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IDCC > SEC Filings for IDCC > Form 10-Q on 25-Oct-2012All Recent SEC Filings

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Form 10-Q for INTERDIGITAL, INC.


25-Oct-2012

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
The following discussion should be read in conjunction with the unaudited, condensed consolidated financial statements and notes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q, in addition to our 2011 Form 10-K, other reports filed with the SEC and the Statement Pursuant to the Private Securities Litigation Reform Act of 1995 - Forward-Looking Statements below. Please refer to the Glossary of Terms in our 2011 Form 10-K for a list and detailed descriptions of the various technical, industry and other defined terms that are used in this Quarterly Report on Form 10-Q. Patent Sales
On September 6, 2012, we announced that certain of our subsidiaries have completed the sale of approximately 1,700 patents and patent applications, including approximately 160 issued U.S. patents and approximately 40 U.S. patent applications, to Intel Corporation ("Intel") for $375.0 million. The sale agreement involved patents primarily related to 3G, LTE and 802.11 technologies. Upon completion of the transaction in third quarter 2012, we recognized $375.0 million as patent sales revenue and $15.6 million as patent sales expense, which was recorded within the patent administration and licensing line on our condensed consolidated statements of income. Included in the patent sales expense was the remaining net book value of the patents sold, as well as commissions and legal and accounting services fees paid in conjunction with the sale.
We intend to pursue additional patent sale opportunities as part of our expanded strategy. However, we are unable to predict the timing and magnitude of any such sales due to the nature of the sales cycle for such transactions. Patent Licensing
Patent licensing royalties of $58.4 million in third quarter 2012 decreased $4.0 million or 6% over second quarter 2012. This sequential decrease was primarily driven by a $5.7 million decrease in royalties from our Japanese per-unit licensees resulting from lower shipments. Technology Solutions
We are engaged in arbitration to determine whether royalties are owed on specific product classes pursuant to one of our technology solutions agreements. The arbitration hearing took place in late June 2012, and a decision is expected in late 2012. As of September 30, 2012, we have deferred related revenue of $40.1 million pending the resolution of this arbitration and recorded such amount within short-term deferred revenue since we expect a decision within the next twelve months. This amount has either been collected or recorded in accounts receivable as of the current balance sheet date. Business Update
On October 23, 2012, we announced a further expansion of the corporate strategy announced in January 2012. The expansion includes enhancing our technology sourcing to broaden the scope of technology areas addressed and establishing a unit, InterDigital Solutions, dedicated to monetizing the company's market-ready technologies and research capabilities. The augmented sourcing function will be subdivided into two main areas:
• Innovation Partners, a new sourcing model based around partnerships with leading inventors and research organizations, as well as the acquisition of technology and patent portfolios that align with InterDigital's roadmap; and

• Innovation Labs, which will continue to pursue internally funded technology with the goal of further building the company's already strong portfolio of intellectual property.

The newly formed InterDigital Solutions unit will focus on commercializing market-ready technologies that emerge from Innovation Labs - such as the company's Smart Access Manager, M2M technology, and SlimChip modem IP.


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As part of our ongoing expense management, we also announced that we initiated a voluntary early retirement program in September 2012. This program rewards longtime contributors to the company's success while enabling the company to refocus resources on targeted new research areas. Approximately 50 employees are expected to retire from employment with the company under the program. We expect to incur a related one-time repositioning cost of between $10 million and $12 million, and expect that the majority of that charge will be recognized in fourth quarter 2012, with the remainder being recognized in first quarter 2013. Beginning in 2013, we expect to realize annualized savings as a result of this program in excess of $10 million.
For more information about the voluntary early retirement program, see Part II, Item 5 "Other Information," of this Quarterly Report on Form 10-Q. Intellectual Property Enforcement
Please see Note 5, "Litigation and Legal Proceedings," in the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a full discussion of the following and other matters:

Nokia, Huawei and ZTE U.S. International Trade Commission ("USITC") Proceeding and Related Delaware District Court Proceeding

On July 26, 2011, InterDigital's wholly-owned subsidiaries InterDigital Communications, LLC, InterDigital Technology Corporation and IPR Licensing, Inc. (collectively, the "Company," "InterDigital," "we," or "our" for the purposes of the discussion of this matter) filed a complaint with the USITC against Nokia Corporation and Nokia Inc. (collectively, "Nokia"), Huawei Technologies Co., Ltd. and FutureWei Technologies, Inc. d/b/a Huawei Technologies (USA) (collectively, "Huawei") and ZTE Corporation and ZTE (USA) Inc. (collectively, "ZTE" and together with Nokia and Huawei, "Respondents"), alleging that they engaged in unfair trade practices by selling for importation into the United States, importing into the United States, and/or selling after importation into the United States, certain 3G wireless devices that infringe seven of InterDigital's U.S. patents (the "Asserted Patents"). The action also extends to certain WCDMA and cdma2000® devices incorporating WiFi functionality. On August 31, 2011, the USITC formally instituted an investigation against Respondents. On May 1, 2012, Huawei Device USA, Inc. was added as a Respondent. On October 5, 2011, InterDigital filed a motion requesting that the USITC add LG Electronics, Inc., LG Electronics U.S.A., Inc. and LG Electronics Mobilecomm U.S.A., Inc. (collectively, "LG") as Respondents to the Company's USITC complaint and the USITC investigation, and that the USITC add an additional patent to the USITC complaint and investigation as well. On December 5, 2011, the Administrative Law Judge ("ALJ") granted this motion, and on December 21, 2011 the USITC determined not to review the ALJ's determination, thus adding the LG entities as Respondents and including allegations of infringement of the additional patent. On January 20, 2012, LG filed a motion to terminate the USITC investigation as it relates to the LG entities alleging there is an arbitrable dispute. The ALJ granted LG's motion on June 4, 2012, and on July 6, 2012, the Commission determined not to review the ALJ's order and partially terminated the investigation as to LG. On August 27, 2012, InterDigital filed a petition for review in the U.S. Court of Appeals for the Federal Circuit of the ALJ's June 4, 2012 order.
On September 10, 2012, the ALJ set a new date for the evidentiary hearing of February 12 to February 22, 2013 and the due date for the ALJ's Final Initial Determination of June 28, 2013. The target date for completion of the investigation was extended to October 28, 2013.
On the same date that InterDigital filed the present USITC action (referenced above), we also filed a parallel action in the United States District Court for the District of Delaware (the "Delaware District Court") against the Respondents alleging infringement of the same Asserted Patents identified in the USITC complaint. On October 3, 2011, InterDigital amended the Delaware District Court complaint, adding LG as a defendant and adding the same additional patent that InterDigital requested be added to the USITC complaint referenced above. The Delaware District Court action has been stayed pending the parallel proceedings in the USITC.

Prior Nokia USITC Proceeding/Federal Circuit Appeal On August 1, 2012, the Federal Circuit issued its decision in the appeal, holding that the Commission had erred in interpreting the claim terms at issue and reversing the Commission's finding of non-infringement. The Federal Circuit adopted InterDigital's interpretation of such claim terms and remanded the case back to the Commission for further proceedings. In addition, the Federal Circuit rejected Nokia's argument that InterDigital did not satisfy the domestic industry requirement. On September 17, 2012, Nokia filed a combined petition for rehearing by the panel or en banc with the Federal Circuit. The petition seeks review only on the domestic industry issue. On September 24, 2012, the Federal Circuit invited responses from InterDigital and the Commission to Nokia's petition. On October 9, 2012, InterDigital and the Commission filed their respective responses to Nokia's petition. If the Federal Circuit denies Nokia's petition, the Federal Circuit will issue its mandate remanding the case for further proceedings by the Commission. Nokia may petition the U.S. Supreme Court for a writ of


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certiorari within 90 days after denial of its request for rehearing. Comparability of Financial Results
When comparing third quarter 2012 financial results against other periods, the following items should be taken into consideration:
•Our third quarter 2012 revenue includes:
? $375.0 million of revenue associated with the Intel patent sale; and ?$1.0 million of past sales related to a new patent license agreement signed during the quarter;
•Our third quarter 2012 operating expenses include:
?lower accrual rates, as compared to third quarter 2011, for two of the three active cycles under our Long-Term Compensation Program ("LTCP"); and ?$15.6 million of expense related to the Intel patent sale.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in our 2011 Form 10-K. A discussion of our critical accounting policies, and the estimates related to them, are included in Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2011 Form 10-K. Except as outlined below, there have been no material changes in our existing critical accounting policies from the disclosures included in our 2011 Form 10-K. Refer to Note 1, "Basis of Presentation," in the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for updates related to new accounting pronouncements. Revenue Recognition
During the current year, we expanded our business strategy of monetizing our intellectual property to include the sale of select patent assets. As patent sales executed under this expanded strategy represent a component of our ongoing major or central operations and activities, we will record the related proceeds as revenue. We will recognize the revenue when there is persuasive evidence of a sales arrangement, fees are fixed or determinable, delivery has occurred, and collectability is reasonably assured. These requirements are generally fulfilled upon closing of the patent sale transaction.
FINANCIAL POSITION, LIQUIDITY AND CAPITAL REQUIREMENTS Our primary sources of liquidity are cash, cash equivalents and short-term investments, as well as cash generated from operations. We have the ability to obtain additional liquidity through debt and equity financings. Based on our past performance and current expectations, we believe our available sources of funds, including cash, cash equivalents and short-term investments and cash generated from our operations, will be sufficient to finance our operations, capital requirements, debt obligations, existing stock repurchase program and dividend program in the next twelve months.
On April 4, 2011, we completed an offering of $230.0 million in aggregate principal amount of 2.50% Senior Convertible Notes due 2016 (the "Notes"). The net proceeds from the offering were approximately $222.0 million, after deducting the initial purchaser's discount and offering expenses. A portion of the net proceeds of the offering were used to fund the cost of the convertible note hedge transactions entered into in connection with the offering of the Notes. We expect to use the remaining net proceeds from the offering for general corporate purposes, which may include, among other things: acquisitions of intellectual property-related assets or businesses or securities in such businesses; capital expenditures; and working capital. Refer to Note 8, "Long-Term Debt," in the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a more detailed discussion of the Notes.
As discussed above in the "Overview" section, on September 6, 2012, we announced that we have completed the sale of approximately 1,700 patents to Intel Corporation for $375.0 million in cash. Upon the closing of the transaction in third quarter 2012, we received $375.0 million of cash and recorded this amount as revenue. Driven by this transaction, we expect to make an estimated federal tax payment of approximately $80 million in fourth quarter 2012. We intend to use the net proceeds from the sale to fund our existing stock repurchase program and for other general corporate purposes. Cash, cash equivalents and short-term investments At September 30, 2012 and December 31, 2011, we had the following amounts of cash, cash equivalents and short-term investments (in thousands):


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                                                                                               Increase /
                                              September 30, 2012       December 31, 2011       (Decrease)
Cash and cash equivalents                   $            520,892     $           342,211     $     178,681
Short-term investments                                   260,435                 335,783           (75,348 )
Total Cash and cash equivalents and
short-term investments                      $            781,327     $           677,994     $     103,333

The increase in cash, cash equivalents and short-term investments was primarily attributable to $300.4 million of cash provided by operating activities, and was partially offset by repurchases of common stock of $152.7 million, $35.5 million in capital investments and patent acquisitions, and $13.4 million of dividend payments.
Cash flows provided by (used in) operations We generated or used the following cash flows from our operating activities in first nine months 2012 and 2011 (in thousands):

                                                        For the Nine Months Ended September 30,
                                                                                        Increase /
                                                          2012             2011         (Decrease)
Net cash provided by (used in) operating activities $      300,422     $  (32,560 )   $    332,982

The positive operating cash flow during first nine months 2012 was derived principally from cash receipts of $440.9 million from patent sales, and patent license and technology solutions agreements. We received $380.0 million of patent sales payments, $39.9 million of per-unit royalty payments, including past sales, current royalties and prepayments, from existing customers and new licensees and $8.0 million of fixed fee payments. Cash receipts from our technology solutions agreements totaled $13.0 million, primarily related to royalties and other license fees associated with our SlimChip modem core. These cash receipts and other changes in working capital were partially offset by cash operating expenses (operating expenses less depreciation of fixed assets, amortization of patents, non-cash compensation, accretion of debt discount, and amortization of financing costs) of $144.3 million, cash payments for short-term and long-term incentive compensation of $10.3 million, estimated federal tax payments of $6.5 million and cash payments for foreign source withholding taxes of $1.4 million.

Cash used in operating activities during first nine months 2011 included cash operating expenses (operating expenses less depreciation of fixed assets, amortization of patents, non-cash compensation, accretion of debt discount, impairment of long-term investments, and amortization of financing costs) of $95.8 million, cash payments for short-term and long-term incentive compensation of $20.1 million, estimated federal tax payments of $19.0 million, and cash payments for foreign source withholding taxes of $4.8 million. These items were partially offset by $101.4 million of cash receipts from patent license and technology solutions agreements along with other changes in working capital. We received $21.1 million of fixed fee payments and $59.5 million of per-unit royalty payments, including past sales and prepayments, from existing customers and a new customer. Cash receipts from our technology solutions agreements totaled $20.8 million, primarily related to royalties and other license fees associated with our SlimChip modem core.

Working capital
We believe that working capital, adjusted to exclude cash, cash equivalents, short-term investments, and current deferred revenue provides additional information about non-cash assets and liabilities that might affect our near-term liquidity. While we believe cash and short-term investments are important measures of our liquidity, the remaining components of our current assets and current liabilities, with the exception of deferred revenue, could affect our near-term liquidity and or cash flow. We have no material obligations associated with our deferred revenue, and the amortization of deferred revenue has no impact on our future liquidity and or cash flow. Our adjusted working capital, a non-GAAP financial measure, reconciles to working capital, the most directly comparable GAAP financial measure, at September 30, 2012 and December 31, 2011 (in thousands) as follows:


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                                       September 30, 2012      December 31, 2011      Increase / (Decrease)
Current assets                        $         881,663      $           768,887     $             112,776
Less: current liabilities                       279,666                  173,153                   106,513
Working capital                                 601,997                  595,734                     6,263
Subtract:
Cash and cash equivalents                       520,892                  342,211                   178,681
Short-term investments                          260,435                  335,783                   (75,348 )
Add:
Current deferred revenue                         94,664                  134,087                   (39,423 )
Adjusted working capital              $         (84,666 )    $            51,827     $            (136,493 )

The $136.5 million net decrease in adjusted working capital is attributable to increases in our current liabilities, primarily associated with higher taxes payable related to our recent $375.0 million patent sale to Intel. Cash used in or provided by investing and financing activities We generated net cash in investing activities of $42.3 million in first nine months 2012 and $22.8 million in first nine months 2011. We sold $77.8 million and $44.7 million of short-term marketable securities, net of purchases, in first nine months 2012 and 2011, respectively. This increase in net sales in first nine months 2012 was driven by higher cash needs associated with our stock repurchase program. Purchases of property and equipment decreased to $2.0 million in first nine months 2012 from $2.5 million in first nine months 2011 due to lower levels of investments in our new and existing facilities. Investment costs associated with capitalized patent costs and acquisition of patents increased to $33.5 million in first nine months 2012 from $19.4 million in first nine months 2011, primarily due to investments in patent acquisitions during first nine months 2012.
Net cash (used in) provided by financing activities decreased by $368.0 million primarily due to our issuance of the Notes and related transactions in second quarter 2011 as discussed above, as well as our repurchases of common stock of $152.7 million in first nine months 2012. Other
Our combined short-term and long-term deferred revenue balance at September 30, 2012 was approximately $161.9 million, a decrease of $126.1 million from December 31, 2011. We have no material obligations associated with such deferred revenue. In first nine months 2012, deferred revenue decreased $126.1 million due to $155.3 million of deferred revenue recognized, partially offset by a gross increase in deferred revenue of $29.2 million. The deferred revenue recognized was comprised of $101.2 million of amortized fixed fee royalty payments and $54.1 million in per-unit exhaustion of prepaid royalties (based upon royalty reports provided by our licensees). The gross increase in deferred revenue of $29.2 million primarily related to cash received or due from patent licensees and technology solutions customers. Of the $29.2 million, $10.4 million relates to the technology solutions agreement arbitration discussed above in the "Overview" section.
Based on current license agreements, we expect the amortization of fixed fee royalty payments and the resolution of the technology solutions agreement arbitration to reduce the September 30, 2012 deferred revenue balance of $161.9 million by $94.7 million over the next twelve months. Additional reductions to deferred revenue will be dependent upon the level of per-unit royalties our licensees report against prepaid balances.

RESULTS OF OPERATIONS
Third Quarter 2012 Compared to Third Quarter 2011
Revenues
The following table compares third quarter 2012 revenues to third quarter 2011
revenues (in millions):

                                       26
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                                           For the Three Months Ended
                                                  September 30,
                                               2012            2011            Increase/(Decrease)
Per-unit royalty revenue                  $        23.6     $    34.2     $     (10.6 )          (31 )%
Fixed fee amortized royalty revenue                33.8          33.2             0.6              2  %
Current patent royalties                           57.4          67.4           (10.0 )          (15 )%
Past sales                                          1.0           7.9            (6.9 )          (87 )%
Total patent licensing royalties                   58.4          75.3           (16.9 )          (22 )%
Patent sales revenue                              375.0             -           375.0            100  %
Technology solutions revenue                        0.6           1.2            (0.6 )          (50 )%
Total revenue                             $       434.0     $    76.5     $     357.5            467  %

The $357.5 million increase in total revenue was primarily attributable to the $375.0 million sale of patents to Intel. Not including the revenue from this patent sale, total revenue decreased $17.5 million. This decrease is primarily attributable to a $10.6 million decrease in per-unit royalty revenue, the majority of which is due to lower shipments from our Japanese per-unit licensees and our licensees with concentrations in the smartphone market. Past sales of $1.0 million in third quarter 2012 related to a new patent license agreement signed during the quarter. Past sales totaled $7.9 million in third quarter 2011 and primarily related to an audit of existing licensee. The decrease in technology solutions revenue was due to lower royalties recognized in connection with our SlimChip modem IP business.
In third quarter 2012 and third quarter 2011, 86% and 70% of our total revenues, respectively, were attributable to companies that individually accounted for 10% or more of our total revenues. In third quarter 2012 and third quarter 2011, the following companies accounted for 10% or more of our total revenues:

                                     For the Three Months Ended September 30,
                                        2012                          2011
Intel Corporation                            86 %        (a)             < 10%
Samsung Electronics Company, Ltd.         < 10%          (b)                34 %
Research in Motion Limited                < 10%     (c)                     13 %
HTC Corporation                           < 10%                             12 %
Sierra Wireless                           < 10%                             11 %


______________________________


(a) Revenues related primarily to sale of patents.
(b) The 3G portion of our patent license agreement with Samsung Electronics Company, Ltd. expires at the end of 2012.
(c) Our 2G/3G patent license agreement with Research in Motion Limited expires at the end of 2012; however, we will continue to receive royalties under this agreement through first quarter 2013. Operating Expenses
The following table summarizes the change in operating expenses by category (in millions):
                                          Three months ended September 30,
                                                 2012              2011           Increase/ (Decrease)
Patent administration and licensing       $           45.6     $     17.9     $     27.7            155  %
Development                                           16.4           17.0           (0.6 )           (4 )%
Selling, general and administrative                    8.9            9.4           (0.5 )           (5 )%
Total operating expenses                  $           70.9     $     44.3     $     26.6             60  %

The $26.6 million increase in operating expenses was primarily due to net changes in the following items (in millions):


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                                                             Increase/
                                                             (Decrease)
Cost of patent sale                                         $     15.6
Intellectual property enforcement and non-patent litigation       11.3
Personnel-related costs                                            1.6
Patent amortization                                                0.8
Patent maintenance and patent evaluation                           0.5
Other                                                             (0.1 )
Strategic alternatives evaluation process costs                   (1.5 )
Long-term compensation                                            (1.6 )
Total increase in operating expenses                        $     26.6

In third quarter 2012, we recognized $15.6 million of expense associated with the patent sale to Intel. Included in this amount was the remaining net book . . .

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