TMCnet News
INTERDIGITAL, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) 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 2013 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. Patent License Agreements Apple Agreement Our patent license agreement with Apple Inc. ("Apple"), which covered certain Apple iPhones (but did not cover Apple iPads or any Apple products designed to operate on CDMA2000 or LTE networks), expired at the end of June 2014. Because this was a fixed-fee agreement, we recognized the revenue associated with this agreement on a straight-line basis over the life of the agreement. Upon expiration of the agreement, Apple has become unlicensed as to all products covered under the agreement. Other As of June 30, 2014, due to the deteriorating financial condition of one of our fixed-fee licensees (the "Financially Distressed Licensee"), we determined that the patent license agreement with such licensee no longer met all of the revenue recognition criteria. As a result, we reduced both accounts receivable and deferred revenue by $15.0 million as of the end of second quarter 2014. This amount represented the amount due to us over the next twelve months from the Financially Distressed Licensee. In third quarter 2014, the Financially Distressed Licensee filed for bankruptcy protection in both South Korea and the United States. We will continue to monitor the situation and will resume revenue recognition under this patent license agreement if and when it again meets all of the revenue recognition criteria. Arbitration with Arima Communications Corporation On July 1, 2014, a panel convened by the American Arbitration Association's International Centre for Dispute Resolution issued a final award in a dispute between InterDigital and Arima Communications Corporation ("Arima"), headquartered in Taiwan, regarding the obligations of the parties relating to Arima's patent license agreement with the Company. This award was subsequently modified on July 14, 2014, resulting in an award to InterDigital of approximately $23.6 million (which included $14.5 million of unpaid patent license fees plus interest and related fees and costs). On July 2, 2014, we commenced an action in the Delaware District Court to confirm the arbitration award, and, on July 28, 2014, InterDigital filed an amended petition in the Delaware District Court to reflect the revised award of approximately $23.6 million (which will continue to accrue interest until payment by Arima). On August 21, 2014, Arima filed a cross-petition to vacate, or in the alternative to modify, the arbitration award. The parties have fully briefed their respective petitions and are awaiting a decision from the Delaware District Court. We will recognize any related revenue in the period in which collectability is reasonably assured. Revenue Recurring revenue of $73.2 million in third quarter 2014 decreased $1.1 million over second quarter 2014 primarily due to lower fixed-fee royalties related to the expiration of the Apple agreement and the absence of revenue from the Financially Distressed Licensee, as discussed above. This decrease in fixed-fee royalties was partially offset by higher per-unit royalties. Additionally, past sales of $2.4 million in third quarter 2014 decreased $117.5 million over second quarter 2014, as second quarter 2014 included $118.4 million of past sales resulting from new agreements. Stock Repurchase During third quarter 2014, we repurchased 1.8 million shares of common stock for $79.6 million. Since the initiation of the Company's new $300 million share repurchase program in June 2014 and through October 29, 2014, we have repurchased 3.4 million shares of our common stock for a cumulative repurchase price of $142.9 million. Intellectual Property Enforcement Please see Note 6, "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 and ZTE 2013 USITC Proceeding (337-TA-868) and Related Delaware District Court Proceedings 32-------------------------------------------------------------------------------- Table of Contents On January 2, 2013, the company's wholly owned subsidiaries InterDigital Communications, Inc., InterDigital Technology Corporation, IPR Licensing, Inc. and InterDigital Holdings, Inc. filed a complaint with the USITC against Samsung Electronics Co., Ltd., Samsung Electronics America, Inc. and Samsung Telecommunications America (collectively, "Samsung"), LLC, Nokia Corporation and Nokia Inc. (collectively, "Nokia"), Huawei Technologies Co., Ltd., Huawei Device USA, Inc. and FutureWei Technologies, Inc. d/b/a Huawei Technologies (USA) (collectively, "Huawei") and ZTE Corporation and ZTE (USA) Inc. (collectively, "ZTE" and together with Samsung, Nokia and Huawei the "337-TA-868 Respondents"), alleging violations of Section 337 of the Tariff Act of 1930 in 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 and 4G wireless devices (including WCDMA-, cdma2000- and LTE-capable mobile phones, USB sticks, mobile hotspots, laptop computers and tablets and components of such devices) that infringe certain of InterDigital's U.S. patents. The complaint also extends to certain WCDMA and cdma2000 devices incorporating Wi-Fi functionality. InterDigital's complaint with the USITC seeks an exclusion order that would bar from entry into the United States infringing 3G or 4G wireless devices (and components), including LTE devices, that are imported by or on behalf of the 337-TA-868 Respondents, and also seeks a cease-and-desist order to bar further sales of infringing products that have already been imported into the United States. On January 16, 2014, the Administrative Law Judge ("ALJ") overseeing the proceeding granted a joint motion by InterDigital and Huawei to terminate the investigation as to Huawei, and on February 12, 2014, the USITC determined not to review the initial determination terminating the investigation as to Huawei. Certain of the asserted patents have been asserted against Nokia and ZTE in earlier pending USITC proceedings (including the Nokia and ZTE 2011 USITC Proceeding (337-TA-800) and the Nokia 2007 USITC Proceeding (337-TA-613), as set forth below) and therefore are not being asserted against those 337-TA-868 Respondents in this investigation. On June 3, 2014, InterDigital and Samsung filed a joint motion to terminate the investigation as to Samsung on the basis of settlement. The ALJ granted the joint motion by initial determination issued on June 9, 2014, and the USITC determined not to review the initial determination on June 30, 2014. On June 13, 2014, the ALJ issued an Initial Determination ("ID") in the in the 337-TA-868 investigation. On August 8, 2014, the Commission determined to review in part the ID and terminated the investigation with a finding of no violation. On October 10, 2014, InterDigital filed a petition for review with the Federal Circuit, appealing the adverse determinations in the Commission's August 8, 2014 final determination. On January 2, 2013, the company's wholly owned subsidiaries InterDigital Communications, Inc., InterDigital Technology Corporation, IPR Licensing, Inc. and InterDigital Holdings, Inc. filed four related district court actions in the Delaware District Court against the 337-TA-868 Respondents. These complaints allege that each of the defendants infringes the same patents with respect to the same products alleged in the complaint filed by InterDigital in USITC Proceeding (337-TA-868). The complaints seek permanent injunctions and compensatory damages in an amount to be determined, as well as enhanced damages based on willful infringement and recovery of reasonable attorneys' fees and costs. On March 13, 2013, InterDigital filed an amended complaint against Nokia and Samsung, respectively, in Delaware District Court to assert allegations of infringement of the recently issued '244 patent. On March 21, 2013, pursuant to stipulation, the Delaware District Court granted InterDigital leave to file an amended complaint against Huawei and ZTE, respectively, to assert allegations of infringement of the '244 patent. On December 30, 2013, the Delaware District Court granted the stipulation of dismissal filed by InterDigital and Huawei, terminating the Huawei district court action. On August 5, 2014, InterDigital and Samsung filed a stipulation of dismissal in light of the parties' settlement agreement. On the same day, the court granted the stipulation of dismissal and dismissed the action with prejudice. On September 26, 2014, the Delaware District Court re-scheduled the Nokia and MMO trial to commence on March 9, 2015. The ZTE trial addressing infringement and validity of the '966, '847, '244 and '151 patents was held from October 20 to October 27, 2014. During the trial, the judge determined that further construction of certain claim language of the '151 patent is required, and the judge decided to hold another trial as to ZTE's infringement of the '151 patent at a later date. On October 28, 2014, the jury returned a unanimous verdict in favor of InterDigital, finding that the '966, '847 and '244 patents are all valid and infringed by ZTE 3G and 4G cellular devices. The Delaware District Court judge previously bifurcated issues relating to damages, FRAND-related affirmative defenses, and FRAND-related counterclaims, which will be addressed at a later phase of the case. Nokia and ZTE 2011 USITC Proceeding (337-TA-800) and Related Delaware District Court Proceeding On July 26, 2011, InterDigital's wholly owned subsidiaries InterDigital Communications, LLC (now InterDigital Communications, Inc.), InterDigital Technology Corporation and IPR Licensing, Inc. filed a complaint with the USITC against Nokia Corporation and Nokia Inc., Huawei Technologies Co., Ltd. and FutureWei Technologies, Inc. d/b/a Huawei Technologies (USA) and ZTE Corporation and ZTE (USA) Inc. (collectively, the "337-TA-800 Respondents"), alleging violations of Section 337 of the Tariff Act of 1930 in 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 (including WCDMA- and cdma2000-capable mobile phones, USB sticks, mobile hotspots and tablets and components of such devices) that infringe certain of InterDigital's U.S. patents. The action also extends to certain WCDMA and cdma2000 devices incorporating Wi-Fi functionality. InterDigital's complaint with the USITC seeks an exclusion order that would bar 33-------------------------------------------------------------------------------- Table of Contents from entry into the United States any infringing 3G wireless devices (and components) that are imported by or on behalf of the 337-TA-800 Respondents, and also seeks a cease-and-desist order to bar further sales of infringing products that have already been imported into the United States. The ALJ's Initial Determination issued on June 28, 2013, finding no violation because the asserted patents were not infringed and/or invalid. Petitions for review of the Initial Determination ("ID") to the Commission were filed by InterDigital and the 337-TA-800 Respondents on July 15, 2013. On September 4, 2013, the Commission determined to review the ID in its entirety. On December 19, 2013, the Commission issued its final determination. The Commission adopted, with some modification, the ALJ's finding of no violation of section 337 as to Nokia, Huawei, and ZTE. The Commission did not rule on any other issue, including FRAND and domestic industry, and stated that all other issues remain under review. In December 2013, InterDigital filed in the Federal Circuit a petition for review seeking reversal of the Commission's final determination. In January 2014, the court granted motions filed by the Nokia and ZTE Respondents for leave to intervene in the appeal. Oral argument in the appeal is scheduled for November 7, 2014. Nokia 2007 USITC Proceeding (337-TA-613) and Related Delaware District Court Proceeding On August 1, 2012, the Federal Circuit issued its decision in InterDigital's appeal of the USITC's Final Determination in this proceeding, 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 January 17, 2013, the Federal Circuit issued its mandate remanding USITC Proceeding (337-TA-613) to the Commission for further proceedings. On February 12, 2014, the Commission issued a notice, order and opinion remanding the investigation to an ALJ. The ALJ has set August 28, 2015 as the target date for completion of the investigation, and has scheduled the hearing in the matter for January 26-30, 2015. Comparability of Financial Results When comparing third quarter 2014 financial results against other periods, the following items should be taken into consideration: • Our third quarter 2014 revenue includes: • $2.0 million of patent sale revenue; and • $2.4 million of past sales. • Our third quarter 2014 operating expenses and income tax provision include: •$0.7 million of non-cash cost of patents sold during the quarter; •a $1.2 million adjustment related to payroll taxes and employment level tax credits, primarily due to an ongoing audit; and •a $5.7 million discrete net benefit within our tax provision, related to U.S. research and development credits. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in our 2013 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 2013 Form 10-K. There have been no material changes in our existing critical accounting policies from the disclosures included in our 2013 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. See below for updates related to certain critical accounting estimates. Second Quarter 2014 Agreements As discussed in Note 3, Significant Agreements, to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, each of the three patent license agreements signed during second quarter 2014 is a multiple-element arrangement for accounting purposes. Consistent with the revenue recognition policy disclosed in Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included in our 2013 Form 10-K, for each agreement, we identified each element of the arrangement, estimated its relative value for purposes of allocating the arrangement consideration and determined when each of those elements should be recognized. Using the accounting guidance applicable to 34-------------------------------------------------------------------------------- Table of Contents multiple-element revenue arrangements, we allocated the consideration to each element for accounting purposes using our best estimate of the term and value of each element. The development of a number of these inputs and assumptions in the model requires a significant amount of management judgment and is based upon a number of factors, including the assumed royalty rates, sales volumes, discount rate and other relevant factors. Changes in any of a number of these assumptions could have had a substantial impact on the relative fair value assigned to each element for accounting purposes. These inputs and assumptions represent management's best estimates at the time of the transactions. The impact that a five percent change to the following key estimate would have had on nine months ended September 30, 2014 revenue is summarized in the following table (in millions): Change in estimate +5% -5% Allocation to past patent royalties $ 5.5 $ (5.5 ) Revenue from Non-financial Sources During nine months ended September 30, 2014 and 2013, our patent licensing royalties were derived from patent license agreements ("PLAs") with twenty-five and twenty-one independent licensees, respectively. During nine months ended September 30, 2014 and 2013, we recognized revenue from two PLAs and one PLA, respectively, for which patents comprised less than one-third of the total consideration paid or due to us under those agreements. In addition, during nine months ended September 30, 2014, we recognized revenue from one PLA that was executed in connection with a patent purchase agreement ("PPA") with the licensee. Total cash paid or due to our licensee under this PPA is approximately 56% of the total cash due to us under this licensee's PLA. During nine months ended September 30, 2014 and 2013, 7% and 3%, respectively, of our total revenue was based on the estimated fair value of the patents in the above transactions. We estimated the fair value of the patents in the above transactions by a combination of a discounted cash flow analysis (the income approach) and an analysis of comparable market transactions (the market approach). For the income approach, the inputs and assumptions used to develop these estimates were based on a market participant perspective and included estimates of projected royalties, discount rates, economic lives and income tax rates, among others. For the market approach, judgment was applied as to which market transactions were most comparable to this transaction. The development of a number of these inputs and assumptions requires a significant amount of management judgment and is based upon a number of factors, including the selection of industry comparables, assumed royalty rates, sales volumes, economic lives of the patents and other relevant factors. Changes in any of a number of these assumptions could have had a substantial impact on the fair value assigned to the patents for accounting purposes. These inputs and assumptions represent management's best estimates at the time of the transaction. The impact that a five percent change in the estimated value of the patents would have had on our nine months ended September 30, 2014 revenue, patent amortization and pretax income is summarized in the following table (in millions): Change in estimate +5% -5% Revenue $ 1.3 $ (1.3 ) Patent Amortization 0.2 (0.2 ) Pre-tax Income $ 1.1 $ (1.1 ) FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES Our primary sources of liquidity are cash, cash equivalents and short-term investments, as well as cash generated from operations. We believe 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 for the next twelve months. 35-------------------------------------------------------------------------------- Table of Contents Cash, cash equivalents and short-term investments At September 30, 2014 and December 31, 2013, we had the following amounts of cash, cash equivalents and short-term investments (in thousands): Increase / September 30, 2014 December 31, 2013 (Decrease) Cash and cash equivalents $ 368,799 $ 497,714 $ (128,915 ) Short-term investments 363,893 200,737 163,156 Total Cash and cash equivalents and short-term investments $ 732,692 $ 698,451 $ 34,241 The increase in cash, cash equivalents and short-term investments was primarily attributable to $186.0 million of cash provided by operating activities, which was partially offset by capital investments of $52.8 million and $98.7 million of cash used by financing activities. Cash flows from operations We generated the following cash flows from our operating activities in first nine months 2014 and 2013 (in thousands): For the Nine Months Ended September 30, Increase / 2014 2013 (Decrease)Net cash provided by operating activities $ 186,029 $ 218,720 $ (32,691 ) Cash provided by operations during first nine months 2014 included cash receipts of $431.5 million from patent license and technology solutions agreements and patent sales. We received $114.6 million of per-unit royalty payments, including past patent royalties, current royalties and prepayments, from existing customers, $305.3 million of fixed-fee payments from existing and new licensees, and $2.0 million of patent sale payments. Cash receipts from our technology solutions agreements totaled $9.6 million, primarily related to royalties and other license fees associated with our SlimChip modem core. These items were partially offset by cash operating expenses (operating expenses less depreciation of fixed assets, amortization of patents and share-based compensation) of $141.8 million, cash payments for short-term incentive compensation of $11.0 million, cash payments for foreign source withholding and income taxes of $86.0 million and other changes in working capital. The positive operating cash flow during first nine months 2013 was derived principally from cash receipts of $387.6 million from patent license and technology solutions agreements and patent sales. We received $340.8 million of per-unit royalty payments, including past sales, current royalties and prepayments, from existing customers, $2.0 million of patent sales and $28.9 million of fixed-fee payments. Included in the $340.8 million of per-unit cash receipts were prepayments totaling $242.4 million from existing licensees. Cash receipts from our technology solutions agreements totaled $15.9 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 and share-based compensation) of $143.0 million, cash payments for short-term and long-term incentive compensation of $17.3 million, cash payments related to the VERP of $12.6 million and cash payments for foreign source withholding taxes of $2.8 million. 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, 2014, and December 31, 2013 (in thousands), as follows: 36-------------------------------------------------------------------------------- Table of Contents September 30, 2014 December 31, 2013 Increase / (Decrease) Current assets $ 959,993 $ 857,514 $ 102,479 Less: current liabilities 217,689 126,438 91,251 Working capital 742,304 731,076 11,228 Subtract: Cash and cash equivalents 368,799 497,714 (128,915 ) Short-term investments 363,893 200,737 163,156 Add: Current deferred revenue 127,746 60,176 67,570 Adjusted working capital $ 137,358 $ 92,801 $ 44,557 The $44.6 million net increase in adjusted working capital is primarily attributable to a net increase in accounts receivable of $41.3 million and a $19.2 million increase in deferred tax assets primarily related to new patent license agreements signed during second quarter 2014 and was partially offset by increases in accrued compensation and accounts payable. Cash flows from investing and financing activities We used net cash in investing activities of $216.2 million in first nine months 2014 and $12.7 million in first nine months 2013. We purchased $163.4 million, net of sales, and sold $25.1 million, net of purchases, of short-term marketable securities in first nine months 2014 and 2013, respectively. Investment costs associated with capitalized patent costs and acquisition of patents increased to $49.6 million in first nine months 2014 from $34.6 million in first nine months 2013, primarily due to an initial payment of $25.0 million on a $45.0 million patent acquisition made in first nine months 2014. Net cash used by financing activities for first nine months 2014 was $98.7 million, a $98.4 million increase from first nine months 2013. This increase primarily resulted from $88.0 million of share repurchases and an $8.0 million increase in dividend payments related to the doubling of our quarterly dividend. Other Our combined short-term and long-term deferred revenue balance at September 30, 2014 was approximately $460.0 million, an increase of $156.0 million from December 31, 2013. We have no material obligations associated with such deferred revenue. The increase was due to a gross increase in deferred revenue of $270.9 million associated with fixed-fee agreement payments or payments due within twelve months and patents received in consideration for patent license agreements signed during second quarter 2014, which was partially offset by $119.2 million of deferred revenue recognized. The deferred revenue recognized was comprised of $88.5 million of amortized fixed-fee royalty payments and $28.1 million in per-unit exhaustion of prepaid royalties (based upon royalty reports provided by our licensees) and $2.6 million of past patent royalties. Based on current license agreements, we expect the amortization of fixed-fee royalty payments to reduce the September 30, 2014 deferred revenue balance of $460.0 million by $127.7 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 2014 Compared to Third Quarter 2013 37-------------------------------------------------------------------------------- Table of Contents Revenues The following table compares third quarter 2014 revenues to third quarter 2013 revenues (in millions): For the Three Months Ended September 30, 2014 2013 Increase/(Decrease) Per-unit royalty revenue $ 37.6 $ 26.3 $ 11.3 43 % Fixed-fee amortized royalty revenue 33.4 16.9 16.5 98 % Current patent royalties a 71.0 43.2 27.8 64 % Past patent royalties b 2.4 12.5 (10.1 ) (81 )% Total patent licensing royalties 73.4 55.7 17.7 32 % Current technology solutions revenue a 2.2 3.3 (1.1 ) (33 )% Past technology solutions revenue b - 51.6 (51.6 ) (100 )% Patent sales 2.0 - 2.0 100 % Total revenue $ 77.6 $ 110.6 $ (33.0 ) (30 )% a. Recurring revenues consist of current patent royalties and current technology solutions revenue. b. Past sales consist of past patent royalties and past technology solutions revenue. The $33.0 million decrease in total revenue was primarily attributable to the $61.7 million decrease in past sales, which was partially offset by the $26.7 million increase in recurring revenues. Past sales decreased due to the inclusion in third quarter 2013 of $51.6 million related to the resolution of a technology solutions agreement arbitration and $12.3 million related to our arbitration with Pegatron Corporation ("Pegatron"). Current patent royalties increased due to increases in both fixed-fee amortized royalty revenue and per-unit royalty revenue. The new patent license agreements signed during second quarter 2014 contributed to the increased fixed-fee royalties, and were partially offset by the expiration of the Apple agreement and the absence of revenue from the Financially Distressed Licensee. Additionally, per-unit royalties increased $11.3 million primarily related to increased shipments by, and the coverage of additional products under, our agreement with Pegatron. Current technology solutions revenue decreased by $1.1 million primarily related to decreased shipments by one of our technology solutions customers. In third quarter 2014 and third quarter 2013, 55% and 63% of our total revenue, respectively, were attributable to companies that individually accounted for 10% or more of our total revenue. In third quarter 2014 and third quarter 2013, the following companies accounted for 10% or more of our total revenue: For the Three Months Ended September 30, 2014 2013 Samsung Electronics Company, Ltd. 22% -% Pegatron Corporation 20% 14% Sony Corporation of America 13% < 10% Intel Mobile Communications GmbH < 10% 49% Operating Expenses The following table summarizes the changes in operating expenses between third quarter 2014 and third quarter 2013 by category (in millions): For the Three Months Ended September 30, 2014 2013 Increase/ (Decrease) Patent administration and licensing $ 33.5 $ 36.8 $ (3.3 ) (9 )% Development 19.2 15.8 3.4 22 % Selling, general and administrative 9.6 8.9 0.7 8 % Total operating expenses $ 62.3 $ 61.5 $ 0.8 1 % 38-------------------------------------------------------------------------------- Table of Contents Operating expenses increased 1% to $62.3 million in third quarter 2014 from $61.5 million in third quarter 2013. The $0.8 million increase in total operating expenses was primarily due to increases/(decreases) in the following items (in millions): Increase/ (Decrease) Depreciation and amortization $ 3.2 Consulting services 2.1 Personnel-related costs 1.6 Commercial initiatives and Signal Trust 1.6 Cost of patent sales 0.7 Patent maintenance and patent evaluation (1.2 ) Intellectual property enforcement and non-patent litigation (7.2 ) Total increase in operating expenses $ 0.8 The $0.8 million increase in operating expenses was primarily due to the $3.2 million increase in patent amortization primarily related to patent acquisitions made within the last year. The $2.1 million increase in consulting services was primarily related to the support of research and development projects and corporate initiatives that have ramped up over the last twelve months. The $1.6 million increase in personnel-related costs was primarily related to hiring activity. The $1.6 million increase in commercial initiatives and Signal Trust expense was related to a new commercial initiative launched in first half 2014 and the Signal Trust for Wireless Innovation (the "Signal Trust"), which was created in fourth quarter 2013. The $0.7 million increase in cost of patent sales was related to patents sold during the quarter, and represents the remaining net book value of the patents sold. The $1.2 million decrease in patent maintenance and patent evaluation was primarily due to decreased due diligence costs associated with both patent acquisition and patent sale opportunities. The $7.2 million decrease in intellectual property enforcement and non-patent litigation primarily related to decreased costs associated with the USITC actions. Patent Administration and Licensing Expense: The decrease in patent administration and licensing expense primarily resulted from the above-noted decrease in costs associated with the USITC actions and a decrease in patent maintenance. These decreases were partially offset by increases in patent amortization, cost of patent sales, personnel-related costs, and costs associated with the Signal Trust as described above. Development Expense: The increase in development expense was primarily attributable to increases in personnel-related costs, consulting services, and commercial initiative-related costs as described above. Selling, General and Administrative Expense: The increase in selling, general and administrative expense was primarily attributable to increases in personnel-related costs and consulting services as described above. Other (Expense) Income The following table compares third quarter 2014 other (expense) income to third quarter 2013 other (expense) income (in millions): For the Three Months Ended September 30, 2014 2013 Change Interest expense $ (4.0 ) $ (3.9 ) $ (0.1 ) 3 % Other 0.3 0.1 0.2 200 % Interest and investment income 0.5 0.8 (0.3 ) (38 )% $ (3.2 ) $ (3.0 ) $ (0.2 ) 7 % In third quarter 2014, other expense was $3.2 million as compared to other expense of $3.0 million in third quarter 2013. The change between periods primarily resulted from lower returns on our investment balances during third quarter 2014 as compared to third quarter 2013. 39-------------------------------------------------------------------------------- Table of Contents Income tax provision In third quarter 2014, our effective tax rate was approximately 3.8% as compared to 43.5% during third quarter 2013, based on the statutory federal tax rate net of discrete federal and state taxes. The decrease in the effective tax rate resulted from the impact of a discrete item in third quarter 2014 related to a $5.7 million net benefit from available U.S. federal research and development tax credits, along with lower forecasted state tax expense resulting, in part, from the Company's income mix between patent licensing royalties and technology solutions revenue. First Nine Months 2014 Compared to First Nine Months 2013 Revenues The following table compares first nine months 2014 revenues to first nine months 2013 revenues (in millions): For the Nine Months Ended September 30, 2014 2013 Increase/(Decrease) Per-unit royalty revenue $ 108.0 $ 81.7 $ 26.3 32 % Fixed-fee amortized royalty revenue 88.5 50.7 37.8 75 % Current patent royalties a 196.5 132.4 64.1 48 % Past patent royalties b 123.2 37.4 85.8 229 % Total patent licensing royalties 319.7 169.8 149.9 88 % Current technology solutions revenue a 7.1 4.2 2.9 69 % Past technology solutions revenue b 0.8 51.6 (50.8 ) (98 )% Patent Sales 2.0 - 2.0 100 % Total revenue $ 329.6 $ 225.6 $ 104.0 46 % a. Recurring revenues consist of current patent royalties and current technology solutions revenue. b. Past sales consist of past patent royalties and past technology solutions revenue. The $104.0 million increase in total revenue was primarily attributable to the $35.0 million increase in past sales, as well as the $64.1 million increase in current patent royalties. The new patent license agreements signed during second quarter 2014 contributed to the increased past sales, as well as the increase in fixed-fee royalties. The increase in fixed-fee royalties were partially offset by the expiration of the Apple agreement and the absence of revenue from the Financially Distressed Licensee. Additionally, per-unit royalty revenue increased $26.3 million primarily related to the $46.6 million royalty increase associated with increased shipments by, and the coverage of additional products under, our agreement with Pegatron. The increase in per-unit royalties from Pegatron was partially offset by a total decrease of $20.5 million attributable to certain of our other per-unit licensees with concentrations in the smartphone market. Current technology solutions revenue increased by $2.9 million primarily due to the inclusion of royalties on certain products upon the resolution of our arbitration with Intel Mobile Communications GmbH. In first nine months 2014 and first nine months 2013, 52% and 65% of our total revenue, respectively, were attributable to companies that individually accounted for 10% or more of our total revenue. In first nine months 2014 and first nine months 2013, the following companies accounted for 10% or more of our total revenue: For the Nine Months Ended September 30, 2014 2013 Samsung Electronics Company, Ltd. 37% -% Pegatron Corporation 15% 18% Intel Mobile Communications GmbH < 10% 24% Sony Corporation of America < 10% 13% Blackberry Limited < 10% 10% Operating Expenses 40-------------------------------------------------------------------------------- Table of Contents The following table summarizes the changes in operating expenses between first nine months 2014 and first nine months 2013 by category (in millions): For the Nine Months Ended September 30, 2014 2013 Increase/ (Decrease) Patent administration and licensing $ 97.6 $ 106.8 $ (9.2 ) (9 )% Development 57.5 45.4 12.1 27 % Selling, general and administrative 30.9 25.1 5.8 23 % Repositioning - 1.5 (1.5 ) (100 )% Total operating expenses $ 186.0 $ 178.8 $ 7.2 4 % Operating expenses increased 4% to $186.0 million in first nine months 2014 from $178.8 million in first nine months 2013. Not including the $1.5 million in repositioning charges in first nine months 2013, operating expenses would have increased 5%. The $7.2 million increase in total operating expenses was primarily due to increases/(decreases) in the following items (in millions): Increase/ (Decrease) Performance-based incentive compensation $ 15.4 Depreciation and amortization 6.4 Consulting services 3.7 Commercial initiatives and Signal Trust 2.5 Cost of patent sales 0.7 Personnel-related costs 0.6 Other 0.6 Patent maintenance and patent evaluation (2.4 ) Intellectual property enforcement and non-patent litigation (18.8 ) Total decrease in operating expenses not including repositioning charges 8.7 Repositioning (1.5 ) Total increase in operating expenses $ 7.2 The $8.7 million increase in operating expenses was primarily due to the $15.4 million increase in performance-based incentive compensation, including both short-term and long-term compensation, that was primarily attributable to both a true-up to increase the beginning period compensation to the current accrual rate and higher accrual rates in first nine months 2014 as compared to significantly lower accrual rates in first nine months 2013. Patent amortization increased $6.4 million primarily due to patent acquisitions made within the last year. The $3.7 million increase in consulting services was primarily related to the support of research and development projects and corporate initiatives that have ramped up over the last twelve months. The $2.5 million increase in commercial initiatives and Signal Trust expense related to a new commercial initiative launched in first half 2014 and the Signal Trust, which was created in fourth quarter 2013. The $0.7 million increase in cost of patent sales is related to patents sold during the quarter, and represents the remaining net book value of the patents sold. The $0.6 million increase in personnel-related costs was primarily related to hiring activity. The $2.4 million decrease in patent maintenance and patent evaluation costs was primarily related to decreased due diligence costs associated with both patent acquisition and patent sale opportunities. The $18.8 million decrease in intellectual property enforcement and non-patent litigation primarily related to decreased costs associated with the USITC actions and licensee arbitrations. Patent Administration and Licensing Expense: The decrease in patent administration and licensing expense primarily resulted from the above-noted decrease in costs associated with the USITC actions and licensee arbitrations and a decrease in patent maintenance. These decreases were partially offset by increases in patent amortization, performance-based incentive compensation, and costs associated with the Signal Trust as described above. Development Expense: The increase in development expense was primarily attributable to increases in performance-based incentive compensation, consulting services, and commercial initiative-related costs as described above. In addition, a $1.0 41-------------------------------------------------------------------------------- Table of Contents million adjustment related to payroll taxes and employment level tax credits, primarily due to an ongoing audit, contributed to the increase. Selling, General and Administrative Expense: The increase in selling, general and administrative expense was primarily attributable to increases in performance-based incentive compensation and consulting services as described above. Repositioning Expense: The decrease in repositioning expense was attributable to the absence of charges related to the VERP in first nine months 2014. Other (Expense) Income The following table compares first nine months 2014 other (expense) income to first nine months 2013 other (expense) income (in millions): For the Nine Months Ended September 30, 2014 2013 Change Interest expense $ (12.0 ) $ (11.5 ) $ (0.5 ) 4 % Other 0.2 (6.9 ) 7.1 (103 )% Interest and investment income 1.1 8.9 (7.8 ) (88 )% $ (10.7 ) $ (9.5 ) $ (1.2 ) 13 % In first nine months 2014, other expense was $10.7 million as compared to other expense of $9.5 million in first nine months 2013. The change between periods primarily resulted from the $6.7 million investment impairment recognized during first nine months 2013, which was partially offset by the interest income associated with the Pegatron arbitration award received in second quarter 2013. Income tax provision In first nine months 2014, our effective tax rate was approximately 33.7% as compared to 41.4% during first nine months 2013, based on the statutory federal tax rate net of discrete federal and foreign taxes. The decrease in the effective tax rate resulted from the impact of a discrete item in first nine months 2014 related to a $5.7 million net benefit from available U.S. federal research and development tax credits, along with lower forecasted state tax expense resulting, in part, from the Company's income mix between patent licensing royalties and technology solutions revenue. STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 - FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Such statements include certain information under the heading "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information regarding our current beliefs, plans and expectations, including without limitation the matters set forth below. Words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "forecast," "goal," variations of any such words or similar expressions are intended to identify such forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation, statements regarding: |