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Tessera Technologies, Inc. (NASDAQ:TSRA)

Q3 2008 Earnings Call Transcript

October 30, 2008, 4:30 pm ET

Executives

Moriah Shilton – IR

Hank Nothhaft – President and CEO

Mike Anthofer – EVP and CFO

Scot Griffin – EVP of Micro-electronics

Analysts

Brett Hodess – Merrill Lynch

Raj Seth – Cowen & Company

Arnab Chanda – Deutsche Bank

Hans Mosesmann – Raymond James

Bennett Notman – Davenport

Mehdi Hosseini – FBR

Michael Collin – Pacific America

Olga Levinson – Barclays

Kevin Vassily – Pacific Crest Security

Operator

Good afternoon. My name is Don, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Moriah, you may begin your conference.

Moriah Shilton

Thank you, Don, and good afternoon, everyone. Thank you for joining us for the Tessera Technologies’ third quarter 2008 results conference call. This call is being broadcast live over the Internet. A webcast replay will be available at tessera.com for 90 days after the call. In addition, a telephone replay of this call will be made available for 48 hours beginning approximately two hours after the completion of this call. To listen to the replay in the US, please dial 800-642-1687, and internationally, dial 706-645-9291. The access code is 68087056.

I will now read a short Safe Harbor statement. During the course of this conference call, management may make projections or other forward-looking statements, which are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual results to differ significantly from those projected. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this release.

A detailed discussion of the material factors that may cause results to differ from the statements made can be found, for example, in the Risk Factors section of Tessera's filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31st, 2007, and its quarterly report on Form 10-Q for the quarter ended June 30th, 2008.

On the call today for management are Hank Nothhaft, Tessera’s President and Chief Executive Officer; Mike Anthofer, Chief Financial Officer; and, Scot Griffin, EVP of Micro-electronics.

During this call today, management will discuss certain non-GAAP financial measures for comparison purposes only, and they will be using non-GAAP numbers in their prepared remarks. The non-GAAP amounts of cost of revenues; R&D; selling, general, and administrative expenses; net income; and, earnings per share do not include the following, stock-based compensation, acquired intangibles, amortization charges, charges for acquired in-process research and development, and non-cash tax expense.

Management believes the non-GAAP amounts provide a more meaningful comparison, measure of quarter-over-quarter and year-over-year financial performance. Please refer to the company's third quarter 2008 earnings press release and to the company's Web site for reconciliation of non-GAAP measures to GAAP.

After management's opening remarks, we will open the call to your questions. So that management is able to respond to as many of you as possible, please restrict yourself to an opening and a follow on question. Please re-enter the queue if you have additional questions.

And with that, I will now turn the call over to Hank.

Hank Nothhaft

Thank you, Moriah. And thanks all of you for joining us today. Though I’ve met many of you or spoken to you on the phone during the last three months, this is my first earnings call as CEO of Tessera even though I have been associated with the company as a director since 2004. Before I start my prepared remarks I wanted to welcome our new CFO, Mike Anthofer. I worked with Mike previously and know firsthand he has the ability to guide our finance team as we continue to grow our worldwide business. Welcome aboard, Mike. We certainly picked a dynamic quarter to join the company.

Now, a brief review of our third quarter financial results, our total third quarter 2008 revenues were $63.5 million, up 29% compared to last year’s third quarter. Royalty and license fees were $57.6 million, up 38% compared to last year’s quarter driven by the increasing amount of DRAM memory in computing and consumer devices, increased sales of 3G handsets, and stronger demand in wireless international markets. Our third quarter royalty and license fees also included catch up payments from audits conducted in the third quarter.

Non-GAAP operating expenses, excluding litigation, came in at $28.3 million below our guidance as we continue to focus on an efficient and effective infrastructure. Our litigation expense was high, however, at approximately $29 million. This resulted in non-GAAP earnings per share of $0.1 and a GAAP loss of $0.11 per share.

Michael will have more detail on our third quarter financial results and our fourth quarter financial guidance later. I would like to provide a few comments on our chip-scale packaging business. Historically, this business serves two primary markets, DRAM and wireless. We expect the strong demand for cell phones and emerging markets and growth in smart phone shipments will continue through the end of the year.

Our recurring royalties generated by growth driver such as these are recognized one quarter in arrears. As such, while overall macro conditions in our served markets are weakening, we believe the near term impact on our revenue will not be as pronounced as others. We continue to pursue the development and commercialization of our next generation packaging and interconnect technology, the µPILR platform. Specifically, we are focused on the optimization of this technology as an alternative to conventional Flip Chip.

This is an exciting opportunity for Tessera as Flip Chip is a growing semi-conductor packaging segment, in which Tessera has not previously participated. Although we are still in the development phase, preliminary results look promising. Our version of the Flip Chip can successfully overcome limitations in current Flip Chip technologies while offering a road map to sub 100 micron pitch. We are working closely with our infrastructure partners to ensure the widespread availability of µPILR substrates for high volume production. And anticipate an announcement of our first licensee in this innovation solution in the near future.

I would now like to discuss our Amkor arbitration and our International Trade Commission, i.e. ITC, actions.

Amkor, first, I‘d like to say we are very pleased and gratified with this rule. We are still digesting the tribunal’s award, which is a very lengthy complicated decision. And which is from a contract perspective unique to Amkor’s license agreement. We can only say two things definitively at this moment, first, the tribunal’s unanimous determination that our patents are valid, enforceable, and infringed indicates our continued belief in the strength of our IP; second, we expect that the final damages award will be material although we don’t know when the final award will be issued.

Because the tribunal’s interim award is so focused on the patent issues and the issue of past liability, we are still unclear on what this means going forward except that Amkor’s license remains in effect. And that Amkor will continue to owe royalties for all products that it makes under Tessera’s patents, including patents that are not at issue on the arbitration. Accordingly, we are not in the position to comment at this time on the full scope of Amkor’s royalty obligation going forward.

As many of you know in the wireless ITC action, the administrative law judge extended the deadline to December 1st to issue his initial determination. He cited the court’s current case load and responsibility and other actions as the reasons for the rescheduled deadline. The rescheduled deadline is not unusual. In fact, the same thing happened in our ITC action against Sharp in 2002. And as you may know, we prevailed in that action. The target completion date of this action is now April 3rd, 2009.

The 10-day hearing in the DRAM-ITC action concluded on October 3rd. The administrative law judge’s initial determination is due by January 14th, 2009. And the target date for completion of this action is April 14th, 2009. So we definitely have a lot going on in April 2009. In our Subcon ITC action, the administrative law judge granted our request to add the 106 patent to the case. As a result, the 7-day hearing has been rescheduled to start on April 27th, 2009. And the target date for completion of this action is December 7th, 2009.

Turning to our imaging and optics business, the future growth opportunities in this market space is significant. I believe we not only picked the right market, but also acquired the right technologies to fully capitalize on its potential. We have assembled, through a combination of acquisitions and internal technology development, a broad portfolio of imaging and optics technologies that range from wafer-level camera solutions and image sensor packaging, to micro optics lenses, and smart image enhancement technologies.

Recently, we demonstrated one example of our portfolio’s far reaching potential and innovation. A functional VGA wafer-level camera module that integrates image enhancement technologies such as face trackings, smile and blink detection. Our recent contract lengths are proof these technologies are what the market needs.

Keep in mind, the wafer-level packaging, wafer-level optics, and wafer-level camera, the average amount of time to get in production and revenue varies according to the nature of the licensee’s facility, their experience, and the technologies being licensed. If a licensee has an existing facility, it can take up to one and a half to two years after licensing for royalties to start. If the facility needs to be built from scratch, it takes longer, up to an additional six to nine months. For technologies like our smart optics, it can take one to one and a half years from licensing to royalties.

With regard to our specific technologies, in smart optics, we’ve had multiple design successes with our current optimal image enhancement technology, and have licensed two of the top central module vendors. Next year, through these licensees, we expect to be involved with multiple handset programs with tier 1 handset vendors. We also anticipate signing at least one more new licensee within the next six months.

In wafer-level packaging, during the third quarter, we announced the second licensee of our SHELLCASE MVP technology, AWLP, based in Seoul, Korea. SHELLCASE MVP introduced in March of this year is one of the industry’s first Through Silicon Via packaging solutions for image sensors. This technology enables OEMs and camera module manufacturers to meet market demand for lower profile, thinner, and more sophisticated mobile devices. We already signed an additional SHELLCASE MVP license, and expect to announce that relationship next year. We anticipate at least one more SHELLCASE MVP licensee in the next six months.

Our first SHELLCASE MVP licensee, Nemotek, is scheduled to be sampling customers in the first quarter of 2009. It is evident these technologies are gaining momentum as individual offerings. However, our real long term success will come from leveraging our image sensor packaging, wafer-level optics, and smart image enhancement technologies to develop unique solutions no other vendor has the ability or portfolio to create.

Our first example of our technology integration comes through our product launch services, which we announced on September 22nd. These product launch services offer a combination of technology and resources from our Tel Aviv and Charlotte facilities. The first product we are offering through these services is our OptiML VGA lens, which is a single element lens designed for cell phone camera modules. We are currently sampling the product with a number of interested parties with a goal of engaging one or more core production in the first half of 2009. In addition to offering the OptiML VGA lens as a standard product, we will work with our customers on production of customized lenses.

Another example is the wafer-level camera. We are developing it to meet the market’s needs for a wafer-level packaged image sensor combined with wafer-level optics. Going forward, we plan to closely integrate our wafer-level image sensor packaging and wafer-level optics technologies. To do so, we will centralize all related activities in our Charlotte facility. We will transfer the equipment, process, and a number of key engineers from our Jerusalem facility to our Charlotte facility. We anticipate seeing significant benefits from combining the two facilities’ R&D teams.

We also expect to reduce operating expense and capital cost. The Jerusalem facility will cease operations in December of this year. And we do not expect any disruption of our current and future licensees.

Before I turn the call over to Mike, I would like to take the opportunity to discuss two additional topics. The first relates to our chip-scale packaging business. As we’ve shared with you previously, two of our major DRAM manufacturer customer contracts have volume-based pricing adjustments. At certain volume levels, these contracts will cause our quarterly DRAM royalty revenue to grow at a rate less than the unit growth of the market. As these adjustments are defined in the customers’ contracts, they are predictable and incorporated into our guidance.

The volume growth of our DRAM customers in their third quarter of 2008 will cause this type of fluctuation. And we expect the pricing adjustments to partially offset the underlying growth of our royalty and license fees in the fourth quarter. Going forward, we expect, depending on our customers’ market share and volume growth, these contracts will impact DRAM revenues every first and fourth quarter.

The second topic relates to our recently acquired FotoNation business. We are now at a point where we are negotiating a number of contracts, which are essentially software contracts. They are different from our previous technology licensing contracts in that they entail provision of software services over extended periods of time. As a result, when signed, we expect to recognize revenue from these imaging contracts over the course of the contract terms, which will generate stable recurring revenue instead of booking a substantial portion of revenue of contract signing.

I’ll now turn over the call to Mike for a detailed review of our third quarter 2008 financials and a discussion of our fourth quarter 2008 guidance. Mike?

Mike Anthofer

Thank you, Hank. Before I begin my comments on the quarter, I want to express my appreciation for the opportunity to serve you as CFO. In my short month here, I’ve found it to be a very exciting company with very talented people. And I look forward to our future at Tessera.

First, a few comments on revenue, third quarter of 2008 total revenue was $63.5 million, which was up 29% year-over-year and 13% quarter-over-quarter. Royalty and license fees were $57.6 million in the quarter, up 38% from the prior year quarter and 15% from the prior quarter. As Hank stated earlier, solid and market demand in both DRAM and wireless throughout the revenue growth.

The third quarter royalty and license fees also included catch-up payments from self audits conducted and completed in the third quarter. Products and services were $5.9 million, which was down 20% year-over-year, and 7% below the prior quarter. This is due to less than anticipated demand from our lithography customers due to their market’s softness, partially offset by stronger than expected communications revenue.

Additionally, as previously conveyed to you, we are exiting the government business at year end. And the quarter revenues have declined substantially, particularly in the year-over-year comparisons. As a reminder, Tessera’s non-GAAP results excludes stock-based compensation, charges for the amortization of acquired intangibles, acquired in-process R&D, and non-cash tax expense. We have included a detailed reconciliation between our GAAP and non-GAAP numbers in both our earnings release and on our Web site for your convenient reference.

Total GAAP expenses, which include cost of revenues and litigation were $67.1 million in the quarter. Stock-based compensation expense was $6.6 million. Amortization of acquired intangibles was $2.9 million. Subtracting these items, total non-GAAP operating expenses were $57.6 million. Included in this total was litigation expense of $29.2 million.

As you know, Tessera has committed to protecting its IT property and our chip-scale business, and achieving success in its actions. We had an expensive quarter due largely to extraordinary activity in preparing for and completing two separate ITC hearings. These litigations are expensive, but necessary in our efforts to ensure continued success in the CSP business.

Total GAAP operating expense was as follows, cost of revenue $3.2 million; R&D $11.8 million; and, SG&A $13.4 million, excluding the aforementioned litigation expense.

In the third quarter, we have impairment charges of $2.4 million, which included, other than temporary write downs, of mortgage backed investments and a minority equity investment in an emerging technology company.

Cash taxes were $4.5 million in the quarter. Our GAAP tax expense was $770,000. The increase in cash taxes is principally due to additional foreign income tax withholding on royalty payments and incremental federal estimated tax payments when compared to the second quarter. The primary reason for the GAAP tax expense is that we had offshore losses, which do – reduce reported earnings, but do not reduce taxable income.

We had a GAAP net loss of $5.4 million or $0.11 per share on a weighted average share count of $47.9 million in the third quarter. Our non-GAAP income was $387,000 or $0.01 per share on a fully diluted weighted average share count of $49.2 million. Operating cash flow for the period was $14.3 million. And we ended the quarter with $286.8 million in cash, cash equivalents, and investments, and we have no debt. This increase represents $10.9 million over the prior quarter.

Now looking to the fourth quarter, we expect total revenues will range between $60 million and $62 million. Royalty and license fees will range between $53 million and $55 million. The demand for cell phones and emerging markets and a greater number of smart phone shipments we saw in the industry’s third quarter will drive the underlying growth of our fourth quarter royalty and licensees.

However, as Hank discussed earlier, we expect the underlying growth in our royalty and licensees to be offset – partially offset by volume-based pricing adjustments that two of our major customers have in their contracts. Our fourth quarter revenue guidance does not include any contribution from Amkor. I want to be clear on that.

Our product and services are expected to be approximately $7 million in the quarter. Our non-GAAP expenses, which include cost of revenue, R&D, and SG&A less litigation should be in the range of $29 million to $30 million for the fourth quarter. Our gradual commitment to increase R&D will play out slowly through the end of this year. And our SG&A, excluding litigation, should be thoroughly flat. As we have no trials this quarter, our litigation expense for the quarter should be significantly less. We expect our stock-based compensation to be approximately $6.2 million, and our amortization charges will again be $2.9 million.

Thank you very much. And now I turn the call back to Hank.

Hank Nothhaft

Thank you, Mike. I think I can speak for Mike, we feel really great about joining Tessera at this time in its history. As you can tell by some of the reported activities and some of the things we see coming up with the company, there’s literally a cornucopia of opportunities confronting us as we move on to the fourth quarter and on into 2009.

I am proud of our recent accomplishments including the consistent year-over-year royalty and license fees growth. The growing momentum on our imaging and optics business as evidenced by our new licensees and technology offerings, and especially the recent Amkor arbitration panel’s decision to uphold our patents, is valid and enforceable. We firmly believe this demonstrates, once again, the strength of our intellectual property. We expect that the monetary award from this arbitration award – this arbitration panel will be material.

I look forward to discussing our fourth quarter’s successes with you early next year. Now, I would like to open the call for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) We’ll pause for just a moment to compile the Q&A roster. And your first question comes from Brett Hodess with Merrill Lynch.

Brett Hodess – Merrill Lynch

Good afternoon. Hank, I am going to give my two questions. The first one is, at what rate do you think the DRAM business would have to grow such that the price recess that occurred in the first – I think you said it was the first and fourth quarter each year?

Hank Nothhaft

Yes.

Brett Hodess – Merrill Lynch

In volume, such that your DRAM revenues would be up sequentially? I guess I’ll just ask the first one, then I’ll ask my follow up.

Hank Nothhaft

So if I understand the question. How fast would the DRAM market or revenues have to grow–?

Brett Hodess – Merrill Lynch

How fast would the DRAM volume, I’m sorry, the units of DRAM have to grow for you to offset the reset on the lower DRAM prices for those two big customers?

Hank Nothhaft

Yes. That’s a good question. But I think it has a lot to do with what the market share of the – not just the volume of the individual participants would be. And so, I’ll have to, honestly, reflect on that question and get back to you for an answer on that. I don’t have a simple answer for you.

Brett Hodess – Merrill Lynch

Yes. What I was getting at there was should we look at each of those quarters when the reset occurs? Is the quarter where you don’t get much revenue growth on the royalty line until you start to get new customers in other areas added in?

Hank Nothhaft

Well that is a – I mean, that is a conclusion you could reach. But like I’ve said, it doesn’t – it used to depend a lot on the market share of the various participants that are involved. And of course, this just really affects the DRAM segment of our business and doesn’t affect the wireless and other growing parts of the chip-scale packaging arena.

Brett Hodess – Merrill Lynch

Yes. And then the second question was, just to be clear, relative to the Amkor case was the fact that they still have a license. So they will have to start to pay you ongoing royalties going forward as well as this average staking gets resolved. Is that correct?

Hank Nothhaft

That’s right. Thanks for asking that question, Brett. So the situation is that they are a licensee and they’re obligated to pay royalties on any product that they produce that uses Tessera patents, whether they were part of the arbitration hearing or not. And so the arbitration ruling went through the end of March 2008. Therefore, going forward from that point in time, they owe us royalties on an ongoing basis.

Brett Hodess – Merrill Lynch

Okay. Very good. Thank you.

Hank Nothhaft

You’re welcome. Thank you for the questions.

Operator

And your next question comes from the line of Raj Seth with Cowen & Company.

Raj Seth – Cowen & Company

Hi. Thanks. Hank, two quick ones, one, there was some disclosure around the wireless ITC case around whether or not various defendants had concluded potential settlement talks with you, I think perhaps mandated by the court. I’m just curious, since that time, have any of those who weren’t continuing discussions with you re-engaged in the last weeks or days?

Hank Nothhaft

Hi, Raj. Thank you for the question. I am not aware of any disclosure that took place of ongoing discussions with the respondents in any of our ITC cases. So I really don’t feel that I’m in a position to respond to that question. I’m sorry.

Raj Seth – Cowen & Company

Okay. There were actually – well I’ll take it offline. And a second question, TI who’s one of your larger customers, obviously, spinning off some pieces of the wireless business. How does that work vis-à-vis your contracts with them if they spend that off to someone who is not currently a licensee? What happens?

Hank Nothhaft

Well, once again it would be – this is happening as you know quite a bit in the semi-conductor and DRAM segment as well as with TI. So it really depends on an individual case-by-case basis to what the contract say and what is negotiated with the assuming party as to whether they have to assume that liability or not. Clearly, it’s our position that when these type of events occur, that the new company, Nyko, if you will, or the spin-off company does either need to agree to assume that license or sign a new license agreement with us to be legally producing the products.

Raj Seth – Cowen & Company

Okay. Thanks.

Operator

And your next question comes from Arnab Chanda with Deutsche Bank.

Arnab Chanda – Deutsche Bank

Thank you. A couple of questions, first of all, Hank, I’m not – or not even close to being an expert on legal issues. But if it seems like a couple of the cases have – the timing has been delayed a little bit. Is that a little – can you explain exactly why that is? And what relationship, if there is any, with the PTO re-examination of some of these things? And I’ll follow up please.

Hank Nothhaft

Okay. Arnab, thank you for the question. I see no connection with any of the delays of schedules in the ITC cases as being connected to any of the activities at the PTO. PTO is really a separate issue and has no direct correlation. IN regards to the ITC actions, I can only take the administrative law judge at face value. He said that he is heavily scheduled and involved with a bunch of other cases and investigations, and therefore, requested a delay to December 1st on our ITC wireless action. I don’t think that pretends any directional signal as to the outcome of the case. We, of course, felt very good about the case we put on and remain so.

Amkor is once again indicative of our 100% hit rate in protecting our IP and defending it. It’s too bad that in the intellectual property situation that we have in this country that we have to continue to litigate on the same patents over and over again and prove that they’re valid. There should be some kind of rule that once you have certified these things three or four or five times that you wouldn’t have to do it again. But such is not the case.

Now in the semicon case, we requested to have the 106 patent entered into the hearing and into the testimony and the administrative action that is taking place there. That is very favorable to us because the 106 patent does not expire until 2014. So that really is up the ante, if you will, and extended the period of time, which the respondents in that case will be subject to our patents and the validity of our patents. So even though there was a slight delay in that case, we view that as highly favorable to our current situation.

Arnab Chanda – Deutsche Bank

Thank you, Hank. And a while ago there was a question about the litigation. I know you obviously don’t want to take about the actual settlement that could occur. But just to maybe in terms of a clue, would it be fair to look at what percentage of the market you have penetrated your royalties from that market? And then, the part that you have not penetrated, do use the similar ratio and get to kind of a potential settlement number or is that unfair to do so? Thank you.

Hank Nothhaft

Thanks for the question, Arnab. Yes, maybe at one point in time that might have been possible. But we’ve been discussing that very actively here in regards to the finding our total available market. And what’s happened is, the manufacture ability of components and the use of chip-scale packaging has proliferated. Whereas we uses to say, we are in the DRAM and wireless market. But now, for example, every PC and laptop that is being manufactured has a WiFi chip in it. It really incorporates our chip-scale packaging technology.

So we’re going to go back and take a really hard look at our team, and how far we’ve actually proliferated with our capability. So whereas maybe a few years ago when at a different time and place and things where simpler, that might have worked. I’m not saying it would have, but it might have worked. I think today, it would not work at all.

Arnab Chanda – Deutsche Bank

And one last question about your optic business, could you talk a little bit about what your goals are for the business in terms of –obviously, large part of the services business comes from there. But the royalties and what kind of milestones where you looking for in sort of the next couple of years? Thank you.

Hank Nothhaft

So are you talking in terms of financial goals or numbers of licensees, or development of specific products and all?

Arnab Chanda – Deutsche Bank

Well maybe the first couple of things.

Hank Nothhaft

Well, I mean, we had a grand vision when we set out to enter this market that we wanted to create a platform and integrate a set of capabilities from a broad portfolio. And innovate in such a way that others that didn’t have this range of technology and portfolio would be unable to compete with us so that we would be able to get value added prices regardless of the form of the licensing or how the product manifested itself from the market. So as far as milestones go, I would want to have major individual future successes. For example, like in EDoF, with tier 1 handset manufacturers in 2009. And then as a milestone, as you look forward in to the 2010 timeframe, that we would have integrated the capabilities of the various companies that we bought and developed internally so that we have platform wins in the 2010 timeframe.

So those are very broad parameters. But we want to basically succeed in the cell phone wireless market first, and then migrate beyond that into the PC and broader markets. And we have talked previously as a management and as a company about a $100 million run rate in the 2010 timeframe. And certainly that remains an active goal here. It’s an aggressive goal. It’s aspirational in some way, but we’re still driving towards that goal and looking at ways to achieve it at this point in time. Does that help?

Arnab Chanda – Deutsche Bank

Yes. Thank you very much, Hank.

Hank Nothhaft

You’re welcome.

Operator

And your next question comes from Hans Mosesmann with Raymond James.

Hans Mosesmann – Raymond James

Thanks. Thank you. A couple of questions on the triggers that you’re seeing with a couple of your DRAM customers, do you have other volume triggers that are going to happen here over the next several quarters? And are there other customers that have this kind of situation with you?

Hank Nothhaft

Hans, thanks for the question. No. There are no other triggers, and therefore, don’t anticipate or will there be any other ceilings or volume pricing incentives that will come into effect in the future.

Hans Mosesmann – Raymond James

Okay. And then as a follow up, because of the nature of your model, you’re getting paid in arrears. What would the seasonality be in the early part of next year if some of your customers have seen the weakness in Q4 and Q1? Would you see that weakness in Q1, Q2 of next year or are there other elements to your growth?

Hank Nothhaft

Hans, you’re correct. We would see it in Q1 and Q2 of next year.

Hans Mosesmann – Raymond James

Okay. Thank you very much.

Hank Nothhaft

You’re welcome. Thank you.

Operator

And your next question comes from Bennett Notman with Davenport.

Bennett Notman – Davenport

Good afternoon. When you talked about the significant sequential decline in legal expense in the next quarter, are we possibly going to get back below the double-digit millions for a quarter of year before a ramp up again as we head to the activity in April? How big a decline should we try and bake in.

Hank Nothhaft

Thank you, Bennett, for the question. There’s a number of factors that are coming into play in legal fees. So I just want to describe how unprecedented the amount of legal activity we had in the third quarter. I mean, we had two full blown ITC trials occur in the third quarter. One was a five-day trial, and then the other one was twice that. I mean, it was a two-week trial. You can imagine not only the legal fees direct – with the lawyers, but all the expert witnesses and management distraction and time in watching to see, and what have you. So as you try to model the company and look forward, the number of activities of that sort are diminishing, and diminishing very rapidly.

The other thing I would point you to that, the fourth quarter is a very odd quarter in many ways in many companies. And there is a lot of seasonality associated with it because of all the holidays that take place in that quarter. So that in itself has a limiting effect on what can and will transpire during the quarter as well. But for me to say it’s going to be single-digit or double-digit, that would be really providing guidance beyond the level of which we’re comfortable providing in the legal area. But I would anticipate a very significant decline in legal expenses in the fourth quarter.

Bennett Notman – Davenport

Okay. And then could you talk a little bit about, I guess, I was thinking you guys might have bought – have used market weakness to buy back some stock in this quarter. It doesn’t appear that you did that. And given that you’ve got what could be some good events and catalysts to move the stock higher coming forward, I’m just sort of curious as to why not? And maybe what the buy back plans would be from this point going forward?

Hank Nothhaft

Thank you, Bennett. So in our case we feel gratified and thankful to have the cash and ready assets that we have on hand. And our intention is to really take advantage of the situation that has occurred in the market. The unfortunate distress of others is sometimes to the benefit of other folks. And so in our case, wanting to build a very significant, successful IP oriented Kennedy, with grand ambitions to grow the company and to increase our profits, where we’re looking at investing our cash or really looking very carefully at intellectual property portfolios, companies, and the like that may be available in these distressed times. So I feel very strongly, as a management team and I know that my board of directors feels exactly the same way, that we can create a much greater return to our shareholders, stakeholders over the long term by investing the money at this time of distress in valuable assets that can be bought for very, very good prices rather than buying back the stock.

Bennett Notman – Davenport

Okay. And then, the one last one for me. On their conference call last night, Amkor alluded to a charge they set aside for their estimate, I guess, of what the settlement would be. And without trying to get you to comment on overall dollar amounts, should we look to their dollar amount as any sort of guideline? Or what do you think of that charge that they took, I guess?

Hank Nothhaft

Well thank you. I can’t really comment on Amkor’s charge. I think I detailed very carefully what the true situation is relative to the award. And so, we today know that the award is material, but we could not describe to you what the exact award would be. And we stand by the statements that we made in this call.

Bennett Notman – Davenport

Thank you very much.

Hank Nothhaft

You’re welcome.

Operator

And your next question comes from Mehdi Hosseini with FBR.

Mehdi Hosseini – FBR

Yes. Thank you for taking my question.

Hank Nothhaft

Mehdi, can you speak up please. I can’t hear you.

Mehdi Hosseini – FBR

Sorry. Thanks for taking my question. Going back to the Amkor and your prepared remarks, that you have contract for packages of patent that are not – that were not involved in the mediation and you checked them to honor that. What is the – what is the important strategy here? If, say, when the mediation panels come back and determine how much they’re liable to pay, and what happens to these other patents that are not dictated and Amkor owes you? How should we think about it? Does that go back to square one requiring more litigation?

Hank Nothhaft

Yes. Thank you, Mehdi, for the question. And I’m going to ask Scot Griffin who’s our EVP of TCC to respond to your question.

Scot Griffin

Thank you, Mehdi. So just the touchstone of the relevant finding by the arbitration panel is that the agreement with Amkor remains in effect. And under that agreement, Amkor is obligated to pay for any patent that it uses. And so the arbitration itself though and what the panel focused on was limited to accept of a handful of patents, and focus really on past liability. So in terms of going forward, based on what we’ve seen, as Hank said previously, we really can’t predict with any clarity at this point in time and based on this interim finding, but hopefully, as we move towards the final award, we’ll have a better sense.

Mehdi Hosseini – FBR

Okay. Let me ask the question a different way. Could Amkor go back to the patent office and request re-exam for the patents that were not disputed in the mediation?

Scot Griffin

Well I suppose it’s possible. But the fact is you have to understand that many of the patents that Tessera owns are about 150 relevant patents worldwide, include patents that are not US patents. And therefore, they would not be able to go US patent office on those patents, for example.

Mehdi Hosseini – FBR

That makes sense. My second question has to do with – in the DRAM market, some of the leading memory manufacturers have begun to ship DDR3. Your prior comments regarding Q4 and Q1 not being as strong as Q2, Q3. Does that also taking into account the ramp up in DDR3 shipments?

Hank Nothhaft

Yes, it does. This is Hank. Yes, it does.

Mehdi Hosseini – FBR

Okay. Thank you.

Operator

(Operator instructions) And your next question comes from Michael Collin with Pacific America.

Michael Collin – Pacific America

Thank you for taking my questions, and congratulations on the interim arbitration ruling against Amkor.

Hank Nothhaft

Well thank you, Michael. We appreciate it.

Michael Collin – Pacific America

My first question’s for Hank. Amkor put up their own press release, and I’m going to quote just one statement they said in their release, “The panel found that most of the packages accused by Tessera are not subject to the patent royalty provisions of the license.” I was wondering if you could give either some context set statements or just know if you disagree with that statement.

Hank Nothhaft

Yes. That’s a very interesting question, Michael. I guess what I can share with you is this. There where five product families that were addressed by this arbitration. And of those five families, there was a representative sampling of 26 packages that were taken. And of the 26, 50%, i.e. one-half, were found to be subject to the patent royalty provisions of the license. The panel then took these findings or those findings and extrapolated them to the packages contained in each product family. It is important to note that the packages contained different pin counts. You may recall or those of you who follow the company know that we are a pin count driven in terms or our royalties, which is what matters most in this time are royalties for us. So obviously, there are many data points, in which descriptive statements such as most can be made, most packages, most pins et cetera. What is important to remember is we believe that the award would be material. And I think that’s probably all that I can say about that.

Michael Collin – Pacific America

Okay. Thank you. That’s really helpful. And my final question is, when does the license with Amkor expire?

Hank Nothhaft

It’s 2011.

Michael Collin – Pacific America

Okay. And you would either be able to either sue or renegotiate at that point I guess?

Hank Nothhaft

Yes. We would have the same rights towards them as anyone else. I guess this is – we’re on the Amkor situation, this is a vintage contract that was signed in 1996. We have one other minor licensee that has similar contract terms. So we do not have a bunch of other contracts out there that are approximate to Amkor situation and mandatory arbitration, et cetera.

Michael Collin – Pacific America

Thank you very much.

Hank Nothhaft

You’re welcome.

Operator

And your next question is from Olga Levinson with Barclays.

Olga Levinson – Barclays

Thanks for taking my question. Can you quantify at all what royalty growth would have been in the December quarter had you not have the price and trigger that you had with the two customers?

Hank Nothhaft

Thank you for the question, Olga. I mean I would like to answer that question, but I don’t feel that I’m in a position to reveal that information. Sorry.

Olga Levinson – Barclays

Okay. And basically you’re saying that’s going to be at the same effect as (inaudible) in the March quarter as well, right?

Hank Nothhaft

Well, that’s a good question, Olga. So it will affect the first and fourth quarters – fourth and first quarters, but necessarily to the same degree in both quarters.

Olga Levinson – Barclays

Okay. And on the last conference call, you had suggested that your initial outlook for 2009 was that DRAM units would probably grow about 15% to 20% and handsets would be up about 10%. Given how the economy shaping up right now, can you update us on your current outlook?

Hank Nothhaft

Yes. That’s a great question. And it’s true what we’ve said. We have looked at new outlooks from some of the research people in the industry. We’re all looking at the same meltdown that we’ve seen in the world financial markets. And so wafer shipments, according to Gardner in the third quarter 2008, we’re down 2%. And they’re looking for a sequential decline to be significantly greater in the fourth quarter ’08 and first quarter ’09, so.

We’re not as directly affected because we’re not ASP driven as some others, but we’ll be affected next year by a reduced forecast and actual reduced shipments and sales of DRAM and wireless products. I’m a little more, I’m going to use the word bullish, but more confident about the wireless growth. I follow that closely given some of my background. And the sales in developing countries have held up remarkably well even to this very current data that I have. And also the huge shift to smart phones.

So even though people are holding on to their phones longer, maybe not buying as many new models, when they are buying smart phones worldwide or taking a bigger and bigger percentage market share because our content is so much greater that the likelihood of the forecast of that market remaining somewhat more solid is pretty good, so. I think when we give guidance next quarter, we’ll have more to say about it because I think this is all happening in real time and everyone’s adjusting their numbers in the phase of what’s happening.

Olga Levinson – Barclays

Okay. And then, just I guess from a housekeeping standpoint, can you talk about what level of GAAP and cash taxes you expect in December and how we should think about 2009?

Hank Nothhaft

Sure. I’m going to have Mike answer that.

Mike Anthofer

Okay, Olga. Yes. Cash taxes right now, we believe, will be about $2.5 million for the quarter. And from a GAAP standpoint, because of the sheltering of losses that exists right now and our tax structure and what not, it probably – the best guidance I could give you off of the PVT would be around 70% at this point.

Olga Levinson – Barclays

Seventeen?

Mike Anthofer

Seven-zero. And we’re working on some discreet items that could take it lower, but I would use 70%.

Olga Levinson – Barclays

Okay. And this $2.5 million for 4Q, do you expect that to continue until ’09 as well or–?

Mike Anthofer – Chief Financial Officer

I couldn’t comment on that right now. I’ll give guidance on that at the next call.

Olga Levinson – Barclays

All right. Thanks a lot.

Mike Anthofer – Chief Financial Officer

You’re welcome. Thank you.

Operator

And our next question is from Kevin Vassily with Pacific Crest Security.

Kevin Vassily – Pacific Crest Security

Thanks for taking my call. A couple of things, first, don’t mean to belabor the Amkor piece, but maybe, Scot, you can comment on the methodology here? In terms of what Amkor stated was the process – there would be – they made an estimate. They had a ticket charge. There’s probably some auditor driven process behind that for them. But they suggested that they would submit their estimate of damages to the arbitration panel and that you would be doing the same. And it would be up to the arbitration panel to award the final damages. Is that a fair assessment of what’s going to happen?

Scot Griffin

Yes. So this past Tuesday, I believe, it’s Tuesday that we receive the award. As part of the – in addition to receiving the ward, we received an additional order laying out a briefing schedule, by which we – each side would inform the arbitration panel of what it believed the final award should be, including not only the damages based upon the guidance the interim award gives, but also the interest rate to be applied. So both sides, I believe, have the opportunity to provide that in the next 21 days or so. We can’t guess at this time as to when the arbitration panel will (inaudible) it.

Hank Nothhaft

It’s formulaic, isn’t it, Scot? I mean this is not a blank sheet of paper?

Scot Griffin

That’s true, but it is an arbitration, and each side is going to have its own view. I’d anticipate that the–

Hank Nothhaft

Right, of applying the formula.

Scot Griffin

Exactly, right.

Kevin Vassily – Pacific Crest Security

All right. We’ve disserted in their conference call yesterday that the charge they took was their estimate on related to any – specifically, to any award that has been kind of determined so far by the panel.

Hank Nothhaft

Right. Kevin, yes this is Hank again. Now, we can’t really comment on what they’re doing because we really don’t know.

Kevin Vassily – Pacific Crest Security

No. That’s fair. I just want to make sure that I understand kind of what steps you guys need to take as you get closer to that six-week review period and the final award.

Hank Nothhaft

Sure. Okay. Technically, it is fair to say we can come up with our own internal estimate as well.

Kevin Vassily – Pacific Crest Security

Okay. But that’s something you will submit to the panel as part of this process.

Hank Nothhaft

Yes.

Kevin Vassily – Pacific Crest Security

Okay. Okay. Second question was on the optical business and the product launch services piece that you referenced in you prepared remarks. Can you talk a little bit about things, one, what the margin profile of this type of service business is going to look like? And assuming there’s enthusiasm in your potential customer base for this type of work, how big of it – of a lion among your P&L will this – could this potentially be?

Hank Nothhaft

Kevin, that’s a great question. So let me explain the rationale why we’re doing this. I think that’ll get to the heart of your question. I’ll put it in a historical context too about why Tessera succeeded in the CSP market, which is related to your question.

So the reason why we’re launching these services is that to get licensees to get on board with some of our advance imaging optics and wafer-level camera technology requires quite a capital investment. So we wanted to take actions to prove our competency, and the pay-back, and the manufacture ability, and to reduce the potential capital cost that people we’re trying to close business with would have to incur. And so by going into, if you will, the production of these singlets of single element lenses, we’re exceeding the market. We’re also creating a lot of know how on our part of trade secrets. And we’re determining all of the tweaks that really have to go into the manufacturing equipment and capital equipment that people will have to buy to recreate an assembly line for these products.

So harking back to our history, the reason why Tessera succeeded to the DRAM image and chip-scale packaging, the intellectual property was great, and we have a lot of innovation and brilliant people. But we also had set up an assembly line. We actually created chip-scale packages. We created all the know how and the trade secrets.

And what we licensed to people was just not the IP, but it was more like a McDonald’s franchise where you got to turn key operation.

And so you have to view the singlet and the services business as a strategic move on our part to educate the market, create trade secretes and know how, to create all the elements of a franchise offering that we then could go to our customers and sell a turn key operation to. So these will be transient and minor parts of our P&L over the long term. Though at times it’ll look like we have gone into the manufacturing of this specific product, I would also provide you the example of Qualcomm as an analog to what we’re doing. From time to time, in order to get their technology adopted, Qualcomm has moved into a product business, actually even manufactured handsets. With division, they sold the products here for a while, and then sold the division to somebody else. And so that’s very much what we’re all about in our services business. Does that help?

Kevin Vassily – Pacific Crest Security

Yes. I think so. So I mean, would it be fair to think about the way it is going to work in the near term, you’ll run most these clocks through the R&D line. And at some point we’ll start to see an increase in your product and services revenue line associated with some of the turn key business you might be doing?

Hank Nothhaft

That’s fair.

Kevin Vassily – Pacific Crest Security

Okay. That’s helpful. Thank you.

Hank Nothhaft

You’re welcome.

Operator

And you have a follow-up question with Hans Mosesmann with Raymond James.

Hans Mosesmann – Raymond James

Hank, a clarification on the 2010 goal of $100 million from the consumer optics imaging type of businesses. How comfortable are you with that? The reason I’m bringing it up is that you’ve mentioned that some of the new players that want to get into that business with you’re IP, it may take them a year, year and a half. So I just want to get some clarifications.

Hank Nothhaft

It’s a stretch full, Hans, no doubt, but achievable. And I’ve been in the office with you, well, for three months. And we’re looking very hard at that goal. Right now we think it is attainable under certain circumstances. So we’re not (inaudible) from it in any way at this point in time. But at the moment, with everything that’s going on in the worldwide economy and what we have here, it’s aspirational. But we do have a lot of traction, and we are winning a lot of deals with smart optics, with OptiML focus. And so we have made great progress. And you haven’t seen revenue from that stuff. And the reason I’ll describe the leap ons, we’ve had five major wins, at least in the OptiML focus area and haven’t arrived $0.01 of revenue yet into the P&L. But it’s coming. And the clock’s ticking against those timeframes that I gave you on my prepared remarks.

Hans Mosesmann – Raymond James

Thank you very much.

Operator

And there are no further questions at this time, sir. Do you have any closing remarks?

Hank Nothhaft

I just want to appreciate all the support we’ve received from our investor base and your belief in us. And we feel somewhat validated and vindicated today based on the recent Amkor ruling. And hopefully we’ll be seeing some other events like that in the foreseeable future. Thank you very much.

Operator

And this concludes today’s third quarter of 2008 earnings call. You may now disconnect.

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