to
Consolidated Financial Statements".)
Net cash flows from investing activities were negative for the six months
ended June 30, 1996 due primarily to the Company's purchase of its King of
Prussia facility, the arrangement of a $2.6 million performance bond for its
current Philippine order 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 six month period ended June 30, 1996, the Company generated $8.3
million from financing activities. The funds were primarily generated by the
exercise of stock options and warrants.
Cash, cash equivalents and short term investments of $82.6 million as of
June 30, 1996 includes $68.8 million held by Patents Corp. and $1.0 of
restricted cash. The UltraPhone accounts receivable of $5.4 million at June 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 June 30, 1996, $1.0 million has been
collected through August 8, 1996.
Inventory levels at June 30, 1996 of $4.8 million are relatively unchanged
as compared to $4.9 million as of December 31, 1995, reflecting the sale of
systems, principally to the Company's Puerto Rican and Philippine customer
offset by the build-up of inventory for the remaining Philippine shipments.
Inventories at December 31, 1995 and June 30, 1996 are both stated net of
valuation reserves of $6.9 million.
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Included in other accrued expenses at June 30, 1996 are professional fees,
consulting and other accruals and deferred rent relating to the corporate
headquarters and manufacturing facilities, as well as sales taxes payable.
Results of Operations - Second Quarter of 1996 Compared to the Second Quarter of
1995
Total Revenues. Total revenues in the second quarter ended June 30, 1996
decreased to $14.1 million from $37.3 million in the second quarter ended June
30, 1996 primarily due to the recognition of $31.0 of licensing revenue in the
1995 period as compared to only $9.1 million in the comparable quarter of 1996.
UltraPhone sales decreased 19% in the second quarter of 1996 to $5.0 million
from $6.1 million in the comparable quarter of 1995.
During the second quarter of 1996, the Company recognized $6.0 million of
Samsung revenue that related to the UltraPhone manufacturing license and
manufacturing technology transfer portion of the agreement. The Company also
recognized $1.5 million for Samsung related to the B-CDMA development portion of
the agreement. Additionally, the Company recognized revenue of $1.6 million as
part of the Siemens series of agreements. During the second 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. This agreement contains advance payment
obligations pursuant to which ITC received in excess of $20.0 million, which was
recognized as revenue during the second quarter of 1995. Additionally, the
Company recognized $4.0 million as part of the Siemens series of agreements
during the second quarter of 1995.
The Company had contract revenue of $141,000 related to its U.S. Federal
government and other services contracts for the second 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 second quarter of
1996 decreased 14.7% to $5.0 million from $5.9 million for the second quarter of
1995. The Company had approximately a zero gross margin on UltraPhone system
sales for the three months ended June 30, 1996 as compared to a positive gross
margin of 4.2% for the three month period ended June 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 $259,000 in the three
month period ended June 30, 1995. The Company completed the shutdown of the
facilities and the termination of employees related to 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 17% to $1.1 million during the
second quarter of 1996 as compared to $975,000 during the second quarter of
1995. The increase is primarily due to increased staff and activity levels, but
was partially offset by a decrease in commission expense due to the decrease in
UltraPhone product revenues in the three month period of 1996.
General and administrative expenses for the second quarter of 1996
decreased 45% to $2.3 million from $4.2 million for the second quarter of 1995.
Expenses related to the protection and exploitation of the Company's patents
decreased by approximately $1.7 million in the 1996 period compared to the 1995
period.
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Research and development expenses for the second quarter of 1996 increased
138% to $4.8 million as compared to $2.0 million during the second 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 second quarter of 1996 was
$956,000 as compared to $821,000 for the second quarter of 1995. The increase is
due primarily to greater average invested cash balances in 1996 compared to
1995. Interest expense for the three month period ended June 30, 1996 was
$43,000 as compared to $443,000 for the three month period ended June 30, 1995.
The decrease is due primarily to the settlement of the HNS obligation.
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 $4,000 as an
increase in minority interest in the second quarter of 1996 representing the
minority interest's portion of the net income of Patents Corp. for the second
quarter of 1996. During the comparable 1995 period, the Company recorded an
increase of $1.9 million in minority interest representing the minority
interest's portion of the net income of Patents Corp. for the second quarter of
1995.
Results of Operations - Six Months Ended June 30, 1996 Compared to Six Months
Ended June 30, 1995
Total Revenues. Total revenues for the six months ended June 30, 1996 decreased
57% to $31.5 million from $74.0 million for the six months ended June 30, 1995
primarily due to a decrease in the amount of License and Alliance revenues
recognized and a decrease in UltraPhone equipment revenues. License and Alliance
revenues for the six months ended June 30, 1996 includes $21.5 million as part
of the Samsung Agreements (see Note 6 of the Notes to Consolidated Financial
Statements) and $3.2 million as part of the Siemens Agreements (see Note 5 of
the Notes of 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 $62.1 million, which was
recognized as revenue during the first half of 1995. Additionally, the Company
recognized revenue of $8.0 million as part of the Siemens series of agreements
during the 1995 period. UltraPhone equipment sales decreased 40% during the six
months ended June 30, 1996 to $6.8 million from $11.5 million in the comparable
period of 1995.
During the six months ended June 30, 1995, the Company had $445,000 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 six
months ended June 30, 1996 decreased 33% to $7.9 million from $11.7 million for
the six months ended June 30, 1995. The Company incurred a negative gross margin
on UltraPhone equipment sales of 15.5% for the six months ended June 30, 1996 as
compared to a negative gross margin of 2.4% for the six month period ended June
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 half of 1996, the Company incurs substantial
negative gross profit margins because production costs are spread over only a
limited number of units of production.
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Contract Services Costs. Contract services costs were $512,000 in the six month
period ended June 30, 1995. There were no contract service costs incurred during
the six months ended June 30, 1996 as the Company has withdrawn from this line
of business and has completed its obligations on any remaining contracts.
Other Operating Expenses. Other operating expenses include sales and marketing
expenses, general and administrative expenses and research and development
expenses.
Sales and marketing expenses decreased 7% to $1.9 million during the six
months ended June 30, 1996 compared to $2.0 million during the six months ended
June 30, 1995. The decrease is primarily due to reduced commissions expense,
commensurate with the reduction in UltraPhone system revenues and was offset by
higher activity levels.
General and administrative expenses for the six months ended June 30, 1996
decreased 36% to $5.5 million from $8.6 million for the six months ended June
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 $3.8
million offset partially by higher activity levels. The 1995 period included
costs for the Motorola suit. (See Part II. Item 1, "Legal Proceedings".)
Research and development expenses increased 138% for the six months ended
June 30, 1996 to $9.2 million from $3.9 million for the six months ended June
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 six months ended June 30, 1996
was $2.1 million as compared to $1.2 million for the six months ended June 30,
1995. The increase is due primarily to greater average invested cash and
investment balances in 1996 compared to 1995. Interest expense for the six month
period ended June 30, 1996 was $76,000 as compared to $610,000 for the six month
period ended June 30, 1995. The decrease is due primarily to the settlement of
the HNS obligation during the second quarter of 1995. 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 $891,000 as an increase in minority interest
in the six months ended June 30, 1996 representing the minority interest's
portion of the net income of Patents Corp. for the six months ended June 30,
1996. During the comparable 1995 period, the Company recorded an increase of
$3.8 million in minority interest representing the minority interest's portion
of the net income of Patents Corp. for the six months ended June 30, 1995.
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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; the inability of the Company to keep pace with
technological developments and/or respond in a timely manner to changes
in customers' needs.
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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 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.
22
<PAGE>
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.
23
<PAGE>
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On November 7, 1994, a complaint was filed in the United States District
Court for the Eastern District of Pennsylvania (Civil Action No. 94-CV-6751)
against the Company and its former chief executive officer alleging certain
violations of the disclosure requirements of the federal securities laws and
seeking damages on behalf of shareholders who purchased the Company's stock
during the class period stated to be March 31, 1994 to August 5, 1994. The
alleged violations relate to the disclosure of three proposed financing
transactions. On July 15, 1996, the Company entered into a settlement agreement
(the "Class Settlement"), to avoid the expense, diversion of management
attention and the uncertainties of trial, under which the Company made no
admissions of wrongdoing. Under the Class Settlement, which is subject to court
approval, the Company has agreed to pay a specified maximum to eligible
plaintiff class members who submit claims; more than 50% of the settlement
amount will be paid by the Company's insurance carrier. The maximum net amount
payable by the Company will not materially adversely affect the Company's
financial position or results of operation.
In October 1993, Motorola, Inc. filed an action against ITC in the United
States District Court for the District of Delaware seeking the court's
declaration that Motorola's products do not infringe certain ITC patents and
that these patents are invalid and unenforceable. ITC filed an answer and
counterclaims seeking a jury's determination that in making, selling or using
and/or participating in the making, selling or using of digital wireless
telephone systems and/or related mobile stations, Motorola has infringed,
contributed to the infringement of and/or induced the infringement of certain
ITC patents. A trial was held in United States District Court for the District
of Delaware (Civil Action No. 94-73 (D. Del.)) on the issue of validity and
infringement of 24 patent claims involving four ITC patents, U.S. Patent Nos.
4,675,863; 4,817,089; 5,119,375 and 4,912,705. By stipulation of the parties,
the case was limited to certain TDMA products made, used and/or sold by
Motorola.
On March 29, 1995, the trial ended with the jury's verdict that ITC's
patent claims at issue in the case are not infringed by the Motorola products
involved in the case. On June 17, 1996, the U.S. District Court for the District
of Delaware affirmed that portion of the jury's verdict. The judge further
sustained the jury's determination of invalidity with respect 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. On June 17, 1996, Motorola filed an appeal from the ruling by the
U.S. District Court for the District of Delaware with the U.S. District Court of
Appeals for the Federal Circuit (Appeal No. 96-1408) and on June 21, 1996, the
Company filed its appeal (Appeal No. 96-1428). It is anticipated that the
parties will file their appeal briefs during the remainder of 1996 and that the
appeals will be argued and decided within approximately 12 to 18 months from
their dates of filing. The Company believes that there are substantial grounds
for reversal of the jury's verdict or the granting of a new trial.
In September 1993, ITC filed a patent infringement action against Ericsson
GE Mobile Communications, Inc. ("Ericsson GE"), its Swedish parent,
Telefonaktieboleget LM Ericsson ("LM Ericsson") and Ericsson Radio Systems, Inc.
("Ericsson Radio"), in the United States District Court for the Eastern District
of Virginia (Civil Action No. 93-1158-A (E.D.Va.)). The Ericsson action seeks a
jury's determination that in making, selling, or using, and/or in participating
in the making, selling or using of digital wireless telephone systems and/or
related mobile stations, Ericsson has infringed, contributed to the infringement
of and/or induced the infringement of eight patents from ITC's patent portfolio.
The Ericsson action also seeks preliminary and permanent injunctions against
Ericsson from further infringement and seeks damages, royalties, costs and
attorneys' fees. Ericsson Radio and Ericsson GE filed a motion to transfer ITC's
action to the United States District Court for the Northern District of Texas
which was granted by the Court. Ericsson GE filed an answer to the Virginia
action in which it denied the allegations of the complaint and asserted a
counterclaim seeking a declaratory judgment that the asserted patents are either
invalid or not infringed. On the same day that ITC filed the Ericsson action in
Virginia, two of the Ericsson Defendants, Ericsson Radio and Ericsson GE, filed
a lawsuit against the Company and ITC in the United States District Court for
the Northern District of Texas (Civil Action No. 3-93CV1809-H
24
<PAGE>
(N.D.Tx.)) (the "Texas action"). The Texas action, which involves the same
patents that are the subject of the Ericsson action, seeks the court's
declaration that Ericsson's products do not infringe ITC's patents, that ITC's
patents are invalid and that ITC's patents are unenforceable. The Texas action
also seeks judgment against the Company and ITC for tortious interference with
contractual and business relations, defamation and commercial disparagement, and
Lanham Act violations. The Company and ITC intend to vigorously defend the Texas
action. Both Ericsson actions have been consolidated in the United States
Federal District Court for the Northern District of Texas. ITC agreed to the
dismissal without prejudice of LM Ericsson. At the request and with the consent
of the parties, the District Judge has executed an order indefinitely extending
a stay of the proceedings until a ruling on the appeals by the U.S. District
Court of Appeals for the Federal Circuit in the Motorola action described above.
In connection with ITC's various patent infringement lawsuits, Patents
Corp. entered into several contingent fee arrangements, principally with outside
legal counsel. Those agreements provided that in the event of a successful
outcome in any of the various lawsuits, as defined in the agreements, Patents
Corp. would owe additional fees to its service providers. The agreements with
outside legal counsel have been terminated. Patents Corp. is currently
discussing with its service providers how much compensation may be due. No
provision has been made in the Company's financial statements for such
contingent fee arrangements.
ITC has filed patient applications in numerous foreign countries. Typical
of processes involved in the issuance of foreign patents, Philips, Alcatel and
Siemens each filed petitions in the German Patent Office seeking to revoke the
issuance of ITC's basic German TDMA system patent granted on June 28, 1990. On
October 19, 1993, after formal opposition proceedings, the German Patent Office
confirmed the validity of the ITC basic German system patent. An appeal has been
filed by Philips, Alcatel and Siemens and additional arguments have been made
based upon prior art not previously considered by the patent office. ITC is and
may from time to time be subject to additional challenges with respect to its
patents and patent applications in foreign countries. Although no assurance can
be given as to the eventual outcome of these patent challenges. ITC intends to
vigorously defend its patents. If any of these patents are revoked, ITC's
patent licensing opportunities in such relevant foreign countries could be
materially and adversely affected.
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.
25
<PAGE>
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Shareholders held on June 24, 1996, the
shareholders of the Company elected one director of the Company, approved an
amendment to the Company's 1995 Stock Option Plan for Employees and Outside
Directors (the "Plan") as described in the Company's Proxy Statement dated May
20, 1996 and ratified the appointment of Arthur Andersen LLP as the Company's
independent accountants for the year ending December 31, 1996. In the election
of Harry G. Campagna as a director, 43,435,506 shares were voted in favor of his
election and 810,951 shares were withheld. In approving the amendment to the
Plan, there were 14,034,850 shares voted in the favor of the amendment,
4,863,644 shares abstaining and 24,866,641 broker non-votes. There were no
broker non-votes with respect to any other matter voted upon at the meeting. The
vote ratifying the appointment of Arthur Andersen LLP was 43,627,147 shares in
favor, 352,545 against and 266,765 abstaining.
26
<PAGE>
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 11 - Computation of Net Income Per Share
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
No current reports on Form 8-K were filed for the quarter ended June
30, 1996.
27
<PAGE>
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: August 12, 1996 /s/ William A. Doyle
----------------------------------------
William A. Doyle, President and
Acting Chief Executive Officer
Date: August 12, 1996 /s/ James W. Garrison
----------------------------------------
James W. Garrison, Vice
President - Finance, Chief
Financial Officer and Treasurer
28
EXHIBIT 11
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
COMPUTATION OF NET INCOME (LOSS) PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
COMPUTATION OF PRIMARY ENDED ENDED ENDED ENDED
EARNINGS (LOSS) PER SHARE: JUNE 30, 1995 JUNE 30, 1996 JUNE 30, 1995 JUNE 30, 1996
- -------------------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net Income (Loss) Applicable to Common
Shareholders $20,521 $ 677 $40,659 $ 4,575
======= ======= ======= =======
Weighted Average of Primary Shares:
Common Stock 44,071 46,138 43,507 45,522
Assumed Conversion of Options and Warrants 1,404 2,434 2,688 2,409
------- ------- ------- -------
45,475 48,572 46,195 47,931
======= ======= ======= =======
Primary Earnings Per Share $ .45 $ .01 $ .88 .10
======= ======= ======= =======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1996
<CASH> 20,306
<SECURITIES> 62,322
<RECEIVABLES> 9,736
<ALLOWANCES> 432
<INVENTORY> 4,751
<CURRENT-ASSETS> 102,353
<PP&E> 15,629
<DEPRECIATION> 6,654
<TOTAL-ASSETS> 118,755
<CURRENT-LIABILITIES> 34,467
<BONDS> 3,142
0
11
<COMMON> 463
<OTHER-SE> 75,656
<TOTAL-LIABILITY-AND-EQUITY> 118,755
<SALES> 6,834
<TOTAL-REVENUES> 31,541
<CGS> 7,897
<TOTAL-COSTS> 7,897
<OTHER-EXPENSES> 9,166
<LOSS-PROVISION> 54
<INTEREST-EXPENSE> 77
<INCOME-PRETAX> 9,103
<INCOME-TAX> 3,505
<INCOME-CONTINUING> 4,707
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,707
<EPS-PRIMARY> .10
<EPS-DILUTED> .10
</TABLE>
