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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
--------------------------------------------------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
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 Number)
781 Third Avenue, King of Prussia, Pennsylvania 19406
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 610-878-7800
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $.01 Per Share
(Title of class)
Securities registered pursuant to Section 12(g) of the Act:
$2.50 Cumulative Convertible Preferred Stock,
Par Value $.10 Per Share
(Title of Class)
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
On March 5, 1999 the aggregate market value of the Registrant's Common
Stock, $.01 par value, held by non-affiliates of the Registrant was
approximately $235,328,233.
On March 5, there were 48,474,381 shares of the Registrant's Common Stock,
$.01 par value, outstanding.
Documents Incorporated by Reference
Portions of the Registrant's definitive proxy statement to be filed in
connection with the annual meeting of shareholders to be held in 1999 are
incorporated by reference into Items 10 through 12 hereof.
1
PART I
Item 1. BUSINESS
General. InterDigital Communications Corporation ("InterDigital"), a public
corporation incorporated in the Commonwealth of Pennsylvania, develops
technology for advanced digital wireless telecommunications applications. In
conjunction with its technology development, InterDigital has developed specific
products incorporating its proprietary technologies for market and sale.
InterDigital has also developed an extensive body of technical know-how and a
broad patent portfolio related to those technologies and related product
embodiments. InterDigital offers its customers, licensees and companies with
which it has strategic relationships what it believes is unique access to both
Time Division Multiple Access ("TDMA") and wide band Code Division Multiple
Access ("CDMA") proprietary and standards compliant digital wireless technology.
Since its inception, InterDigital has expended substantial sums to develop
its patented technologies, establish and continuously upgrade the patent
portfolio owned by InterDigital Technology Corporation ("ITC"), a wholly-owned
subsidiary, develop and commercialize products delivering the advantages
afforded by its technologies, and establish a market for those products.
InterDigital had an accumulated deficit of approximately $160 million as of
December 31, 1998.
Strategy. InterDigital's strategic objective is to grow as a leading-edge
provider of communications technology. InterDigital believes achieving that
position will enable it to deliver sustainable earnings growth through a
combination of revenues from strategic engineering relationships, product sales,
licensing and alliances.
B-CDMA Alliance (TM) Program. The Company's current B-CDMA Alliance program
relates to its proprietary Broadband Code Division Multiple Access(TM)
("B-CDMA(TM)") air interface technology, InterDigital's trademarked brand of
wide band CDMA technology. Under the B-CDMA Alliance program, InterDigital seeks
to establish strategic relationships with key companies in the
telecommunications industry, with the objectives to (i) spread the
commercialization of products based on its technologies, (ii) generate licensing
revenues through the product sales involving its licensed technologies and the
marketing activities of InterDigital's B-CDMA Alliance partners and licensees,
and (iii) continue its development of its B-CDMA technology for a possible range
of extended applications such as packet data and Internet access.
In December 1994, InterDigital initiated the B-CDMA Alliance program by
entering into an integrated series of agreements with Siemens Aktiengesellschaft
("Siemens") covering UltraPhone(R) system marketing and product development,
wide band CDMA technology development, TDMA and CDMA patent licensing and other
areas of cooperation. InterDigital entered into its second B-CDMA Alliance with
Samsung Electronics Co., Ltd ("Samsung") in February 1996. The Samsung
agreements cover B-CDMA technology development, TDMA and CDMA patent licensing,
product development, technology transfer and other areas of cooperation. In
March 1998, InterDigital entered into its third B-CDMA Alliance with Alcatel
Espana ("Alcatel") covering B-CDMA technology development, patent licensing,
product development and sales, technology transfer, standards support, and other
areas of cooperation.
In February 1999, Siemens withdrew from the current B-CDMA development
project. In connection therewith, Alcatel is re-evaluating its role in the
B-CDMA development project. (See "- B-CDMA Technology and Product Development -
B-CDMA Alliance Partners".)
Strategic Engineering Relationships. In January 1999, InterDigital
initiated its effort to create strategic engineering relationships when it
entered into an agreement with Nokia Corporation ("Nokia") providing for the
development of new technology for third generation wireless communications
products designed for high data rate applications, such as Internet access. The
agreement also includes royalty bearing TDMA and CDMA patent licenses, which are
paid up generally through the project period, and provide a structure for
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determining the royalty payments thereafter. InterDigital is positioning itself
through this arrangement to deliver significant value to companies seeking to
develop third generation ("3G") standard compliant technologies and product
embodiments. This new relationship supports InterDigital's strategic shift, from
a supplier of proprietary, finished systems to a provider of communications
technology to the industry as a whole.
Licensing. InterDigital has also sought to capture value from ITC's patent
portfolio based upon third party usage of the underlying inventions. In this
regard, ITC implemented a comprehensive patent licensing strategy which started
in 1993. ITC offers licenses to make, have made, use or sell products
incorporating its patented inventions. Together with InterDigital, ITC offers
non-exclusive, royalty bearing patent, technology and know-how, and trademark
licenses to telecommunications manufacturers that manufacture, use or sell, or
intend to manufacture, use or sell, equipment that utilizes InterDigital's
extensive portfolio of intellectual property. InterDigital licenses its
technologies both to companies with whom it has strategic relationships
(including alliance partners) and to other companies. These efforts have lead to
patent license agreements with a total of eighteen companies as of December 31,
1998. One licensee has been added in 1999, bringing the total to nineteen as of
March 30, 1999. (See, "Technology and Patent Licensing" and Item 3. "Legal
Proceedings".)
InterDigital's licensing and alliance programs have resulted in the
recognition of $92.5 million, $6.0 million and $28.7 million of licensing,
alliance and other strategic partner revenue in 1998, 1997 and 1996,
respectively.
Products. InterDigital markets and sells the UltraPhone product, which is a
fixed wireless local loop radio telephone system (based on InterDigital's TDMA
technology) providing businesses and households access to basic telephone
service through a wireless local loop. InterDigital markets the UltraPhone
product in selected markets around the world as an optimal solution to rural
telecommunications needs. However, in early 1998, InterDigital ceased
re-engineering and re-design efforts on this product. During 1998, InterDigital
had approximately $4.9 million of sales related to the UltraPhone product, as
compared to approximately $43.8 million in 1997.
InterDigital and its B-CDMA Alliance partners have also started to market
wireless local loop radio telephone systems based on InterDigital's B-CDMA
technology. Field trials of these systems are in progress. InterDigital's B-CDMA
product is known as the TrueLink(TM) product. InterDigital plans to sell
TrueLink components, including ASICs (Application Specific Integrated Circuits).
During 1998, InterDigital had approximately $1.9 million of sales related to
InterDigital's TrueLink(TM) product, including service revenues to Samsung and
ASICs and other components sold to Siemens for its integration into
pre-production products.
Risks. InterDigital's strategy is forward looking in nature and, as such,
is inherently subject to risks and uncertainties. The successful commercial
development and deployment of InterDigital's technologies and products based on
those technologies, engineering-based partnerships and projects, the development
of sustainable earnings growth, and the receipt of revenues are dependent upon
many factors, some of which are detailed elsewhere in this Form 10-K, such as
technological achievement, the continued validation of the theories upon which
the new technology is being designed, the world market for those technologies
and products, the effect of the Siemens withdrawal, Samsung's continued
participation in the B-CDMA Alliance and in B-CDMA product develeopment and
sales, the outcome of Alcatel's re-evaluation of its commitment to the B-CDMA
Alliance, the fulfillment of InterDigital's expectations by companies with whom
it has a strategic relationship, the continued validity of InterDigital's
patents, the continued availability of debt, equity, alliance partner or other
strategic relationship funding sufficient to support an increasing level of
efforts over several years and, ultimately, market acceptance of the resultant
products. Other factors which could cause actual results to differ materially
from those which InterDigital seeks to achieve are detailed elsewhere in this
"Business" section and in "Management's Discussion and Analysis of Financial
Position and Results of Operations - Overview and Statement Pursuant to the
Private Securities Litigation Reform Act of 1995".
3
B-CDMA Technology and Product Development
General. InterDigital, together with its B-CDMA Alliance partners, have
been developing products embodying InterDigital's B-CDMA technology,
InterDigital's particular embodiment of wide band CDMA air interface technology.
The initial phases of the development effort have been oriented towards
commercial deployment of wireless local loop products with performance and cost
characteristics applicable to a market segment distinct from InterDigital's
UltraPhone system. These applications include urban and suburban deployment in
both developed and developing countries of systems providing high quality voice,
high-speed data transfer and multi-media capabilities. InterDigital expects that
its B-CDMA technology could be developed for a possible range of extended
applications.
InterDigital has applied its proprietary B-CDMA technology in the
architecture of its TrueLink wireless local loop product. Unlike conventional
multiple access systems which utilize radio sharing techniques based on division
of available bandwith into narrow channels and/or time slots, B-CDMA technology
distributes multiple, simultaneous conversations and/or data transmissions
across a broad segment of radio spectrum. The TrueLink product is designed to
provide subscribers with the capability to access to the public switched
telephone network on demand for voice, data, facsimile, ISDN, and
video/multimedia services.
The TrueLink system implements a transparent wireless infrastructure which
offers telecommunications services in a point-to-multipoint network. It consists
of four major network elements: the radio carrier station ("RCS"), the remote
network terminal ("RNT"), the radio distribution unit ("RDU"), and the Access
Integrator ("AI"). The RCS, the functional base station, connects to the public
switched telephone network through either the RDU or the local telephone
company's central office via terrestrial links. The RCS transmits to the RNT,
which is located on the subscribers' premises and provides the subscriber line
interface to telephone equipment. The RCS transmission to the RNT replaces the
traditional wireline. Finally, the AI provides administrative and maintenance
functions for the system. The TrueLink system is particularly suited for urban
and suburban environments.
B-CDMA Alliance Partners. As of December 31, 1998, InterDigital's B-CDMA
Alliance partners included Siemens, Samsung, and Alcatel. In February 1999,
Siemens, as a result of a corporate realignment in its business, notified
InterDigital that Siemens was withdrawing from the current B-CDMA development
project. As part of the B-CMDA project, Siemens performed or was to perform a
variety of tasks, including without limitation the development of a radio,
system test and the manufacture of certain prototype and finished product.
InterDigital and Siemens are in the process of negotiating Siemens withdrawal
from the project. However, InterDigital can give no assurance that it will
receive the assistance it requires or that the withdrawal can be affected
without a material impact on InterDigital's resource requirements related to the
project or on the project as a whole. InterDigital did not have any revenues
relative to the Siemens agreement in 1998 and does not believe that Siemens
withdrawal, on its own, will materially affect InterDigital's 1999 revenues.
Since the Siemens announcement, Alcatel has begun to re-evaluate its
commitment to the B-CDMA development project. Alcatel's decision to continue or
not continue with the project may be affected by, among other factors, the
schedule for delivery of products and additional costs and resource allocation
stemming from the Siemens withdrawal. Alcatel's continuing commitment to the
project will likely result in a restructuring of the existing contractual
relationship, including provisions concerning resource allocation and milestone
related payments. There can be no assurance that Alcatel and InterDigital will
agree to continue the development effort or restructure the contract. If Alcatel
does not continue to participate in the current B-CDMA development effort on
terms acceptable to InterDigital, InterDigital may re-evaluate its resource
commitment to the development project. A withdrawal by Alcatel would not affect
currently projected 1999 revenues. However, this action would change
InterDigital's business prospects with regard to B-CDMA products, at least as
currently envisioned, and could negatively impact InterDigital's revenues beyond
1999, including revenues anticipated from licensing and product sales.
4
In addition, from time to time companies re-evaluate strategies relative to
their development projects. InterDigital believes that, as is customary in any
such re-evaluation process, various projects being undertaken by Samsung,
including Samsung's development and commercialization of B-CDMA products based
on B-CDMA technology, could be impacted in the future if such projects do not
show the potential for producing acceptable profits or suitable market growth.
Because Samsung is not currently making further contributions to the
InterDigital B-CDMA development project, any decision by Samsung to discontinue
its B-CDMA products would not require InterDigital to commit additional
resources to the current B-CDMA development project. In addition, a withdrawal
by Samsung would not affect currently projected 1999 revenues. However, as with
any B-CDMA Alliance partner withdrawal from the B-CDMA program, a withdrawal by
Samsung could negatively impact future revenues that InterDigital was
anticipating to derive (in the form of royalties) from the sales of B-CDMA
products by Samsung.
Competition. A number of companies, many of which are substantially larger
and have substantially greater financial, technical, marketing and other
resources than InterDigital, sell or may introduce products which will be
competitive with InterDigital's (and its B-CDMA Alliance partners') B-CDMA
products. In addition, in situations where a potential customer's needs for
local loop services favors deployment of wireless technologies, there are many
existing and announced terrestrial and satellite -based delivery systems that
may be considered. Other manufacturers offer competitive analog and digital
wireless local loop systems. Fixed analog and digital cellular systems are also
offered to provide service in the local loop. Competitive CDMA technologies are
currently being deployed as wireless local loop and cellular applications. At
least one company is offering add-on modules which are promoted as having the
capability of converting cellular systems into wireless local loop systems.
InterDigital believes that, if it and its alliance partners can enter the market
ahead of certain of its competitors, its competitive position will be enhanced.
While InterDigital believes that its development efforts are likely to give it
and its alliance partners this competitive advantage, there can be no assurance
that InterDigital will be able to accomplish its goal, either by maintaining its
commercialization schedule or otherwise. Some competitors may be further along
in their development efforts than InterDigital is fully aware. Finally, if
Alcatel withdraws from the current B-CDMA development project and, as a result,
InterDigital reduces its investment in that project, InterDigital's TrueLink
system would have difficulty competing in the marketplace since the current
development project involves re-engineering for cost-effectiveness. An inability
or perceived inability to compete on a price or other basis may result in a
decision by InterDigital to discontinue or limit this product line.
Even in that competitive environment, however, InterDigital believes that
its B-CDMA technology has several advantages as compared to other currently
available or developing digital wireless technologies in these applications:
o Robust Radio Signal. The B-CDMA radio signal is expected to have
extremely high immunity to interference and multipath fading because the
radio signal is spread over a larger bandwidth than that utilized by other
technologies. In addition, the advanced digital signal processing
techniques employed in InterDigital's B-CDMA technology implementation are
expected to allow a greater portion of a degraded signal to be recovered.
o Simplified Network Planning. InterDigital's B-CDMA technology allows
nearly all available radio frequencies to be utilized in each cell site.
This simplifies frequency planning and the process of cell site planning
and network expansion as compared to other digital wireless technologies.
o Bandwidth on Demand. InterDigital expects that its B-CDMA technology
will allow operators to offer services supported by bandwidth on demand to
their customers. This means that customers can, through a single air
interface, readily access a full range of services ranging from basic
telephony to ISDN.
o System Design Flexibility. The B-CDMA air interface technology has
been designed to allow product implementations capable of utilizing
virtually any currently available voice coding technology. (These
technologies utilize varying rates of data transfer, which affects service
quality and system capacity). This is expected to allow product developers
and operators the ability to balance the competing demands of system
capacity and service quality. InterDigital expects that systems utilizing
its B-CDMA technology will have higher capacity capabilities at comparable
service quality levels as compared to systems utilizing other technologies.
o Privacy. InterDigital believes that CDMA technologies (both broadband
and narrowband) allow more secure transmission than other wireless
technologies currently available, making intentional or accidental
eavesdropping extremely difficult with commercially available technology.
5
B-CDMA Technology, Business Strategy and Market. Although the wireless
local loop market has not generated the rapid growth predicted by market
analysts, InterDigital believes that this market continues to offer revenue
opportunities. InterDigital expects that B-CDMA products will be deployed in
urban and suburban settings, in commercial and residential applications, for
voice, data, facsimile, ISDN, and video/multimedia services, primarily through
one of its B-CDMA Alliance partners. InterDigital expects that the B-CDMA
product will compete with many of the products with which the UltraPhone product
has competed (see "- The UltraPhone System - Competition and Market") and
against other current and future products, some of which purport to offer many
of the advantages of InterDigital's B-CDMA technology. InterDigital believes
that demand will be highest in developing countries which are planning
significant infrastructure development and where significant numbers of persons
are not presently served or are served by antiquated systems, or in any areas in
developed or developing countries where the demographics do not justify
investments in cellular infrastructure. InterDigital also expects that there
will be demand for such products in developed countries where there is a growing
demand for advanced services, in particular high data rate transmission
capability. InterDigital intends to position itself as a provider of B-CDMA
components, primarily for its partners. InterDigital also intends to pursue
additional B-CDMA technology- based strategic relationships with the objectives
of incorporating B-CDMA ASIC's and other components into partners' systems, or
manufacturing TrueLink by those partners for distribution and sale by those
partners. There can be no assurance that InterDigital will be able to form any
such strategic relationships.
Backlog. InterDigital had no orders on backlog for the TrueLink product at
December 31, 1998. To the extent orders are received during 1999, back orders
are not expected to substantially affect the Company's 1999 operating results.
Production of Proprietary Products. InterDigital and Siemens had provided
contractually for the manufacture of InterDigital's TrueLink(TM) wireless local
loop product by Siemens. InterDigital does not have any other agreements in
place for the production of the TrueLink(TM) product. As a result of Siemens
withdrawal from the current B-CDMA development project, InterDigital does not
expect that Siemens will continue to manufacture for InterDigital beyond the
near term and, possibly, at all. Samsung is currently evaluating whether or not
it desires to become a manufacturer of B-CDMA products for InterDigital. There
can be no assurance that, in the future, InterDigital will be able to enter into
any agreements for the manufacture of TrueLink or OEM procurement contracts for
TrueLink, either at all or on terms acceptable to InterDigital. InterDigital has
entered into an agreement with Texas Instruments, Inc. to manufacture
InterDigital's new integrated chip based on InterDigital's B-CDMA technology.
InterDigital anticipates that, in the future, such chips may be marketed and
sold to differing markets by either Texas Instruments or by InterDigital.
Strategic Engineering Services and Product Development
Based upon the core competencies of its engineering group resulting from
its research and development work in the TDMA and wide band CDMA arenas dating
back to the 1980's time period, InterDigital believes that it is positioned to
deliver significant value to companies seeking to develop 3G compliant
technologies and product embodiments. In the first of such arrangements,
InterDigital and Nokia entered into a strategic technology development agreement
in January 1999 covering the development of new technology for 3G wireless
communications products designed for high data rate applications, such as
Internet access. The agreement provides that InterDigital is to deliver
technology building blocks for Nokia to use in 3G wireless products. The
agreement provides that Nokia will fund the project, maintain an active role in
the development plan and, when the development is complete, be able to use the
technology in 3G products. InterDigital is to own the developed technology and
will have the ability to license the technology to other companies, as well as
design, manufacture, sell and use products and components that utilize that
technology. The Company continues to approach other major telecommunication
companies with the objective of structuring strategic engineering services
relationships, particularly within the 3G market.
As of March 1, 1999, InterDigital employed approximately 135 people whose
primary responsibilities are B-CDMA and 3G technology development, and
additionally utilizes the efforts of outside engineering resources and
engineering contributions from companies with whom it has strategic
relationships. Further development of InterDigital's technologies may require
additional technical and administrative support, as well as additional marketing
resources and higher levels of sustained efforts for the next several years. In
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addition, if InterDigital were to restructure the current B-CDMA development
project in a manner that requires it to make additional commitments,
InterDigital could require significant additional engineering resources. The
recruitment of personnel with technical expertise in wireless communications
technology development is highly selective and competitive. In addition to
recruiting high quality engineers, InterDigital intends to attempt to satisfy
its increasing need for engineering resources through, among other things,
consulting services and further strategic relationships. The failure to attract
and retain highly qualified personnel could interfere with InterDigital's
technology and product development efforts.
InterDigital has expensed $17.2 million, $24.2 million and $21.6 million
during 1998, 1997 and 1996, respectively, related to all of its research and
development efforts for both TDMA and B-CDMA based product development.
Technology and Patent Licensing
General. InterDigital's patents, patent applications and rights to file
patent applications on certain future inventions are owned by ITC. ITC currently
holds approximately 123 United States and approximately 331 non-U.S. patents
relating specifically to digital wireless radiotelephony technology (TDMA and/or
CDMA) which expire at various times beginning in 2004 and ending in 2019. ITC
also has approximately 15 other patents, both in the United States and in
non-U.S. countries. ITC has also filed approximately 61 United States and
approximately 238 non-U.S. patent applications relating primarily and variously
to the CDMA and TDMA technologies. ITC's patents have effective terms of up to
20 years from the date of their first filing.
In high technology fields characterized by rapid change and engineering
distinctions, the validity and value of patents are often subject to complex
legal and factual challenges and other uncertainties. Accordingly, ITC's patent
claims are subject to uncertainties which are typical of patent enforcement
generally. If any third party successfully asserts that certain of
InterDigital's patent claims are not valid or do not cover their products,
InterDigital's licensing potential and revenues could be adversely affected. In
addition, in the normal course of business, third parties have asserted, and may
assert in the future, that InterDigital is engaged in the infringing use of a
third party's patents or proprietary technology. If any such third party
successfully asserts that InterDigital is engaged in any such infringing use,
InterDigital may be required to contest the validity of such patents or
proprietary technology, to acquire licenses to use the patented or proprietary
technology and/or to redesign InterDigital's products to avoid further
infringement. The cost of enforcing and protecting the patent portfolio or
defending InterDigital against infringement claims can be significant.
Patent Licensing Activities. ITC has undertaken a comprehensive licensing
program, the ultimate objective of which is the realization of licensing
revenues from third party use of inventions underlying its patent portfolio. ITC
generally seeks to license its patents on reasonable terms and conditions,
including reasonable royalty rates. ITC believes that making its patented
digital wireless technologies available to third parties will provide a
potentially significant source of revenue. In 1990, the initial digital cellular
telephone standard known as IS-54 employing TDMA technology was jointly adopted
by the Telecommunications Industry Association ("TIA") and Electronics Industry
Association ("EIA") as an interim standard. ITC believes that, in many
instances, licenses for certain of its patents are required in order for third
parties to manufacture and sell digital cellular products in compliance with the
TIA/EIA/IS- 54-B Cellular System Dual-Mode Mobile Station-Base Station
Compatibility Standard (the "IS-54-B Standard") and the 800 MHz Cellular System,
TDMA Radio Interface, Dual-Mode Mobile Station - Base Station Compatibility
Standard (the "IS-136 Standard"). In addition, InterDigital believes that in
many instances licenses under its patents are required in order for third
parties to manufacture and sell equipment in compliance with certain other
TDMA-based standards currently in use worldwide. Those standards include but are
not limited to the Global System for Mobile Communication, the Japanese Digital
Cellular Standard, Digital Enhanced Cordless Telephone and Personal Handyphone
System. Currently, numerous manufacturers supply digital cellular equipment
conforming to such standards.
At December 31, 1998, ITC had granted non-exclusive, non-transferable,
perpetual, worldwide, royalty-bearing licenses to use certain TDMA patents (and
in certain instances, technology) to Hughes Network
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Systems ("HNS"), American Telephone & Telegraph Company, Siemens,
Matsushita Electric Industrial Co. Ltd., Sanyo Electric Co., Ltd., Pacific
Communications Systems Inc., Mitsubishi Electric Corporation, Hitachi Ltd.,
Kokusai Electric Co., NEC Corporation, OKI Electric Industry Ltd. ("OKI"),
Samsung, Sharp Corporation, Kyocera Corporation, Denso Corporation and Toshiba
Corporation. The OKI agreement was the result of a settlement of litigation
filed by ITC in 1993. Certain licenses typically contain "most favored nations"
provisions, applied on a going forward basis only, and provisions which could,
in certain events, cause the licensee's obligation to pay royalties to
InterDigital to be suspended for an indefinite period, with or without the
accrual of the royalty obligation. Certain of InterDigital's licensees had, in
the past, stated, among other things, that the outcome of a prior litigation
over ITC's patents materially impacts the royalties due under their license
agreements. While InterDigital believes that these positions, to the diminishing
extent that they continue to be asserted, are meritless, the positions taken by
ITC's licensees may impact ITC's ability to secure new licenses or to generate
recurring licensing revenue under the existing agreements. ITC's licensing
opportunities are also affected by the increasing concentration of the industry,
particularly as to infrastructure, which results in a substantial portion of the
licensing opportunities being concentrated in a small number of non-licensed
manufacturers, many of whom are generally opposing the validity of ITC's patents
in multiple forums.
At December 31, 1998, ITC had granted non-exclusive, non-transferable,
perpetual, worldwide, royalty-bearing licenses to use certain CDMA patents (and
in certain instances, technology) to Siemens, Samsung, Alcatel and Qualcomm
Incorporated ("Qualcomm"), and a limited, non-exclusive, non-transferable,
royalty-bearing license to Advanced Digital Technologies. One of these licenses
involved a CDMA cross-license agreement with Qualcomm, entered into in 1994 in
settlement of litigation filed in 1993. In return for a one-time payment of $5.5
million, ITC granted to Qualcomm a fully-paid, worldwide license to use and
sublicense certain specified and then existing (but excluding defined
after-filed and/or granted) ITC CDMA patents (including related divisional and
continuation patents) to make and sell products for IS-95-type wireless
applications, including, but not limited to, cellular, PCS, wireless local loop
and satellite applications. Qualcomm has the right to sublicense certain of
ITC's licensed CDMA patents so that Qualcomm's licensees will be free to
manufacture and sell IS-95-type CDMA products without requiring any payment to
ITC. Neither ITC's patents concerning cellular overlay and interference
cancellation nor its current inventions are licensed to Qualcomm. Under the
settlement, Qualcomm granted to InterDigital a royalty-free license to use and
to sublicense the patent that Qualcomm had asserted against InterDigital and a
royalty-bearing license to use certain Qualcomm CDMA patents in InterDigital's
B-CDMA products, if needed. InterDigital does not believe that it will be
necessary to use any of such royalty-bearing or non-licensed Qualcomm patents in
its B-CDMA system. In addition, Qualcomm agreed, subject to certain
restrictions, to license certain CDMA patents on a royalty bearing basis to
those InterDigital customers that desire to use Qualcomm's patents. The license
to InterDigital does not apply to IS-95-type systems, or to satellite systems.
Certain of Qualcomm's patents, relating to key IS-95 features such as soft and
softer hand-off, variable rate vocoding, and orthogonal (Walsh) coding, are not
licensed to InterDigital. The license to Advanced Digital Technologies was
entered into as a part of the spin-off of InterDigital's government contracting
business in 1996. This license is limited in its field of use to CDMA technology
on the date of the license.
In 1999, InterDigital entered into royalty bearing TDMA and CDMA patent
licenses with Nokia, which are paid up generally through the project period, and
provide a structure for determining royalty payments thereafter.
Patent Litigation
Ericsson. 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 (the "Ericsson action") which was subsequently transferred to the
United States District Court for the Northern District of Texas. 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 an
8
injunction against Ericsson from infringement and seeks damages, royalties,
costs and attorneys' fees. 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 InterDigital and ITC in the United States District Court for the
Northern District of Texas (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 InterDigital and ITC for tortious
interference with contractual and business relations, defamation and commercial
disparagement, and Lanham Act violations. The Ericsson action and the Texas
action have been consolidated. ITC agreed to the dismissal without prejudice of
LM Ericsson.
In December 1997, Ericsson Inc., the successor to Ericsson GE and Ericsson
Radio, filed an action against ITC in the United States District Court for the
Northern District of Texas (the "1997 Texas action") seeking the court's
declaration that Ericsson Inc.'s products do not infringe two patents issued to
InterDigital earlier in 1997 as continuations of certain patents at issue in the
Texas action. Later that month, Ericsson Inc. filed an amended Complaint seeking
to include these two new patents in the Texas action in an effort to consolidate
the two cases. In January 1998, both Ericsson Inc. and InterDigital and ITC
filed motions requesting that Ericsson Inc.'s amended Complaint be allowed and
that the 1997 Texas action be dismissed, to which the Court agreed. During the
third quarter of 1998, Ericsson Inc. filed a Motion for Partial Summary
Judgement, with respect to which InterDigital has replied. The Court has not yet
ruled on this Motion. Also during the third quarter, the United States District
Court for the Northern District of Texas granted InterDigital's Motion to amend
its Counterclaim by adding four additional patents. The litigation is currently
in the discovery stage. InterDigital and ITC intend to vigorously defend the
Texas action. However, if any of ITC's patents are held invalid, ITC's licensing
opportunities and collection of royalty revenues could be materially and
adversely affected.
Patent Oppositions. ITC has filed patent applications in numerous foreign
countries. ITC is and expects from time to time to be subject to challenges with
respect to its patents and patent applications in foreign countries. ITC intends
to vigorously defend its patents. However, if any of ITC's patents or
applications are revoked, ITC's patent licensing opportunities in the relevant
foreign countries, and possibly in other countries, could be materially and
adversely affected.
The UltraPhone System
General. The UltraPhone telephone system is a digital telecommunications
system, based on TDMA technology, which is designed to provide wireless local
loop telephone service as an alternative to conventional wireline systems. It
offers greater flexibility and ease of installation than conventional
wireline-based systems and is designed to provide high transmission quality,
capacity and spectrum efficiency to large numbers of users over a broad region.
Utilizing InterDigital's patented TDMA and other proprietary technologies, the
UltraPhone telephone system enables its users, which have historically consisted
primarily of local Telephone Operating Companies ("TELCOs"), to offer
communication services in places where the cost of, or time required for,
installing, maintaining or upgrading conventional wireline telephone service
supports selection of the UltraPhone system. For these reasons, the UltraPhone
telephone system is particularly well-suited for rural areas of developing
countries. Sales of UltraPhone systems accounted for approximately 5%, 86% and
47%, respectively, of the total revenues of InterDigital during 1998, 1997 and
1996. Through December 31, 1998, InterDigital has sold over 356 UltraPhone
systems worldwide, with aggregate UltraPhone product revenue totaling over $210
million.
9
The UltraPhone system consists of an advanced digital radio central network
station serving individual or clustered subscriber units omni-directionally
covering a radius of up to approximately 40 miles from the Base Station
(depending upon the terrain). InterDigital has also developed a rapidly
deployable and transportable version of the fixed UltraPhone Base Station which
is designed to provide high quality and private telephone communications in
cases of natural disaster, tactical military situations, emergencies and other
temporary circumstances.
Competition and Market. The UltraPhone product competes with wireline and
wireless systems which provide basic telephone service in developing nations. It
has competed with many of the products that InterDigital expects its TrueLink
product to compete with. (See "- B-CDMA Technology and Product Development -
Competition"). The UltraPhone system has been deployed in applications ranging
from remote rural to dense urban areas, but is generally utilized and
differentiates itself from competitive products by generally being more cost
effective in rural applications where its service features are required. Other
technologies, including wireline based systems and wireless systems with smaller
service areas than the UltraPhone system, are generally more cost effective and
may provide more advanced features in dense urban applications where the
UltraPhone system is not typically marketed. Microwave-based wireless systems
with larger service areas than the UltraPhone system and which have data
transfer capability up to 64 Kilobits per second, are generally more cost
effective than the UltraPhone system in more remote rural applications where the
UltraPhone system is also not typically marketed.
Intense price competition exists in the market in which the UltraPhone
system competes. Historically, InterDigital has marketed the UltraPhone system
at sales prices which generated little, if any, margin. Absent significant cost
reduction, which would require substantial additional engineering investment,
margins are not expected to improve. In early 1998, the Company made a strategic
decision to cease re-engineering and re-design efforts on the UltraPhone system.
Accordingly, the Company does not expect improvements in margins from sales of
the UltraPhone product. In addition, InterDigital expects that its ability to
generate profitable UltraPhone sales will continue to be hampered by the
world-wide economic uncertainties, which InterDigital believes has affected its
customers and potential customers ability to undertake costly infrastructure
projects. On the other hand, the UltraPhone system offers its potential
customers a proven product which demonstrates reliability and high quality.
UltraPhone Business Strategy. InterDigital believes that the UltraPhone
product can be competitive in selected markets around the world, and intends to
concentrate on those niche opportunities where the potential exists to win
profitable contracts. InterDigital also intends to continue to service, but not
emphasize, the United States market to the extent that the UltraPhone system
meets specified requirements.
10
Backlog. At December 1998, InterDigital's backlog of orders for UltraPhone
telephone equipment and services was approximately $1.0 million. There were no
significant orders in backlog at December 31, 1997.
Production. InterDigital assembles, integrates and tests the UltraPhone
Subscribers and Base Stations using component parts manufactured by various
suppliers to InterDigital's specifications. In most, but not all instances,
component parts could be purchased from several different sources. Should
InterDigital's relationship with most of its suppliers cease in the future,
InterDigital believes that alternative sources of the various component parts
are available, although such an event would likely have an adverse impact on
shipments to its customers and support activities. In certain instances,
however, critical component parts for the UltraPhone system are purchased from
single sources thereby making InterDigital dependent upon those sources. Given
InterDigital's decision to eliminate spending on re-engineering and re-design of
the UltraPhone product, if select components were to become unavailable,
InterDigital would have to evaluate whether the then current market for the
UltraPhone product would warrant the investment necessary to establish another
source. If InterDigital were to determine the investment was not warranted and
there was no other source of supply, the sales of UltraPhone could cease or be
curtailed. InterDigital has also entered into a technology transfer agreement
under which Samsung is licensed to produce UltraPhone systems and may thereby
become a potential supplier to InterDigital.
Technical and Quality Standards and Market Acceptance. The UltraPhone
system is required to meet conditions promulgated by international, domestic or
regional organizations or financing agencies, and to comply with
country-specific type acceptance or certification standards. An organization
jointly owned by the Bell regional holding companies develops and publishes
compliance standards which have been adopted as either compulsory or elective
benchmarks by the Bell regional holding companies and other United States
TELCOs. In addition to these and additional organization recommendations and
technical or acceptance standards which may be applicable, an international set
of quality standards has been promulgated, generally for future implementation,
by the International Standardization Organization. InterDigital has, in the
past, been able to comply with all technical and acceptance standards necessary
to consummate its sales contracts, including ISO-9001 certification.
Product Sales
Sales by Geographic Area. Product revenues by geographic area are as
follows (in thousands):
Year Ended December 31,
--------------------------
1998 1997 1996
------ ------- -------
U.S. $ 911 $ 1,253 $ 1,958
Non-U.S. 5,840 42,601 23,016
------ ------- -------
$6,751 $43,854 $24,974
====== ======= =======
Major Customers. During 1998, InterDigital's revenue related to B-CDMA
components totaled approximately $1.9 million. Also, during 1998, Myanma Posts
and Telecommunications notified InterDigital that it wishes to terminate its
contract with InterDigital due to financing difficulties. In 1997,
InterDigital's Indonesian and Philippine customers represented 75% and 7% of
total product revenues, respectively. All of such customer sales represented
sales of the UltraPhone product. During 1997, InterDigital began shipping
prototype units of the TrueLink product and shipped a total of approximately
$1.1 million of that product to Siemens. During 1996, InterDigital's Philippine
customer (Philippine Long Distance Telephone Company) and its Indonesian
customer accounted for 56% and 16% of product revenues, respectively.
11
Technical Standards
InterDigital is active in the ongoing standards setting process for third
generation mobile products and wireless local loop products sponsored by certain
standards setting bodies. Working on its own and with its strategic partners,
InterDigital is proposing standards which incorporate elements of its
technologies. These are being proposed in the U.S. and internationally and
include technology building blocks built into InterDigital's B-CDMA technology,
plus extension of that technology for third and fourth generation applications.
InterDigital also hopes, through one or more of its B-CDMA Alliance partners, to
establish the critical mass which would allow B-CDMA technology to be considered
a defacto standard, where appropriate. In addition, InterDigital is proposing
standards based on new technology it is developing for Nokia. InterDigital
generally has designed and builds UltraPhone equipment, and intends to design
and have built TrueLink system components, in accordance with such industry
regulations and standards as may be appropriate.
Government Regulation
The telecommunications industry in general is subject to continued
regulation on the federal, state and international levels. The sale of
telecommunications equipment, such as the UltraPhone telephone system, is
regulated in the United States and in many other countries, primarily to ensure
compliance with federal technical standards for interconnection, radio emissions
and non-interference (i.e. type acceptance of a particular product).
Employees
As of March 1, 1999, InterDigital had approximately 215 full-time
employees. In addition, the services of consultants and part-time employees are
utilized. None of InterDigital's employees are represented by a collective
bargaining unit. A breakdown of InterDigital's full-time employees by functional
area is as follows:
Number of
Functional Area Employees
--------------- ---------
Sales and Marketing 5
Customer Support 13
Manufacturing 13
Research and Development 135
Patent Licensing 8
Corporate and Administration 41
---
Total 215
===
12
Executive Officers of InterDigital
The Executive Officers of InterDigital are:
Name Age Position
---- --- --------
Willaim A. Doyle 49 President and Director
Howard E. Goldberg 53 Executive Vice President -
Stategic Alliance and
President of InterDigital
Patents Corporation ("Patents Corp.")
Joseph Gifford 53 Executive Vice President -
Business Development
Mark Lemmo 41 Executive Vice President - Engineering
& Product Operations
Gary Lomp 41 Executive Vice President and Chief
Technology Officer
Charles "Rip" Tilden 45 Executive Vice President - Communications,
Investor Relations and Strategic Planning
Richard J. Fagan 42 Senior Vice President and Chief Financial
Officer
William J. Merritt 40 Senior Vice President, General Counsel and
Secretary
William A. Doyle, a director of InterDigital since May 1996, has served as
President of InterDigital since November 1994. Previously, Mr. Doyle had been
Executive Vice President and Chief Administrative Officer from February 1994 to
November 1994 and Vice President from March 1991 to February 1994. He also
served as InterDigital's General Counsel and Secretary from March 1991 to
December 1994.
Howard E. Goldberg was promoted to President of InterDigital Patents
Corporation in October, 1998, while still retaining his title as Executive Vice
President-Strategic Alliance of InterDigital. Prior to that, he also held the
positions of General Counsel and Secretary from May 1995 to October 1998. Mr.
Goldberg served as Vice President, General Counsel and Secretary from December
1994 to May 1995. He served as a lawyer in various consulting and full time
employment capacities prior to that from April 1993, including the position of
Vice President - Legal Affairs and Associate General Counsel.
Joseph Gifford was appointed Executive Vice President, Business Development
in April 1997. Prior to joining InterDigital Communications Corporation, Mr.
Gifford was an executive at Motorola, Inc. from August 1993 to April 1997, where
he was responsible for business development in the Wireless Access Systems
Division.
Mark Lemmo was promoted to Executive Vice President, Engineering & Product
Operations in October 1996. Previously, Mr. Lemmo had been Vice President-Sales
and Marketing since June 1994 and Vice President of Engineering from August 1991
to June 1994.
Gary Lomp was named Executive Vice President and Chief Technology Officer
in June 1998. He served in various capacities as a Vice President relating to
InterDigital's B-CDMA research and development efforts from October 1992, when
he joined InterDigital as part of the acquisition of SCS Telecom and SCS
Mobilecom, through June 1998.
Charles "Rip" Tilden was named Executive Vice President - Communications,
Investor Relations and Strategic Planning of InterDigital in March 1998. Prior
to that, he held the positions of Senior Vice President from May 1997 and Vice
President from November 1996 until May 1997. Before joining InterDigital, Mr.
Tilden served as Vice President, Corporate Affairs at Alco Standard Corporation
in Wayne, PA, an office products and paper distribution company, since December
1994. Before moving to Alco Standard, Mr. Tilden was Vice President,
Communications for GenCorp in Akron, OH, an aerospace defense, automotive and
polymer products company from 1988 to 1994.
Richard J. Fagan joined InterDigital as a Senior Vice President and Chief
Financial Officer in November 1998. Prior to that, he served as Controller and
Treasurer of Quaker Chemical, a Pennsylvania chemical corporation, since 1994
and as Assistant Corporate Controller of that corporation from 1993 to 1994.
13
William J. Merritt was promoted to Senior Vice President, General Counsel
and Secretary in October 1998. Prior to that, he served in the capacity of Vice
President - Legal and Assistant Secretary since January 1996. Prior to joining
InterDigital, from 1987 to 1996, Mr. Merritt held a variety of positions in the
Legal Department for Long Island Lighting Company, a New York electric and gas
utility company, the last of which was Assistant General Counsel responsible for
all company litigation and corporate matters. Mr. Merritt was also General
Counsel to that company's power plant operation subsidiary, Dynamic Energy
Services Corporation, since 1995.
InterDigital's Executive Officers are elected to the offices set forth
above to hold office until their successors are duly elected and have qualified.
All of such persons, with the exception of Mr. Lomp, are parties to agreements
which provide severance pay benefits, among other things, in certain events of
termination of employment. Certain of these agreements generally provide for the
payment of severance up to a maximum of one year's salary and up to a maximum of
one year's continuation of medical and dental benefits. In certain of these
agreements, in the event of a termination or resignation within one year
following a change of control, which is defined as the acquisition, including by
merger or consolidation, or by the issuance by InterDigital of its securities,
by one or more persons in one transaction or a series of related transactions,
of more than fifty percent (50%) of the voting power represented by the
outstanding stock of InterDigital, the employee would generally receive two
years of salary and the immediate vesting of all stock options.
14
Item 2. PROPERTIES
InterDigital owns one facility, subject to a mortgage, with an aggregate of
approximately 50,000 square feet of office, development, warehousing and
assembly facilities in King of Prussia, Pennsylvania. (See Note 11.) In December
1996, InterDigital entered into a five year lease for approximately 67,000
square feet of office and development facilities in Melville, New York. This
facility is the primary location for the majority of InterDigital's B-CDMA
development activities. (See Note 10.)
Item 3. LEGAL PROCEEDINGS
InterDigital is both plaintiff and defendant in certain litigation relating
to its patents. (See Item 1. "Business-Technology and Patent Licensing" of this
Form 10-K.)
In addition to litigation associated with patent enforcement and licensing
activities and the litigation described above, InterDigital is a party to
certain other legal actions arising in the ordinary course of its business.
Based upon information presently available to InterDigital, InterDigital
believes that the ultimate outcome of these other actions will not materially
affect InterDigital.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
15
Item 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The following table sets forth the range of the high and low sales prices
of InterDigital's Common Stock as reported by the American Stock Exchange.
High Low
1998 ------ -----
First Quarter 6 3/16 2 9/16
Second Quarter 7 7/16 5 3/16
Third Quarter 5 7/8 2 11/16
Fourth Quarter 6 7/8 3
1997 High Low
----- -----
First Quarter 7 7/16 5 1/4
Second Quarter 6 15/16 4 1/2
Third Quarter 6 5/16 4 15/16
Fourth Quarter 5 9/16 2 13/16
As of March 5, 1999, there were approximately 2,298 holders of record of
InterDigital's Common Stock.
InterDigital has not paid cash dividends on its Common Stock since
inception. It is anticipated that, in the foreseeable future, no cash dividends
will be paid on the Common Stock and any cash otherwise available for such
dividends will be reinvested in InterDigital's business. The payment of cash
dividends will depend on the earnings of InterDigital, the prior dividend
requirements on its remaining series of Preferred Stock and other Preferred
Stock which may be issued in the future, InterDigital's capital requirements and
other factors considered relevant by the Board of Directors of InterDigital.
16
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The information set forth below should be read in conjunction with the
Consolidated Financial Statements and notes thereto, and the other financial
information included elsewhere in this Form 10-K, as well as "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
herein.
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Consolidated Statement of Operations Data
(in thousands, except per share data)
Revenues:
Product and Services $ 6,751 $ 43,854 $ 24,974 $ 16,581 $ 20,086
Licensing and Strategic Partner 92,470 5,982 28,719 67,693 28,709
Contract services -- -- -- 681 1,171
-------- -------- -------- -------- --------
Total revenues 99,221 49,836 53,693 84,955 49,966
Income (loss) from continuing operations 36,968 (34,267) (11,644) 34,605 (13,753)
Discontinued operations -- -- -- -- (295)
Net income (loss) before preferred dividends 36,968 (34,267) (11,644) 34,605 (14,048)
Net income (loss) applicable to
common shareholders $ 36,713 $(34,523) $(11,904) $ 34,340 $(14,330)
======== ======== ======== ======== ========
Net income (loss) per share -- Basic:
Continuing Operations $ 0.76 $ (0.72) $ (0.26) $ 0.78 $ (0.37)
Discontinued Operations -- -- -- -- (0.01)
-------- -------- -------- -------- --------
Net income loss) per share -- Basic $ 0.76 $ (0.72) $ (0.26) $ 0.78 $ (0.38)
======== ======== ======== ======== ========
Weighted Average number of shares
outstanding -- Basic 48,380 48,166 46,462 43,925 37,463
======== ======== ======== ======== ========
Net Income (loss) per share -- Diluted:
Continuing Operations $ 0.75 $ (0.72) $ (0.26) $ 0.74 $ (0.37)
Discontinued Operations -- -- -- -- (0.01)
-------- -------- -------- -------- --------
Net Income (loss) per share -- Diluted $ 0.75 $ (0.72) $ (0.26) $ 0.74 $ (0.38)
======== ======== ======== ======== ========
Weighted average number of shares
outstanding -- Diluted 48,771 48,166 46,462 46,503 37,463
======== ======== ======== ======== ========
Operations and Other Data:
Number of UltraPhone systems sold 6 66 49 25 34
Number of UltraPhone subscriber stations sold 2,070 23,430 10,764 5,474 8,570
Consolidated Balance Sheet Data (in thousands):
Cash and cash equivalents $ 20,059 $ 17,828 $ 11,954 $ 9,427 $ 6,264
Short Term Investments 32,318 7,976 43,063 55,060 --
Working capital 54,752 22,902 57,076 59,008 10,118
Total assets 99,523 69,363 112,636 83,167 43,830
Long-term debt 3,772 4,460 5,011 1,061 753
Accumulated deficit (160,039) (196,752) (162,229) (150,325) (184,665)
Total shareholders' equity 75,808 38,505 72,507 62,440 14,872
17
Item 7. 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, InterDigital 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. InterDigital'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 the mid-1990's InterDigital experienced losses caused by (i) the
failure to achieve sufficient sales volumes of UltraPhone systems to cover
associated overhead, (ii) substantial investments in UltraPhone product
redesigns and enhancements, (iii) substantial investment in B-CDMA research and
development, and (iv) significant litigation costs associated with enforcement
of InterDigital Technology Corporation's ("ITC") intellectual property rights.
At the same time that InterDigital was experiencing these losses, it began to
realize positive results from its efforts to capitalize upon the revenue
potential of its TDMA and CDMA patent portfolio and to align itself with key
telecommunication companies. During 1994, 57% of InterDigital's total revenues
resulted from licensing revenues, including revenue related to InterDigital's
first B-CDMA alliance agreement with Siemens. During 1995, InterDigital reported
its first profitable fiscal year since its inception due to licensing and
strategic partner revenue. During 1996, InterDigital completed its second major
B-CDMA Alliance with Samsung, and licensing and strategic partner revenue
constituted 53% of total revenues for the year. However, since licensing and
strategic partner revenue had been based upon the receipt of up-front,
non-refundable payments pursuant to license and alliance agreements entered into
at sporadic intervals, InterDigital's profit and loss status varied from quarter
to quarter. In 1997, InterDigital was unprofitable, primarily due to
substantially increased investment in the development of its B-CDMA technology.
1997 revenues of $49.8 million included $4.4 million from licensing revenue from
its B-CDMA Alliance partners, $1.6 million of recurring royalty fees from one
licensee, and $43.8 million from product sales.
In late 1997 and early 1998, the continuing viability of UltraPhone
business was further impacted by intensified product and price competition,
chiefly due to the introduction into the market of the lower cost Digital
Enhanced Cordless Telephone system and by economic uncertainties in Asia. In
January 1998, InterDigital restructured its operations to cease all UltraPhone
development efforts and de-emphasize related sales efforts to devote its
resources to B-CDMA technology and product development. In March 1998,
InterDigital entered into its third B-CDMA Alliance, with Alcatel, under which
agreement Alcatel agreed, among other things, to pay InterDigital $25 million in
technology transfer and services fees over a period of time through 2003. In
1998, InterDigital recognized $4.6 million in revenue related to the Alcatel
agreement. During 1998, InterDigital entered into four new TDMA licensing
agreements and received revenues under several other licensing agreements.
Licensing and strategic partner revenue totaled $92.5 million in 1998. In
January 1999, InterDigital entered into a strategic engineering relationship
with Nokia involving the development of new technology for 3G products designed
for high data rate applications, such as Internet access. This agreement
includes royalty bearing TDMA and CDMA patent licenses, which are paid up
generally through the project period, and also provides a structure for
determining the royalty payments thereafter. InterDigital will recognize $31.5
million in licensing revenue in the first quarter of 1999 related to paid-up
royalties from the Nokia Agreement.
In February 1999, Siemens withdrew from InterDigigal's current B-CDMA
development project. Following InterDigital's announcement of Siemens
withdrawal, Alcatel informed InterDigital that it intends to re-evaluate its
participatiaon in the B-CDMA development project and the B-CDMA Alliance and has
commenced that re-evaluation. Alcatel's decision to continue or not continue
with the project may be affected by, among other factors, the schedule for
delivery of products and additional costs and resource allocation stemming from
the Siemens withdrawal. Alcatel's continuing commitment to the project will
likely result in a restructuring of the existing contractual relationship,
including provisions concerning resource allocation and milestone related
payments. There can be no assurance that Alcatel and InterDigital will agree to
continue the development effort or restructure the contract. If Alcatel does not
continue to participate in the current B-CDMA development effort on terms
acceptable to Interdigital, InterDigital may re-evaluate its resource commitment
to the development project. A withdrawal by Alcatel would not affect currently
projected 1999 revenues. However, this action would change InterDigital's
business prospects with regard to B-CDMA products, at least as currently
envisioned, and could negatively impact InterDigital's revenues beyond 1999,
including revenues anticipated from licensing and product sales.
18
In addition, from time to time companies re-evaluate strategies relative to
their development projects. InterDigital believes that, as is customary in any
such re-evaluation process, various projects being undertaken by Samsung,
including Samsung's development and commercialization of B-CDMA products based
on B-CDMA technology, could be impacted in the future if such projects do not
show the potential for producing acceptable profits or suitable market growth.
Because Samsung is not currently making further contributions to the
InterDigital B-CDMA development project, any decision by Samsung to discontinue
its B-CDMA products would not require InterDigital to commit additional
resources to the current B-CDMA development project. In addition, a withdrawal
by Samsung would not affect currently projected 1999 revenues. However, as with
any B-CDMA Alliance partner withdrawal from the B-CDMA program, a withdrawal by
Samsung could negatively impact future revenues that InterDigital was
anticipating to derive (in the form of royalties) from the sales of B-CDMA
products by Samsung.
InterDigital expects the variability in its licensing and strategic partner
revenues and, consequently, its cash flow to continue until significant
recurring royalties are received under the applicable agreements. InterDigital's
expectation as to its ability to generate revenue related to licensing and
strategic partner activities is forward looking in nature and, as such, is
inherently subject to risks and uncertainties and is dependent upon various
factors or events, among other risks, uncertainties, factors and events detailed
elsewhere in this Annual Report, including the effect of the Siemens withdrawal,
whether or not Alcatel continues its participation and/or makes further
contributions to the B-CDMA development effort, Samsung's continued development
and commercialization of B-CDMA products, InterDigital's continuation of its
developments work for Nokia, the ability to enter into additional alliances,
strategic engineering relationships and/or licenses for InterDigital's patents
and other intellectual property, the extent to which and when current and new
licensees ship products that utilize the licensed technology and the licensees'
abilities or willingness to pay the applicable license or royalty fees. Further,
InterDigital relies on certain third parties to assist with its development
activities. Delays or difficulties in such third parties' development efforts
can lead to changes in the strategies of the companies with whom InterDigital
has strategic relationships, which could ultimately affect InterDigital's
relationships with such companies, the marketability of InterDigital's
technology and products, and the receipt of revenues. Revenues and other
business prospects could also be adversely impacted by adverse decisions in
InterDigital's outstanding and any future intellectual property rights
litigation or other patent-related proceedings, including but not limited to,
any non-issuance of ITC's patent applications or declaration of invalidity or
declaration of non-infringement of ITC's patents. (See "- Statement Pursuant to
the Private Securities Litigation Reform Act of 1995" below and Notes 1, 3, 4
and 5 to "Notes to Consolidated Financial Statements".)
InterDigital also expects to continue to derive revenues from its product
operations. InterDigital and its B-CDMA Alliance partners have engaged in the
marketing of their products based on InterDigital's B-CDMA technology. Field
trials of these systems are in progress. During 1998, InterDigital had
approximately $1.9 million of sales related to InterDigital's TrueLink product.
These sales included service revenue to Samsung and B-CDMA ASIC and other
component sales to Siemens for its integration into pre-production products. In
addition, although InterDigital is not actively pursuing many wireless local
loop opportunities that might have previously been considered for the UltraPhone
system, InterDigital intends to continue to market the UltraPhone system on a
selective basis in rural niche markets where the potential for profit exists and
through post contract add-ons and systems expansions and servicing and follow on
orders. InterDigital's ability to derive future revenue from product sales will
be affected by, among other factors detailed elsewhere in this Annual Report,
the affect of the Siemens withdrawal, whether or not Alcatel continues its
participation and/or makes further contributions to the B-CDMA development
effort, Samsung's success with its B-CDMA program, and the intensified
competition for sales of wireless local loop telephone systems. (See
"- Statement Pursuant to the Private Securities Litigation Reform Act of 1995"
below.)
FINANCIAL POSITION, LIQUIDITY AND CAPITAL REQUIREMENTS
InterDigital had working capital of $54.8 million at December 31, 1998
compared to working capital of $22.9 million at December 31, 1997. The increase
in working capital since December 1997 is due primarily to the increase in cash
and short term investments derived from the success of the patent licensing and
strategic partner programs in 1998. InterDigital 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 expenses. From the fourth quarter
of 1994 through the second quarter of 1996, InterDigital generated cumulative
operating profits and substantially strengthened its cash position through its
alliance partner, strategic engineering relationship and licensing transactions.
However, during the third and fourth quarters of 1996 and during all of fiscal
1997, InterDigital again experienced operating
19
losses. In 1998, InterDigital experienced operating losses in the first
and third quarters, offset by profits in the second and fourth quarters. Despite
this variability, InterDigital reported its strongest earnings in its history
for 1998. InterDigital expects that it may continue to experience significant
fluctuations in working capital due to variations in the amount and timing of
license and strategic partner related revenue.
InterDigital experienced positive cash flows of $30.1 million from
operations during 1998 as compared to negative cash flows of $23.8 million in
1997. The positive cash flows from operations are primarily due to the success
of the patent licensing program during the year.
Net cash flows from investing activities for 1998 include investments in
property and equipment of $1.8 million and additions to patents of another $1.8
million. Also included in net cash flows from investing activities is
InterDigital's investment of $24.2 million of funds in short-term, highly liquid
securities.
During 1998, InterDigital experienced negative cash flows of $353,000 from
financing activities primarily for the payment of long term debt.
Cash and cash equivalents of $20.1 million as of December 31, 1998 includes
$143,000 of restricted cash. Short term investments of $32.2 million as of
December 31, 1998 were held by InterDigital Finance Corporation, a wholly owned
subsidiary of InterDigital. Accounts receivable of $15.0 million at December 31,
1998 reflect amounts due from normal trade receivables, including non-U.S. open
accounts, as well as funds to be remitted under letters of credit and licensing
agreements. Of the outstanding trade receivables as of December 31, 1998, $13.7
million has been collected through March 5, 1999.
20
Inventory levels decreased at December 31, 1998 to $5.1 million from $12.3
as of December 31, 1997, reflecting InterDigital's estimate of the net
realizable value of inventory for the UltraPhone product relative to its niche
market. Inventories at December 31, 1998 and December 31, 1997 are stated net of
valuation reserves of $13.7 and $5.8 million, respectively.
Included in other accrued expenses at December 31, 1998 are professional
fees, consulting and other accruals and deferred rent relating to the corporate
headquarters and manufacturing facilities, as well as sales taxes payable.
Demands on working capital in 1999 and beyond are expected to be
significant. Subject to Alcatel's continued participation in the current
development effort, InterDigital expects to aggressively support its B-CDMA
technology development efforts to further commercialize its technology in 1999.
As the commercial development effort for the next version of TrueLink and the
next generation B-CDMA ASIC continues, substantial additional expenditures are
expected to be incurred for further development and re-engineering, marketing
and other activities. Siemens withdrawal from the B-CDMA project may impose
additional development costs on InterDigital. In addition, a renegotiation of
the Alcatel agreement could adversely affect both the Company's short term
revenue and its development cost burden. Further, in 1999 and beyond,
InterDigital expects to incur substantial development costs as it focuses
development efforts on 3G wireless technology. Some of these costs
are expected to be absorbed by companies with whom InterDigital has strategic
relationships. Further, the cost of prosecuting patent applications worldwide,
defending the validity of ITC's patents, and litigating patent infringement
actions related to ITC's patents can be substantial.
InterDigital is capable of supporting its operating requirements during
1999 through internally generated funds. Should the need arise to fund new
development activities, contingency resolution, external growth activities or
other matters. InterDigital may seek financing by means of a bank loan or line
of credit or through the sale of debt or equity securities. InterDigital does
not presently maintain bank lines of credit and can give no assurance that it
could secure such a loan or line of credit, either at all or on acceptable
terms. In addition, there can be no assurances that InterDigital will be able to
sell any such securities, or, if it can, that it can do so on terms acceptable
to InterDigital.
InterDigital believes that its investment in inventories and non-current
assets at December 31, 1998 are realizable based on expected selling prices and
order volumes. Property and equipment are currently being utilized in
InterDigital's on-going business activities, and InterDigital believes that no
additional write-downs are required at this time due to lack of use or
technological obsolescence. With respect to other assets, InterDigital believes
that the value of its patents is at least equal to the value included in the
December 31, 1998 balance sheet.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the revenues
from each revenue category as a percentage of total revenues and gross margins
from product sales:
As A % of Total Revenues
--------------------------
Year Ended December 31,
--------------------------
1998 1997 1996
---- ---- ----
Revenues:
Product Revenues 6.8% 88.0% 46.5%
Licensing and Strategic
Partner 93.2 12.0 53.5
------ ----- -----
Total Revenues 100.0% 100.0% 100.0%
Product Gross Margins (160.4)% (4.4)% (9.6)%
====== ===== =====
1998 Compared With 1997
Total Revenues. Total revenues in 1998 increased 99.1% to $99.2 million
from $49.8 million in 1997 due to the significant increase in licensing and
strategic partner revenue. In 1998, licensing and strategic partner revenue
included $4.6 million from Alcatel, $3.4 million from Samsung, $83.5 million
from new and existing license agreements and $962,000 in recurring royalties. In
1997, licensing and strategic partner revenue included the recognition of the
final $1.6 million of strategic partner revenue from Siemens, $2.8 million from
Samsung and $1.6 million in recurring royalties.
Cost of Product Revenues. Cost of product revenues decreased in 1998 to
$17.6 million from $41.9 million in 1997. The decrease is directly related to
the decrease in product sales. In 1998, there were insufficient product sales to
absorb manufacturing overhead and increases in inventory reserves resulting in a
negative gross margin of 160.4% as compared to a positive gross margin of 4.4%
in 1997. In 1998, InterDigital recorded charges totaling $7.9 million to reduce
the carrying value of its inventory of UltraPhone components to its net
realizable value due to excess inventories resulting from the cancellation of
the Myanmar contract. Quantities are now considered excess relative to the niche
market for UltraPhone products.
Other Operating Expenses. Other operating expenses include sales and
marketing expenses, general and administrative expenses, patents administration,
and product development expenses.
Sales and marketing expenses decreased 46.9% to $3.9 million during 1998 as
compared to $7.3 million in 1997. The decrease is primarily due to decreased
sales commissions and decreased marketing activity for the UltraPhone product.
General and administrative expenses for 1998 decreased 25.9% to $5.3
million from $7.2 million in 1997. The decrease is due to cost management and
the reduction in workforce in early 1998.
21
Patents administration and licensing costs increased 118.4% to $11.1
million in 1998 from $5.1 million in 1997. The increase is primarily due to
increased activities related to the generation of licensing revenue and the
protection and enforcement of InterDigital's patent portfolio.
Product development costs decreased 29.2% to $17.2 million in 1998 from
$24.2 million in 1997. The decrease is primarily due to reduced development of
InterDigital's UltraPhone system and to the timing of certain B-CDMA related
development expenses.
Other Income and Expense. Interest expense was $367,000 in 1998 as compared
to $410,000 in 1997. In 1998, interest expense includes $199,000 of mortgage
interest on InterDigital's King of Prussia property which was purchased in 1996,
and $168,000 of interest on capital leases. In 1997, mortgage interest was
$225,000 and interest on leases was $180,000.
Interest income for 1998 increased 18.5% to $2.5 million from $2.1 million
in 1997 due to higher average invested cash balances during 1998.
1997 Compared With 1996
Total Revenues. Total revenues in 1997 decreased 7.2% to $49.8 million from
$53.7 million in 1996 due to the significant decrease in licensing and strategic
partner revenue in 1997 partially offset by an increase in product revenues of
75.6% to $43.8 million from $25.0 million in 1996. Licensing and strategic
partner revenue of $6.0 million in 1997 included $2.8 million of alliance
revenue from Samsung, the final $1.6 million of alliance revenue recognized on
the Siemens agreement and $1.6 million of recurring royalty fees from one
licensee. In 1996, license and strategic partner revenue of $28.7 million
included $23.0 million of alliance revenue from Samsung, $4.8 million of
alliance revenue recognized on the Siemens agreements and $900,000 of recurring
royalty fees from one licensee.
Cost of Product Revenue. The cost of product sales in 1997 revenue
increased 53.1% to $41.9 million from $27.4 million in 1996. This increase is
due primarily to the increase in product revenues. InterDigital achieved
sufficient product revenue to substantially absorb manufacturing overhead costs
resulting in a 4.4% positive gross margin compared to a negative 9.6% gross
margin in 1996.
InterDigital restructured its operations to de-emphasize and eliminate most
areas of spending related to its UltraPhone business. InterDigital's gross
profit margin ratios on UltraPhone product sales had been negatively affected by
the relative proportions of direct and distributor sales, by the average number
of subscribers and clusters per system sold, by its ability to absorb
manufacturing overhead costs through generation of sufficient production volume,
by the field service costs for installation, warranty, training and post-sale
support, and by varying selling prices and product materials costs. Consistent
with industry practices, distributor commissions have been included in both
revenues and cost of sales. Historically, InterDigital'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 and increases in inventory reserves, producing negative gross
margins.
Other Operating Expenses. Other operating expenses include sales and
marketing expenses, general and administrative expenses and product development
expenses.
Sales and marketing expenses increased 55.5% to $7.3 million during 1997 as
compared to $4.7 million in 1996. The increase is primarily due to increases in
product marketing efforts, participation in trade shows, sales commission and
activity levels associated with InterDigital's B-CDMA based product.
General and administrative expenses for 1997 increased 10.6% to $12.3
million from $11.1 million in 1996. The increase is due primarily to an increase
in amortization of patents as well as an increase in
22
expenses related to the protection and exploitation of InterDigital's
patents portfolio and corporate communications activity.
Product development expenses increased 12.2% in 1997 to $24.2 million from
$21.6 million in 1996. Staff and activity levels devoted to the development of
the B-CDMA technology increased significantly.
Other Income and Expense. Interest expense for 1997 was $410,000 as
compared to $271,000 for 1996. Interest expense for 1997 includes $225,000 of
mortgage interest on InterDigital's King of Prussia property which was purchased
in 1996 and $180,000 of interest on leases. In 1996, mortgage interest was
$124,000 and interest on leases was $135,000.
Interest income for 1997 decreased 50.1% to $2.1 million from $4.2 million
in 1996 due to substantially lower average invested cash balances during 1997 as
compared to 1996.
Minority Interest. In December 1992, InterDigital sold 5.76% of the common
shares of Patents Corp., which had, prior thereto, been a wholly-owned
subsidiary of InterDigital. InterDigital recorded an increase in minority
interest in the second quarter of 1996 of $4,000. During September 1996,
InterDigital reacquired the minority interest of Patents Corp. in exchange for
shares of InterDigital's Common Stock and will therefore no longer record a
charge for minority interest.
Backlog
At December 31, 1998, shippable backlog of product and related services was
approximately $1.0 million.
Year 2000
Many currently installed computer systems in many companies are not capable
of distinguishing 21st century dates from 20th century dates. As a result,
beginning on January 1, 2000, both IT (Information Technology) and non-IT
systems used by many organizations in a wide variety of industries (including
technology, transportation, utilities, finance and telecommunications) will
produce erroneous results or fail unless they have been modified or upgraded to
process date information correctly. Significant uncertainty exists concerning
the scope and magnitude of problems associated with the century change.
InterDigital recognizes the need to ensure our operations will not be adversely
affected by Year 2000 system failures. In this regard, InterDigital has begun to
implement a Year 2000 compliance program, consisting of auditing, assessing,
remediating, testing, and contingency planning, to ensure InterDigital's IT and
non-IT systems will function properly beyond 1999. The program is designed to
cover both systems operated by InterDigital as well as systems operated by third
parties that InterDigital considers to be material to its operations.
InterDigital has established a Committee consisting of members of management
from various disciplines to implement this program and has engaged a consultant
to assist the Committee.
As part of its Year 2000 compliance program, InterDigital is engaging in a
comprehensive assessment of the potential overall impact of the impending
century change on its business, financial condition and operating results.
InterDigital has conducted a thorough audit of its systems and has begun to test
and upgrade certain of its systems for Year 2000 compatibility. In addition,
InterDigital has begun the process of identifying and contacting certain third
parties upon which it relies to ensure that those third parties have assessed
the Year 2000 issues on their own systems and are taking steps to ensure that
their systems are Year 2000 compatible. InterDigital believes that it will have
the ability to allocate adequate resources for its Year 2000 compliance program
and expects any Year 2000 remediation required to continue its operations to be
made on its own systems to be completed on a timely basis. However, InterDigital
has not completed its assessment, and still has many systems that require
evaluation and/or testing for Year 2000 compliance. In addition, InterDigital
cannot yet estimate with any degree of certainty the timing for completion of
its compliance program, and expects differing aspects of that program will be
completed at varying times. There can be no assurance that these systems or the
systems of third parties upon which InterDigital's business relies will be
identified or remediated on a timely basis or successfully. This could cause
delays or
23
difficulties in development efforts. Moreover, InterDigital's products and
components may be integrated into larger systems that InterDigital cannot
adequately evaluate for Year 2000 compliance. InterDigital may face claims based
on Year 2000 problems in other companies' products, or issues arising from the
integration of multiple products within an overall system. InterDigital's
business, financial condition, or results of operations could be materially
adversely affected by the failure of its systems, or those operated by third
parties upon whom InterDigital relies to properly operate or manage dates beyond
1999.
To date, InterDigital has not incurred any material costs directly
associated with its Year 2000 compliance efforts. InterDigital has incurred the
compensation expense associated with its salaried employees who have devoted
some of their time to its Year 2000 assessment, remediation efforts and the cost
of its consultant. InterDigital does expect to expand additional resources on
its remediation efforts out of general corporate funds, but does not expect the
total cost of Year 2000 remediation efforts to be material to its business,
financial condition and operating results. Those costs have not yet been fully
assessed. During the months prior to the century change, InterDigital will
continue to evaluate its products and systems, as well as certain products and
systems provided to it by third parties, to determine whether they are Year 2000
compliant. Despite this assessment, InterDigital may not identify and
correct all significant Year 2000 problems on a timely basis. Year 2000
compliance efforts may involve significantly more time and expense than
expected, and unremediated problems could affect its business, financial
condition, and operating results. InterDigital currently has no contingency
plans to address the risks associated with unremediated Year 2000 problems but
intends to develop such plans, to the extent reasonably practicable, as part of
its compliance program.
Statement Pursuant to the Private Securities Litigation Reform Act of 1995
The foregoing Management's Discussion and Analysis and discussions of
InterDigital's "Business" contain forward looking statements reflecting,
among other things, InterDigital's current beliefs and expectations as to its
strategic objectives, earnings growth, revenue potential and variability, and
working capital requirements; the development, standardization, capabilities,
production, commercialization, marketing and evolution of its B-CDMA products
and/or the underlying technology and of its new technologies; the ability to
diversify into new technologies and applications; objectives of, potential for
and competitive positions of InterDigital's product business; market for
products and marketing plans; litigation; growth in industry markets, demand and
in telecommunication infrastructure; the affect of the Siemens withdrawal; the
outcome of Alcatel's and Samsung's re-evaluations, and InterDigital's ability to
capture value from B-CDMA technology and products; the continuation of the
development effort with Nokia and of the technology and products developed under
the Nokia agreement to enhance InterDigital's competitive position; ability to
form additional alliances and strategic engineering relationships, capture value
from InterDigital's patent portfolio, license its intellectual property and
generate licensing revenues; patent validity, enforceability, applicability and
infringement and license; enforceability; the actions of InterDigital's B-CDMA
Alliance partners, Nokia, and other licensees; the ability to attract and retain
personnel; and Year 2000 compliance. Words such as "objectives", "seeking",
"expects", "believes", "intends", "anticipates", "plans", "hopes", variations of
such words, and words with similar meaning or connotations are intended to
identify such forward looking statements.
Such statements are subject to risks and uncertainties. InterDigital
cautions the readers that important factors in some cases have affected and, in
the future, could materially affect actual results and cause actual results to
differ materially from the results expressed in any such forward looking
statement. These factors include but are not limited to: general economic
conditions of InterDigital's customers, potential customers and the wireless
industry; actual or perceived world-wide economic conditions; the reversal or
slowdown in anticipated TELCO infrastructure spending; the effects of, and
changes in, foreign trade, monetary and fiscal conditions, policies, laws and
regulations or other activities of foreign and the United States governments,
agencies and similar organizations; foreign exchange rates and fluctuation in
those rates;
24
adverse foreign tax consequences; delays in remittance and difficulties of
collection of foreign payments; efforts to nationalize foreign-owned operations;
unstable foreign governments, legal systems and intergovernmental disputes;
foreign governmental action or inaction; imposition of unfavorable government or
industry standards; the inability to maintain or secure adequate capital (or
access thereto) to fund operations; the failure to achieve and/or maintain
market acceptance of InterDigital's products and technology or to introduce new
competitive products on a timely and cost effective basis; the inability to hire
and/or retain appropriately qualified technical, sales or management personnel;
the availability of competitive products superior on a perceived, relative or
actual basis with InterDigital's products; technical, financial or other
difficulties or delays in the development, re-engineering, production, testing,
commercialization and marketing of InterDigital's products or technologies;
failure of B-CDMA based equipment to meet performance tests; lack of sufficient
endorsement of InterDigital's technology and products from operators, producers
and others, or the failure to achieve widespread dissemination thereof; demand
for and pressures on margin on InterDigital's products; the failure to enter
into additional alliances and strategic engineering relationships necessary to
achieve InterDigital's business objectives; the failure to fully and
successfully implement the alliance and strategic engineering programs including
the failure or inability of companies with whom InterDigital has strategic
relationships to meet InterDigital's expectations or contractual commitments;
availability of required frequencies or other things necessary to fulfill their
obligations to InterDigital; failure to achieve desired development goals,
budget and/or schedule relating to the Nokia development project; Nokia's
exercise of its rights to terminate the development project for convenience;
inability to retain or hire adequate personnel; inability of Siemens and
InterDigital to negotiate mutually acceptable terms for their withdrawal;
attempts by other B-CDMA Alliance partners to renegotiate their relationships
including withdrawal from the B-CDMA Alliance; failure of InterDigital or third
parties to successfully identify or remediate Year 2000 problems or a timely
basis or at all; higher than expected Year 2000 remediation costs; the
difficulty or inability to enforce contractual commitments abroad; the failure
of InterDigital to successfully negotiate licensing agreements for
InterDigital's patents and other intellectual property or to enforce
InterDigital's rights under its license agreements; substantial increased costs
and other burdensome effects of legal and administrative cases and proceedings,
and the outcomes thereto, relating to InterDigital's assertion of its patents
rights, and other claims against InterDigital's patents or its products; the
inability or failure of InterDigital to protect its intellectual property
rights, including enforcing non-disclosure and non-competition agreements,
prosecuting key patent applications or defending key patents, and the inability
to successfully prove infringement of its patents. Other risk factors and
further explanations of certain of the above risk factors are included in the
foregoing "Management's Discussion and Analysis" and discussions of
InterDigital's "Business" contained in this Annual Report. In addition,
other factors may exist that may not be fully known to InterDigital at this
time. InterDigital undertakes no obligation to publicly update any forward
looking statements, whether as a result of new information, future events or
otherwise.
25
Item 8. INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Number
------
CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Public Accountants 27
Consolidated Balance Sheets 28
Consolidated Statements of Operations 29
Consolidated Statements of Shareholder's Equity 30
Consolidated Statements of Cash Flows 31
Notes to Consolidated Financial Statements 32
SCHEDULES:
Schedule II - Valuation and Qualifying Accounts 50
All other schedules are omitted because they are not required, are not
applicable or equivalent information has been included in the financial
statements and notes thereto
26
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To InterDigital Communications Corporation:
We have audited the accompanying consolidated balance sheets of
InterDigital Communications Corporation (a Pennsylvania corporation) and
subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
and the schedule referred to below are the responsibility of InterDigital's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of InterDigital Communications
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Philadelphia, PA
February 24, 1999
27
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
December 31,
---------------------------
1998 1997
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents, including restricted
cash of $143 and $193, respectively $ 20,059 $ 17,828
Short term investments 32,218 7,976
Accounts receivable, net of allowance for
doubtful accounts of $975 and $897, respectively 14,983 3,058
Inventories 5,102 12,284
Other current assets 3,056 5,428
--------- ---------
Total current assets 75,418 46,574
--------- ---------
Property, plant and equipment 9,697 11,373
Patents, net of accumulated amortization of
$6,701 and $5,579 respectively 9,948 9,292
Long term deposits 2,934 519
Other 1,526 1,605
--------- ---------
24,105 22,789
--------- ---------
$ 99,523 $ 69,363
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long term debt $ 723 $ 869
Accounts payable 5,973 8,223
Accrued compensation and related expenses 2,959 2,920
Deferred revenue 3,936 3,461
Foreign and domestic taxes payable 2,249 481
Other accrued expenses 4,826 7,717
--------- ---------
Total current liabilities 20,666 23,671
--------- ---------
LONG TERM DEBT 3,049 3,591
--------- ---------
DEFERRED REVENUE -- 3,596
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 10 and 11)
SHAREHOLDERS' EQUITY:
Preferred Stock, $ .10 par value, 14,399 shares
authorized -- $2.50 Convertible Preferred,
102 shares issued and outstanding 10 10
Common Stock, $.01 par value, 75,000 shares
authorized, 48,427 shares and 48,230 shares
issued and outstanding 484 482
Additional paid-in capital 235,631 234,765
Accumulated deficit (160,039) (196,752)
--------- ---------
76,086 38,505
Treasury stock, 50 shares held at cost 278 --
--------- ---------
Total shareholders' equity 75,808 38,505
--------- ---------
$ 99,523 $ 69,363
========= =========
The accompanying notes are an integral part of these statements.
28
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
------------------------------------
1998 1997 1996
------- -------- --------
REVENUES:
Product revenues $ 6,751 $ 43,854 $ 24,974
Licensing and strategic partner revenue 92,470 5,982 28,719
------- -------- --------
99,221 49,836 53,693
------- -------- --------
OPERATING EXPENSES:
Cost of product revenues 17,577 41,914 27,370
Sales and marketing 3,864 7,276 4,679
General and administrative 5,327 7,189 6,893
Patents administration and licensing 11,145 5,102 4,222
Product development 17,166 24,248 21,609
------- -------- --------
55,079 85,729 64,773
------- -------- --------
Income (loss) from operations 44,142 (35,893) (11,080)
OTHER INCOME (EXPENSE):
Interest income 2,454 2,070 4,151
Interest expense (367) (410) (271)
------ -------- --------
Income (loss) before income taxes and
minority interest 46,229 (34,233) (7,200)
INCOME TAX PROVISION (9,261) (34) (3,554)
------- -------- --------
Income (loss) before minority interest 36,968 (34,267) (10,754)
MINORITY INTEREST - - (890)
------- -------- --------
Net income (loss) 36,968 (34,267) (11,644)
PREFERRED STOCK DIVIDENDS (255) (256) (260)
------- -------- --------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS $36,713 $(34,523) $(11,904)
======= ======== ========
NET INCOME (LOSS) PER COMMON SHARE - BASIC $ 0.76 $ (0.72) $ (0.26)
======= ======== ========
NET INCOME (LOSS) PER COMMON SHARE - DILUTED $ 0.75 $ (0.72) $ (0.26)
======= ======== ========
The accompanying notes are an integral part of these statements.
29
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands except per share data)
$2.50 Additional
Convertible Common Paid-In Accumulated Treasury
Preferred Stock Stock Capital Deficit Stock Total
-----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 $ 11 $ 444 $ 212,310 $ (150,325) --- $ 62,440
Exercise of Common Stock options --- 4 2,311 --- --- 2,315
Exercise of Common Stock warrants --- 16 7,342 --- --- 7,358
Dividend of Common Stock and cash to
$2.50 Preferred shareholders --- --- 42 (260) --- (218)
Sale of Common Stock under Employee
Stock Purchase Plan --- 1 349 --- --- 350
Issuance of Common Stock associated
with the Patents Corp. merger --- 15 11,891 --- --- 11,906
Conversion of preferred stock to common (1) 1 --- --- --- ---
Net loss --- --- --- (11,644) --- (11,644)
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 10 481 234,245 (162,229) --- 72,507
Exercise of Common Stock options --- --- 17 --- --- 17
Exercise of Common Stock warrants --- --- 18 --- --- 18
Dividend of Common Stock and cash to
$2.50 Preferred shareholders --- --- 92 (256) --- (164)
Sale of Common Stock under Employee
Stock Purchase Plan --- 1 393 --- --- 394
Net loss --- --- --- (34,267) --- (34,267)
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 10 482 234,765 (196,752) --- 38,505
Exercise of Common Stock options --- 1 479 --- --- 480
Dividend of Common Stock and cash to
$2.50 Preferred shareholders --- --- 53 (255) --- (202)
Sale of Common Stock under Employee
Stock Purchase Plan --- 1 334 --- --- 335
Treasury Stock Acquired (278) (278)
Net income --- --- --- 36,968 --- 36,968
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ 10 $ 484 $ 235,631 $ (160,039) $ (278) $ 75,808
====================================================================================
30
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
-------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 36,968 $ (34,267) $ (11,644)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities-
Depreciation and amortization 4,629 4,855 3,747
Deferred revenue (3,121) (4,003) 4,803
Inventory reserve increase (decrease) 7,942 (107) (1,045)
Minority interest in subsidiary - - 890
Decrease (increase) in assets-
Receivables (11,925) 10,863 (10,764)
Inventories (760) 1,686 (7,965)
Other current assets (278) 1,846 (2,439)
Increase (decrease) in liabilities-
Accounts payable (2,250) (6,904) 10,814
Accrued compensation 39 632 (745)
Other accrued expenses (1,123) 1,555 1,053
-------- -------- --------
Net cash provided by (used in) operating activities 30,121 (23,844) (13,295)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale (purchase) of short-term investments, net (24,242) 35,087 11,997
Purchase of property and equipment (1,831) (3,927) (8,740)
Patent Costs (1,778) (966) (870)
Other non-current assets 314 (190) (319)
-------- -------- --------
Net cash provided by (used in) investing activities (27,537) 30,004 2,068
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sales of Common Stock
and exercises of stock options and warrants 815 429 10,025
Lease obligations incurred 251 452 4,667
Payments on long-term debt, including capital lease obligations (939) (1,003) (717)
Cash dividends on Preferred Stock (202) (164) (221)
Purchase of Treasury Stock (278) - -
-------- -------- --------
Net cash provided by (used in) financing activities (353) (286) 13,754
-------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,231 5,874 2,527
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 17,828 11,954 9,427
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 20,059 $ 17,828 $ 11,954
======== ======== ========
The accompanying notes are an integral part of these statements.
31
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. BACKGROUND:
InterDigital Communications Corporation and its subsidiaries (in these
Notes, collectively "InterDigital") develops and markets advanced digital
wireless telecommunications systems using both proprietary and standards
compliant technologies for voice and data communications. In conjunction with
its technology development, InterDigital has developed an extensive body of
technical know-how and a broad patent portfolio related to those technologies
and related product embodiments.
Through its technical know-how, patent portfolio and internal expertise,
InterDigital has entered into strategic relationships with four companies to
date, three of which are still on-going, based in large part on technology
development. (See Notes 3, 4, 5 and 18.) InterDigital and its B-CDMA Alliance
partners are developing a new air interface technology and products, based on
InterDigital's patented B-CDMA technology and other proprietary technologies.
The initial phases of the development effort are oriented towards development
and commercialization of wireless local loop systems. InterDigital's B-CDMA
Alliance partners are currently re-evaluating their commitment to the B-CDMA
Alliance. (See notes 4 and 5.) InterDigital has also entered into a cooperative
agreement which provides for the development of new technology for third
generation wireless communications products. (See note 18.) Companies with whom
InterDigital has strategic relationships also have licensed varying portions of
ITC's patent portfolio.
InterDigital, through ITC, has also sought to capitalize upon the revenue
potential of its patent portfolio through the implementation, starting in 1993,
of a comprehensive patent licensing strategy. This strategy has resulted in
patent license agreements with a total of eighteen companies as of December 31,
1998 and, together with InterDigital's strategy to align itself with other
telecommunications companies, has resulted in the recognition of $92.5 million,
$6.0 million and $28.7 million of licensing and strategic partner revenue in
1998, 1997, and 1996, respectively.
InterDigital's TDMA-based wireless local loop product is the UltraPhone
system, a telephone system providing business and households access to basic
telephone service through a wireless local loop. UltraPhone systems revenues
accounted for less than 5% of total revenues of InterDigital during 1998. In
1998, InterDigital restructured its operations to de-emphasize the UltraPhone
product and has reduced the carrying value of UltraPhone related inventory to
its net realizable value. InterDigital's new product, TrueLink, is a wireless
local loop product based on InterDigital's proprietary B-CDMA technology. This
product was commercially launched in Hannover, Germany at the CEBIT
telecommunications show in March 1998. Also in 1998, InterDigital and two of its
B-CDMA Alliance partners commenced field trials of systems embodying
InterDigital's B-CDMA technology at various sites. During 1998, InterDigital had
approximately $1.9 million of TrueLink product sales.
InterDigital's operations are subject to numerous risks and uncertainties,
including but not limited to, successful commercial development and deployment
of InterDigital's technologies and products based on those technologies. The
development of sustainable earnings growth is dependent upon many factors, such
as technological achievement, the continued validation of the theories upon
which the new technology is being designed, the effect of the Siemens withdrawal
from the B-CDMA Alliance, InterDigital's ability to continue working with its
other B-CDMA Alliance partners on acceptable terms or at all, the world market
for InterDigital's technologies and InterDigital's and its licensees' and
alliance partners' products, the ability to generate a satisfactory gross profit
on product revenues, uncertainty and volatility of future profitability, cash
flows and access to capital, dependence on alliance and strategic engineering
arrangements and key personnel, the continued validity of InterDigital's
patents, the continued availability of debt, equity, alliance partner or
strategic relationship funding sufficient to support an increasing level of
efforts over several years, and market acceptance of the resultant products,
among other factors.
32
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of InterDigital
and its subsidiaries. All significant inter-company accounts and transactions
have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted 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.
Cash, Cash Equivalents and Short-Term Investments
InterDigital considers all highly liquid investments purchased with
remaining maturities of three months or less to be cash equivalents. Investments
are held at amortized cost which approximates market value. At December 31,
1998, all of InterDigital's short-term investments are classified as available
for sale pursuant to Statement of Financial Accounting Standards ("SFAS") No.
115. "Accounting for Certain Investments in Debt and Equity Securities".
Therefore, any unrealized holding gains or losses should be presented in a
separate component of stockholders' equity. At December 31, 1998 and 1997, there
were no significant unrealized holding gains or losses.
Cash and cash equivalents consist of the following (in thousands):
December 31,
-------------------------
1998 1997
-------- ---------
Money market funds and demand accounts $ 3,160 $ 8,979
Repurchase agreements 516 7,856
Commercial paper 16,383 993
------ ------
$ 20,059 $ 17,828
======== ========
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, 1998 consisted
of $18.2 million in government-issued discount notes and $14.0 million in
corporate debt securities. Short-term investments available for sale as of
December 31, 1997 consisted of $2.6 million in government-issued discount notes
and $5.3 million in corporate debt securities.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
on a first-in, first-out basis and market based on net realizable value.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization of
property, plant and equipment are provided using the straight-line method. The
estimated useful lives for computer equipment, machinery
33
and equipment, and furniture and fixtures are generally three to five years.
Leasehold improvements are being amortized over their lease term, generally five
to ten years. The buildings are being depreciated over twenty-five years.
Depreciation expense was $3.5 million, $3.2 million, and $2.5 million in 1998,
1997 and 1996, respectively.
Patents
The costs to obtain certain patents for InterDigital's TDMA and CDMA
technologies have been capitalized and are being amortized on a straight-line
basis over their estimated useful lives, generally 10 years. Amortization
expense was $1.1 million, $1.4 million and $696,000 in 1998, 1997 and 1996,
respectively.
Product Development
All product development expenditures are charged to product development
expense in the period incurred.
Revenue Recognition
Product revenues are recognized upon shipment of systems. Installation,
training and other services are recognized upon completion of services.
Patent licensing revenues included in licensing and strategic partner
revenues consist primarily of up-front royalty payments and one-time,
non-refundable fees which were recognized at the time of the applicable
agreement. Strategic partner revenues included in licensing and strategic
partner revenues were generated by patent, technology and know-how licensing and
development agreements. Due to the combined nature of the agreements, revenue is
recognized over the performance period. Recurring royalty revenues under both
licensing and strategic partner agreements, to the extent received, may be
recognized in the future according to the terms of the agreements. (See Notes 3,
4, 5 and 18.)
Concentration of Credit Risk
Financial instruments which potentially subject InterDigital to
concentration of credit risk consist primarily of cash equivalents, short-term
investments, and accounts receivable. InterDigital places its cash equivalents
and short-term investments only in highly rated financial instruments and in
United States Government obligations. InterDigital's accounts receivable are
derived principally from sales of product and patent license agreements which
provide for deferred and/or installment payments. Approximately 87% of
InterDigital's 1998 product sales were export sales. (See Note 6.) InterDigital
generally requires a United States dollar irrevocable letter of credit for the
full amount of significant export sales to be in place at the time of shipment,
except in cases where credit risk is considered to be acceptable.
Impairment of Long-Lived Assets
Pursuant to SFAS No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of", InterDigital is required to
evaluate the impairment of long-lived assets and certain intangibles assets when
factors indicate that such assets should be evaluated for possible impairment.
InterDigital reviews the realizability of its long-lived assets by analyzing the
projected undiscounted cash flows. No such adjustments have been recorded in
1998, 1997 and 1996.
Net Income (Loss) Per Common Share
InterDigital follows SFAS No. 128. "Earnings per Share", which was
effective the year ended December 31, 1997. This statement requires the
disclosure of both basic and diluted earnings per share as well as the
retroactive restatement of prior years' per share disclosures. The following
tables reconcile the numerator and denominator of the basic and diluted net
income (loss) per share computations (in thousands, except for per share
data):
34
Year Ended December 31, 1998 Year Ended December 31, 1997
--------------------------------- ----------------------------------
Per-
Income Shares Per-Share Income Shares Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
---------- ------------- --------- ----------- ------------- -------
Income (Loss) per Share-Basic:
Income (loss) available to
common stockholders $36,713 48,380 $0.76 $(34,523) 48,166 $(0.72)
Effect of Dilutive Options and
Warrants -- 391 (0.01) -- -- --
------- ------ ----- -------- ------ ------
Income (Loss) per Share-Diluted
Income (loss) available to
common stockholders +
assumed conversions $36,713 48,771 $0.75 $(34,523) 48,166 $(0.72)
======= ====== ===== ======== ====== ======
Year Ended December 31, 1996
-------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
Income (Loss) per Share-Basic:
Income (loss) available to
common stockholders $(11,904) 46,462 $(0.26)
Effect of Dilutive Options and
Warrants -- -- --
-------- ------ ------
Income (Loss) per Share-Diluted
Income (loss) available to
common stockholders+
assumed converions $(11,904) 46,462 $(0.26)
======== ====== ======
At December 31, 1998 options and warrants to purchase 7.4 million shares of
Common Stock were outstanding at exercise prices ranging from $4.9375 to
$11.625, but were not included in the computation of diluted earnings per share
because the results would be anti-dilutive. Options and warrants (See Note 14)
to purchase Common Stock were outstanding during 1997 and 1996, but were not
included in the computation of diluted net income (loss) per share because they
are anti-dilutive.
Supplemental Cash Flow Information
In 1998 InterDigital paid $6.9 million in foreign withholding taxes and
$650,000 in federal and state income taxes. InterDigital paid $22,000 of federal
and state income taxes during 1997. In 1996, InterDigital paid $3.7 million, in
foreign withholding, federal and state income taxes. Additionally, InterDigital
paid $350,000, $362,000 and $253,000 of interest during 1998, 1997 and 1996,
respectively.
Reclassifications:
Certain prior period amounts have been reclassified to conform to the 1998
presentation.
35
3. SIEMENS AGREEMENTS:
On December 16, 1994, InterDigital entered into a Master Agreement and a
series of four related agreements, some of which were subsequently amended, as
elements of an integrated transaction establishing a broad based marketing and
technology alliance with Siemens.
As partial consideration for the rights and licenses granted by
InterDigital, Siemens agreed to pay $20 million, of which $15.1 million was paid
in cash, with the remaining payment offset against payments due to Siemens from
InterDigital in conjunction with the Samsung alliance. In accordance with
accounting requirements, InterDigital recognized the $20 million of revenue over
the contract performance period due to the combined nature of the contracts. All
revenues related to the rights and licenses granted by InterDigital to Siemens
were recognized prior to 1998. In 1997 and 1996 InterDigital recognized $1.6
million and $4.8 million, respectively, of revenue related to the Siemens
agreement.
In February of 1999 Siemens announced that it intends to withdraw from the
current B-CDMA development project. InterDigital and Siemens are in the process
of defining the process for Siemens' withdrawal from the project.
4. SAMSUNG AGREEMENTS:
On February 9, 1996, InterDigital entered into a series of agreements with
Samsung as a second major step in implementing its alliance strategy. Under the
various agreements, Samsung made up-front payments to InterDigital 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, InterDigital made, via offset certain payments to
Siemens, which in turn, committed to provide additional technical
assistance.(See Note 3.) The net up-front amount received by InterDigital, after
giving effect to the receipt of certain exemptions from Korean Service
Withholding Tax granted by the Korean Ministry of Information and
Communications, was approximately $29 million. Samsung is also obligated to
provide engineering manpower for the development of InterDigital'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. The
agreements give Samsung the right to manufacture and sell privately labeled
UltraPhone systems.
InterDigital recognized $3.4, $2.8 million and $23 million as revenue
during 1998, 1997 and 1996, respectively. The balance of the revenue is expected
to be recognized through fiscal 1999, the expected date of completion of the
applicable development effort. Samsung is currently re-evaluating its commitment
to its current B-CDMA product development effort. If it were to cease its
product development efforts, InterDigital would not expect to receive any
additional payments from Samsung.
5. ALCATEL AGREEMENTS:
On March 12, 1998, InterDigital entered into an Agreement with Alcatel
Espana for B-CDMA technology development, patent licensing, product development,
technology transfer, standards support and other areas of cooperation. Under the
terms of the Agreement, Alcatel agreed to pay technology transfer and services
fees of approximately $25 million. Of this fee, $5.4 million was paid in March
1998. The Agreement provides for payment of an additional $12.6 million based on
the achievement of certain product development and commercialization milestones.
The Agreement also provides for payment of the remaining fee in conjunction with
the purchase of B-CDMA ASICs (Application Specific Integrated Circuits)
through December 2003. In 1998 InterDigital recognized $4.6 million in revenue
related to the Alcatel agreement. Alcatel is currently re-evaluating its
commitment to the current B-CDMA development project. If it were to withdraw
from the project, InterDigital would not expect to recognize any additional
revenue from Alcatel.
6. MAJOR CUSTOMERS AND GEOGRAPHIC DATA:
Product Revenue
During 1998, 43% of InterDigital's product revenue was for shipments to
Namibia through an alliance partner. Direct sales to strategic partners
represented 28% of product revenue.
36
During 1997, InterDigital's Indonesian and Philippine customers accounted
for 75% and 7% of total product revenues, respectively. During 1996,
InterDigital's Philippine customer and its Indonesian customer accounted for 56%
and 16% of product revenues, respectively.
Due to the economic uncertainties in Asia, InterDigital does not expect any
significant orders from its Indonesian or Philippine customers in the near
future.
Product revenues by geographic area are as follows (in thousands):
Year Ended December 31,
---------------------------
1998 1997 1996
---- ---- ----
U.S. $ 911 $ 1,253 $ 1,958
Non-U.S. 5,840 42,601 23,016
-------- -------- --------
$ 6,751 $ 43,854 $ 24,974
======= ======== ========
Licensing and Strategic Partner Revenue:
In 1998, ITC entered into four new TDMA license agreements with Sharp
Corporation, Kyocera Corporation, Toshiba Corporation, and Denso Corporation,
and revised TDMA license agreements with Sanyo and Kokusai, and granted a CDMA
(including technology) license to Alcatel (See Note 5). In prior years, ITC had
granted non-exclusive, non-transferable, perpetual, worldwide, royalty-bearing
licenses to use certain TDMA patents (and in certain instances, technology) to
HNS, American Telephone & Telegraph Company, Siemens (see Note 3), Matsushita
Electric Industrial Co. Ltd., Sanyo Electric Co., Ltd., Pacific Communications
Systems Inc., Mitsubishi Electric Corporation, Hitachi Ltd., Kokusai Electric
Co., NEC Corporation, OKI, and Samsung (see Note 4). In prior years, ITC had
granted non-exclusive, non-transferable, perpetual, worldwide, royalty-bearing
licenses to use certain CDMA patents (and in certain instances, technology) to
Siemens, Samsung, Qualcomm and Advanced Digital Technologies. Many of these
licenses contain "most favored licensee" provisions, applied on a going forward
basis only, and provisions which could, in certain events, cause the licensee's
obligation to pay royalties to InterDigital to be suspended for an indefinite
period, with or without the accrual of the royalty obligation.
In 1998, InterDigital recognized $4.6 million and $3.4 million in revenue
related to the Alcatel and Samsung agreements, respectively. During 1998
InterDigital entered into four new TDMA licensing agreements and revised
agreements with two existing licensees. These licensing transactions resulted in
an additional $83.5 million of revenue in 1998. Additionally, recurring royalty
fees of $962,000 were recognized in 1998.
In 1997, InterDigital recognized $2.8 million in licensing and strategic
partner revenue from Samsung, $1.6 million from Siemens and $1.6 million of
recurring royalty revenue from one licensee. The 1996 licensing and strategic
partner revenues included $23.0 million from Samsung, $4.8 million from Siemens
and $900,000 of recurring royalty fees from one licensee.
7. PATENTS CORP.:
During the fourth quarter of 1992, InterDigital formed Patents Corp. and
contributed to Patents Corp. its entire ownership interest in ITC in return for
100% of its common stock. InterDigital had previously contributed all of its
past, present and future (conceived on or before February 2002) patent rights to
ITC. Subsequently, Patents Corp. issued 22 Units in a private placement at
$250,000 per Unit, receiving net proceeds of $5.2 million in return for 5.76% of
the ownership interest in Patents Corp.
During September 1996, InterDigital entered into an Agreement and Plan of
Merger (the "Plan of Merger") with Patents Corp. and IP Acquisition Corporation
("Merger Co"), a wholly-owned subsidiary of InterDigital, providing for the
merger of Merger Co with and into Patents Corp. (the "Merger") and the issuance
of approximately 1.5 million shares of InterDigital Common Stock to the
shareholders of Patents Corp. in exchange for their Patents Corp. Common Stock.
37
Upon completion of the Merger, Patents Corp. became a wholly-owned subsidiary of
InterDigital and $7.1 million, representing the excess of the fair value of
InterDigital Common Stock exchanged over the book value of the minority
interest, was assigned as additional Patents assets on the consolidated balance
sheet.
8. INVENTORIES:
December 31,
---------------------------
1998 1997
-------- --------
(In thousands)
Component parts and work-in-progress $ 2,958 $ 10,249
Finished goods 2,144 2,035
-------- ---------
$ 5,102 $ 12,284
======== =========
Inventories are stated net of valuation reserves of $13.7 million and $5.8
million as of December 31, 1998 and 1997, respectively. In 1998, InterDigital
recorded charges totaling $7.9 million to reduce the carrying value of its
inventory of UltraPhone components to its net realizable value, due to excess
inventories resulting from the cancellation of the Myanmar contract. Quantities
are now considered excess relative to the niche market for UltraPhone products.
9. PROPERTY, PLANT AND EQUIPMENT:
December 31,
---------------------------
1998 1997
-------- ---------
(In thousands)
Land, building & improvements $ 4,258 $ 4,231
Machinery and equipment 8,971 8,018
Computer equipment 7,484 6,699
Furniture and fixtures 2,806 2,771
Leasehold improvements 1,139 1,108
-------- ---------
24,658 22,827
Accumulated depreciation (14,961) (11,454)
-------- ---------
Net PP&E $ 9,697 $ 11,373
======== =========
38
10. LONG-TERM DEBT OBLIGATIONS:
December 31,
--------------------
1998 1997
---- ----
(In thousands)
Mortgage Debt $ 2,575 $ 2,673
Capitalized leases 1,197 1,787
-------- ---------
Total long-term debt obligations 3,772 4,460
Less -- Current portion (723) (869)
-------- ---------
$ 3,049 $ 3,591
======== =========
During 1996, InterDigital purchased its King of Prussia facility for $3.7
million, including cash of $930,000 and a 16 year mortgage of $2.8 million with
interest payable at a rate of 8.28% per annum.
Capitalized lease obligations are payable in monthly installments at an
average interest rate of 11.2%, through 2001. The net book value of equipment
under capitalized lease obligations is $1.7 million.
Maturities of principal of the long-term debt obligations as of December
31, 1998 are as follows (in thousands):
1999 $ 723
2000 449
2001 363
2002 149
2003 149
------
Thereafter 1,939
------
$3,772
======
11. COMMITMENTS AND CONTINGENCIES:
InterDigital has entered into various operating lease agreements, primarily
for office, assembly and warehouse space. Total rent expense was $1.4 million,
$1.3 million and $1.0 million for the years ended December 31, 1998, 1997 and
1996, respectively. Minimum future rental payments for operating leases as of
December 31, 1998 are as follows (in thousands):
1999 $ 1,991
2000 1,639
2001 1,625
2002 614
2003 412
Thereafter 1,167
--------
$ 7,448
========
Included in the minimum future rental payments is $167,000 for the lease
which expires in 1999, of InterDigital's former Great Neck, New York facilities
comprising 15,000 square feet and $206,000 per year for the lease of another New
York facility comprising approximately 38,000 square feet. InterDigital is
currently negotiating releases under one of these agreements. There can be no
assurance that InterDigital will be able to obtain this release. InterDigital
has recorded an accrual to cover expected facility expenses incurred through the
estimated date of release under the agreements. InterDigital does not expect an
additional material charge to expense related to this lease. If InterDigital
were not released from the aforementioned lease agreement, approximately $3.4
million would be payable under the leases through 2006.
39
Sole Source Suppliers
InterDigital currently buys several of its base station and subscriber
station components from sole source suppliers. A change in or loss of suppliers
or difficulties in the supply of components from said sources could cause a
delay in manufacturing and shipments, a possible loss of sales, and could cause
InterDigital to fail to fulfill certain performance obligations under current
customer contracts, which would affect operating results adversely.
Employment Agreements
InterDigital has entered into agreements with certain officers that provide
for the payment of severance pay benefits, among other things, in certain events
of termination of employment. Certain of these agreements generally provide for
the payment of severance up to a maximum of one year's salary (approximately
$1.9 million at December 31, 1998) and up to a maximum of one year's
continuation of medical and dental benefits. In certain of these agreements, in
the event of a termination or resignation within one year following a change of
control, which is defined as the acquisition, including by merger or
consolidation, or by the issuance by InterDigital of its securities, by one or
more persons in one transaction or a series of related transactions, of more
than fifty percent (50%) of the voting power represented by the outstanding
stock of InterDigital, the employee would generally receive two years of salary
(approximately $3.9 million at December 31, 1998) and the immediate vesting of
all stock options.
12. LITIGATION:
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") which
was subsequently transferred to the United States District Court for the
Northern District of Texas. 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 an injunction against Ericsson from infringement and
seeks damages, royalties, costs and attorneys' fees. 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 InterDigital and ITC in the United States District
Court for the Northern District of Texas (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 InterDigital and ITC
for tortious interference with contractual and business relations, defamation
and commercial disparagement, and Lanham Act violations. The Ericsson action and
the Texas action have been consolidated. ITC agreed to the dismissal without
prejudice of LM Ericsson.
In December 1997, Ericsson Inc., the successor to Ericsson GE and
Ericsson Radio, filed an action against ITC in the United States District Court
for the Northern District of Texas (the "1997 Texas action") seeking the court's
declaration that Ericsson Inc.'s products do not infringe two patents issued to
InterDigital earlier in 1997 as continuations of certain patents at issue in the
Texas action. Later that month, Ericsson Inc. filed an amended Complaint seeking
to include these two new patents in the Texas action in an effort to consolidate
the two cases. In January 1998, both Ericsson Inc. and InterDigital and ITC
filed motions requesting that Ericsson Inc.'s amended Complaint be allowed and
that the 1997 Texas action be dismissed, to which the Court agreed. During the
third quarter of 1998, Ericsson Inc. filed a Motion for Partial Summary
Judgement, with respect to which InterDigital has replied. The Court has not yet
ruled on this Motion. Also during the third quarter, the United States District
Court for the Northern District of Texas granted InterDigital's Motion to amend
its Counterclaim by adding four additional patents. The litigation is currently
in the discovery stage. InterDigital records expenses for fees related to
litigation as they are incurred.
40
13. PREFERRED STOCK:
The holders of the $2.50 Convertible Preferred Stock are entitled to
receive, when and as declared by the Board, cumulative annual dividends of $2.50
per share payable in cash or Common Stock (as defined) at the election of
InterDigital (subject to a cash election right of the holder), if legally
available. Such dividends are payable semiannually on June 1 and December 1. In
the event InterDigital fails to pay two consecutive semiannual dividends within
the required time period, certain penalties may be imposed. The $2.50
Convertible Preferred Stock is convertible into Common Stock at any time prior
to redemption at a conversion price of $12 per share (subject to adjustment
under certain conditions). In 1998, 1997 and 1996, InterDigital declared and
paid dividends on the $2.50 Convertible Preferred Stock of $255,000, $256,000
and $260,000, respectively. These dividends, were paid with cash of $202,000,
$162,000 and $218,000, and 8,860, 19,281 and 5,862 shares of Common Stock,
respectively.
Upon any liquidation, dissolution or winding up of InterDigital, the
holders of the $2.50 Convertible Preferred Stock will be entitled to receive,
from InterDigital's assets available for distributions to shareholders, $25 per
share plus all dividends accrued, before any distribution is made to the Common
shareholders. After such payment, the holders of the $2.50 Convertible Preferred
Stock would not be entitled to any other payments. The redemption price for each
share of $2.50 Convertible Preferred Stock is $25 per share.
The holders of the $2.50 Convertible Preferred Stock do not have any voting
rights except on those amendments to the Articles of Incorporation which would
adversely affect their rights, create any class or series of stock ranking
senior to or on a parity with the $2.50 Preferred, as to either dividend or
liquidation rights, or increase the authorized number of shares of any senior
stock. In addition, if two or more consecutive semiannual dividends on the $2.50
Preferred are not paid by InterDigital, the holders of the Preferred, separately
voting as a class, will be entitled to elect one additional director of
InterDigital.
14. COMMON STOCK OPTIONS PLANS AND WARRANTS
Common Stock Option Plans
InterDigital has granted options under two incentive stock option plans,
four non-qualified stock option plans and one plan which provides for grants of
both incentive and non-qualified stock options to non-employee directors,
officers and employees of InterDigital and certain others, depending on the
plan. One incentive stock option plan, three non-qualified stock option plans
and the plan that allows for both incentive and non-qualified stock options are
authorized to grant options for up to 600,000, 2,035,600, 1,500,000, 2,000,000
and 4,000,000 shares, respectively of InterDigital's Common Stock. No further
grants are allowed under the remaining stock option plans. The Board of
Directors or a Committee of the Board determines the number of options to be
granted. The option prices are determined based on market prices in accordance
with the terms of the plans. Under the terms of the incentive stock option plan,
the option price cannot be less than 100% of fair market value of the Common
Stock at the date of grant and incentive stock options granted become
exercisable at 20% per year beginning one year after date of grant and generally
remain exercisable for 10 years. Under the non-qualified option plans, options
are generally exercisable for a period of 10 years from the date of grant and
may vest on the grant date, another specified date or over a period of time. All
options granted under the plan which provides for both incentive and
non-qualified stock options to non-employee directors and grants awarded to
inventors most commonly vest in six bi-annual installments. All incentive
options granted under such plan have exercise prices of not less than 100% of
the fair market value of the Common Stock on the grant date in accordance with
Internal Revenue Code requirements.
Information with respect to stock options under the above plans is
summarized as follows (in thousands, except per share amounts):
41
Available Weighted
for Outstanding Options Average
Grant Number Price Range Exercise Price
--------- ------ -------------- --------------
BALANCE AT DECEMBER 31, 1995 6,378 4,014 $.01-$14.875 $7.01
Granted (862) 862 $5.625-$11.53 7.79
Canceled 88 (88) $.60-$14.875 9.93
Exercised -- (399) $.60-$8.875 5.75
----- ----- -------------- -----
BALANCE AT DECEMBER 31, 1996 5,604 4,389 $.01-$14.875 7.14
Granted (2,539) 2,539 $4.375-$5.688 5.45
Canceled 879 (879) $5.250-$14.500 9.15
Exercised -- (3) $0.600-$5.625 4.79
----- ----- -------------- -----
BALANCE AT DECEMBER 31, 1997 3,944 6,046 $.01-$11.625 6.14
Granted (608) 608 $3.250-5.6875 5.04
Canceled 715 (715) $5.375-$10.750 3.13
Exercised -- (153) $0.600-5.625 3.13
----- ----- -------------- -----
BALANCE AT DECEMBER 31, 1998 4,204 5,786 $01-$11.625 $6.05
===== ===== ============== =====
InterDigital has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Accordingly, no compensation cost has been
recognized in the Statements of Operations for InterDigital's stock option
plans. Had compensation cost been calculated based on the fair value at the
grant date for awards in 1998, 1997 and 1996 consistent with the provision of
SFAS No. 123, InterDigital's net income (loss) and net income (loss) per share
would have been changed to the following pro forma amounts:
1998 1997 1996
------- --------- -------
Net income (loss) applicable to Common
Shareholder-as reported $36,713 $(34,523) $(11,904)
Net income (loss) applicable to Common
Shareholders - pro forma $32,837 $(37,894) $(13,757)
Net income (loss) per share - as reported - basic $ 0.76 $ (0.72) $ (0.26)
Net income (loss) per share - as reported - diluted $ 0.75 $ (0.72) $ (0.26)
Net income (loss) per share - pro forma - basic $ 0.68 $ (0.79) $ (0.30)
Net income (loss) per share - pro forma - diluted $ 0.67 $ (0.79) $ (0.30)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1998, 1997 and 1996; no dividend yield; expected
volatility of 83% for 1998, 70% for 1997, and 80% for 1996, risk-free interest
rates of approximately 5.22%, 6.24 % and 6.25% for 1998, 1997 and 1996,
respectively, and an expected option life of 3.05 years for 1998 and 3.72 years
for 1997 and 1996. The weighted average fair value at the date of grant for
options granted during 1998, 1997 and 1996 is estimated as $5.04, $2.89 and
$5.11 per share, respectively. The pro forma effect on net income (loss) for
1998, 1997 and 1996 is not representative of the pro forma effect on net income
(loss) in future years because it does not take into consideration pro forma
compensation expense related to grants made prior to 1995.
42
The following table summarizes information regarding the stock options
outstanding at December 31, 1998 (in thousands, except per share amounts):
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of As of Contractual Exercise As of Exercise
Exercise Prices 12/31/98 Life Price 12/31/98 Price
- --------------- ----------- ----------- -------- ----------- --------
$ 0.01-$ 5.38 1,151 6.96 $ 4.15 915 $ 3.95
$ 5.44-$ 5.44 1,928 8.72 $ 5.44 981 $ 5.44
$ 5.50-$ 6.00 1,173 10.18 $ 5.73 906 $ 5.75
$ 6.13-$ 7.69 741 7.17 $ 7.08 703 $ 7.05
$ 7.75-$11.50 538 13.97 $ 8.92 537 $ 8.92
$11.63-$11.63 255 45.95 $11.63 255 $11.63
----- ----- ------ ----- ------
$ 0.01-$11.63 5,786 9.87 $ 6.05 4,297 $ 6.26
===== ===== ====== ===== ======
Common Stock Warrants
As of December 31, 1998, in addition to the option plans discussed above,
InterDigital has various warrants outstanding to purchase 3,574,000 shares of
Common Stock at exercise prices ranging from $2.50 to $10.00 per share, with a
weighted average exercise price of $5.37 per share. As of December 31, 1998, all
of these warrants are currently exercisable. These warrants expire in various
years through 2006. The exercise price and number of shares of Common Stock to
be obtained upon exercise of certain of these warrants are subject to adjustment
under certain conditions.
15. SHAREHOLDER RIGHTS PLAN:
In December 1996, InterDigital's Board of Directors declared a distribution
under its Shareholder Rights Plan of one right for each outstanding common share
of InterDigital to shareholders of record as the close of business on January 3,
1997. In addition, any new common shares issued after January 4, 1997 will
receive one right for each common share. Each right entitles shareholders to buy
one one-thousandth of a share of Series B Junior Participating Preferred Stock
at a purchase price of $45 per share, subject to adjustment. Ordinarily, the
rights will not be exercisable until 10 days after a non-exempt person or group
owns or acquires more than 15% of InterDigital's outstanding Common Stock or a
non-exempt person or group begins an offer for 15% or more of InterDigital's
outstanding Common Stock. In general, in the event that InterDigital is acquired
in a merger or other business combination interaction, each holder of a right
will have the right to receive, upon exercise, Units of Preferred Stock (or, in
certain circumstances, Company Common Stock, cash, property, or other securities
of InterDigital) having a current market value equal to two times the exercise
price of the Right.
16. RELATED-PARTY TRANSACTIONS:
During 1996, InterDigital utilized as a consultant the son of an executive
officer and member of the Board of Directors. He was paid $72,000, for these
consulting services and was reimbursed certain traveling expenses.
17. INCOME TAXES:
The 1998 income tax provision includes a federal alternative minimum tax
provision of $860,000, a foreign withholding tax provision of $8.35 million, and
a current state tax provision of $100,000, partially offset by a state tax
refund of $49,000. The 1997 income tax provision includes a current state tax
provision of $34,000. The 1996 income tax provision includes a current foreign
withholding tax provision of $3.3 million and a current state tax provision of
$133,000. At December 31, 1998, InterDigital had net operating loss
carryforwards of approximately $96.7 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 December 31,
1998.
43
The net operating loss carryforwards are scheduled to expire as follows:
2002 $ 7.9 million
2003 18.2 million
2004 20.0 million
2005 11.9 million
thereafter 38.7 million
---------------
$ 96.7 million
===============
Pursuant to the Tax Reform Act of 1986, annual use of InterDigital'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 InterDigital'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. InterDigital believes that no ownership change for
purposes of Section 382 occurred up to and including December 31, 1998.
InterDigital'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.
18. SUBSEQUENT EVENT (unaudited):
On January 22, 1999, InterDigital entered into an agreement with Nokia
involving the development of new technology for third generation wireless
telecommunications products designed for high data rate applications, such as
Internet access. The agreement includes royalty bearing TDMA and CDMA patent
licenses, which are paid up generally through the project period, and provides a
structure for determining the royalty payments thereafter. In the first quarter
of 1999, InterDigital recorded $31.5 million as licensing revenue relative to
the Nokia agreement.
44
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Cash Equivalents and Investments. InterDigital does not use derivative
financial instruments in its investment portfolio. InterDigital places its
investments in instruments that meet high credit quality standards, as specified
in InterDigital's investment policy guidelines This policy also limits the
amount of credit exposure to any one issue, issuer, and type of instrument.
InterDigital does not expect any material loss with respect to its investment
portfolio.
The following table provides information about InterDigital's investment
portfolio. For investment securities, the table presents principal cash flows
and related weighted average interest rates by expected maturity dates. All
investment securities are expected to mature in 1999.
(in thousands)
Cash equivalents .................... $20,059
Average interest rate ............ 5.28%
Short-term investments .............. 32,218
Average interest rate ............ 4.96%
Total portfolio ..................... $52,272
Average interest rate ............ 5.08%
Long-term Debt The table below sets forth information about InterDigital's
long-term debt obligation, by expected maturity dates.
1999 2000 2001 2002 2003 and beyond Total Fair Value
-------- -------- -------- -------- --------------- ---------- ----------
Fixed Rate $723,000 $449,000 $363,000 $149,000 $2,088,000 $3,772,000 $3,772,000
Weighted Average Interest Rate 9.71% 8.51% 7.41% 8.30% 8.28% 8.50%
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
45
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF INTERDIGITAL
Information concerning executive officers appears under the caption Item 1.
"Business- Executive Officers of InterDigital" in Part I of this Form 10-K.
Information concerning directors is incorporated by reference herein from the
information following the caption "ELECTION OF DIRECTORS -Nominees for Election
to the Board of Directors for a Three Year Term Expiring at 2001 Annual Meeting"
to but not including "-Committees and Meetings of the Board of Directors" in
InterDigital's proxy statement to be filed with the Commission within 120 days
after the close of InterDigital's fiscal year ended December 31, 1998 and
forwarded to shareholders prior to the 1999 annual meeting of shareholders (the
"Proxy Statement").
Information in the two paragraphs immediately following the caption
"Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the
Proxy Statement is incorporated by reference herein.
Item 11. EXECUTIVE COMPENSATION
Information following the caption "Executive Compensation -Summary
Compensation Table" to but not including the caption "Shareholder Return
Performance Graph" and information following the caption "Compensation Committee
Interlocks and Insider Participation" in the Proxy Statement is incorporated by
reference herein.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information following the caption "Security Ownership of Certain Beneficial
Owners" to but not including the caption "Compensation Committee Interlocks and
Insider Participation" in the Proxy Statement is incorporated by reference
herein.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
46
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) The following documents are filed as part of this Form 10-K:
(1) Financial Statements.
(2) Financial Statement Schedule.
The Index to Financial Statements and Schedules and the Financial
Statements begin on page 26.
(3) Exhibits.
*2.1 Plan of Merger by and among InterDigital, Patents Corp. and
Merger Co. dated as of August 16, 1996 (Exhibit 2 to
InterDigital's Registration Statement No. 333-10521 filed on
August 20, 1996).
*3.1 Restated Articles of Incorporation. (Exhibit 3.1 to
InterDigital's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1996 (the "September 1996 Form 10-Q)).
*3.2 By-laws, as amended October 6, 1996 (Exhibit 3.2 to the September
1996 Form 10-Q).
*4.1 Rights Agreement between InterDigital and American Stock Transfer
& Trust Co. ("AST")(Exhibit 4 to InterDigital's Current Report
on Form 8-K filed on December 13, 1987).
*4.2 Amendment No. 1 to the Rights Agreement AST (Exhibit 4.2 to
InterDigital's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 1997 (the "June 1997 Form 10-Q")).
*4.3 Amendment No. 2 to the Rights Agreement between InterDigital and
AST (Exhibit 4.3 to the June 1997 Form 10-Q).
*10.1 Non-Qualified Stock Option Plan, as amended (Exhibit 10.4 to
InterDigital's Annual Report on Form 10-K for the year ended
Decembeer 31, 1991).
*10.2 Intellectual Property License Agreement between InterDigital and
Hughes Network Systems, Inc. (Exhibit 10.39 to InterDigital's
Registration Statement No. 33-28253 filed on April 18, 1989).
*10.3 1992 License Agreement dated February 29, 1992 between
InterDigital and Hughes Network Systems, Inc. (Exhibit 10.3 to
InterDigital's Current Report on Form 8-K dated February 29,
1992 (the "February 1992 Form 8-K)).
10.4 E-TDMA License Agreement dated February 29, 1992 between
InterDigital and Hughes Network Systems, Inc. (Exhibit 10.4
to the February 1992 Form 8-K).
*10.5 1992 Non-Qualified Stock Option Plan (Exhibit 10.1 to
InterDigital's Current Report on Form 8-K dated October 21,
1992).
*10.6 1992 Employee Stock Option Plan (Exhibit 10.71 to InterDigital's
Annual Report on Form 10-K for the year ended December 31, 1992).
*10.7 1995 Employee Stock Option Plan, as amended (Exhibit 10.7 to
InterDigital's Annual Report on Form 10-K for the year ended
December 31,1997 (the "1997 Form 10-K")).
*10.8 1997 Stock Option Plan for Non-Employee Directors (Exhibit
10.34 to InterDigital's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1997 (the "September 1997
Form 10-Q")).
47
*10.9 Amendment #2 to the Employee Stock Purchase Plan (Exhibit 10.9
to the 1997 Form 10-K).
*10.10 Amendment #1 to the Employee Stock Purchase Plan (Appendix to
InterDigital's Proxy Statement filed May 23, 1996).
*10.11 Employee Stock Purchase Plan (Exhibit 10.52 to InterDigital's
Registration Statement No. 33- 65630 filed on June 6, 1993).
*10.12 Master Agreement among InterDigital, ITC, and Siemens dated
December 16, 1994 (Exhibit 99.1 to InterDigital's Current
Report on Form 8-K dated December 16, 1994 the
("December 1994 8-K)). **
*10.13 Patent License Agreement among InterDigital, ITC and Siemens
dated December 16, 1994 (Exhibit 99.2 to the December 1994
Form 8-K). **
*10.14 TDMA/CDMA Development and Technical Assistance Agreement
between InterDigital and Siemens dated December 16, 1994
(Exhibit 99.3 to the December 1994 Form 8-K). **
*10.15 Cooperation Agreement between InterDigital and Siemens dated
December 1994 (Exhibit 99.5 to the December 16, 1994
Form 8-K). **
*10.16 ASIC Design and Development Agreement dated February 12, 1996
by and between InterDigital Communications Corporation
and LSI Logic Corporation (Exhibit 10.19 to InterDigital's
Annual Report on Form 10-K for the year ended December 31,
1996 (the "1996 Form 10-K")).
*10.17 Employment Agreement dated February 25, 1997 by and between
InterDigital Communications Corporation and Howard E.
Goldberg (Exhibit 10.24 to the 1996 Form 10-K).
*10.18 Employment Agreement dated November 20, 1996 by and between
InterDigital Communications Corporation and William A. Doyle
(Exhibit 10.25 to the 1996 Form 10-K).
*10.19 Employment Agreement dated November 18, 1996 by and between
InterDigital Communications Corporation and Charles Tilden
(Exhibit 10.26 to the 1996 Form 10-K).
*10.20 Severance Benefit Agreement dated April 26, 1996 by and between
InterDigital Communications Corporation and D. Ridgely Bolgiano
(Exhibit 10.27 to the 1996 Form 10-K).
*10.21 Severance Benefit Agreement dated April 26, 1996 by and between
InterDigital and Mark Lemmo (Exhibit 10.32 to InterDigital's
Quarterly Report on Form 10-Q for the quarterly period ended
March 30, 1997).
*10.22 Employment Agreement dated June, 1997 by and between
InterDigital and Joseph Gifford (Exhibit 10.33 to the September
1997 Form 10-Q).
10.23 Employment Agreement dated September 3, 1998 by and between
InterDigital and William Merritt.
10.24 Employment Agreement dated November 16, 1998 by and between
InterDigital and Richard Fagan.
48
21 Subsidiaries of InterDigital.
23.1 Consent of Arthur Andersen LLP.
27 Financial Data Schedule.
---------------
* Incorporated by reference to the previous filing indicated.
** Confidential treatment has been granted for portions of these agreements.
(b) Reports filed on Form 8-K during the last quarter of 1998:
InterDigital filed a Current Report on Form 8-K dated November 2, 1998
under Item 5 - Other Events relating to its license agreement with
Denso Corporation. No financial statements were filed with this report.
49
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Charged
Balance at to Costs Balance at
Beginning of and End of
Description Period Expenses Deductions Period
----------- ------------ -------- ---------- --------
1998
- ----
Allowance for uncollectible accounts $897 $ 84 $ 6 $975
1997
- ----
Allowance for uncollectible accounts $558 $508 $169 $897
1996
- ----
Allowance for uncollectible accounts $340 $339 $121 $558
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, InterDigital has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 30th day of
March, 1999.
INTERDIGITAL COMMUNICATIONS
CORPORATION
By: /s/ William A. Doyle
-----------------------------
William A. Doyle
President and Principal Executive Officer
By: /s/ R.J. Fagan
-----------------------------
Richard J. Fagan
Senior Vice President and
Chief Financial Officer
51
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of InterDigital and
in the capacities and on the dates indicated.
Date: March 30,1999 /s/ D. Ridgely Bolgiano
--------------------------------
D. Ridgely Bolgiano, Director
Date: March 30,1999 /s/ Harry Campagna
--------------------------------
Harry Campagna, Director
Date: March 30,1999 /s/ William A. Doyle
--------------------------------
William A. Doyle, Director
Date: March 30,1999 /s/ Robert Roath
--------------------------------
Robert Roath, Director
Date: March 30,1999 /s/ Joseph S. Colson, Jr.
--------------------------------
Joseph Colson, Director
52
EXHIBIT INDEX
Exhibit
No. Description
10.23 Employment Agreement dated September 3, 1998 by and between
InterDigital and William Merritt.
10.24 Employment Agreement dated November 16, 1998 by and between
InterDigital and Richard Fagan.
21 Subsidiaries of InterDigital.
23.1 Consent of Arthur Andersen LLP.
27 Financial Data Schedule.
53