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Executives

Moriah Shilton - IR

Hank Nothhaft - Chairman & CEO

Mike Anthofer - CFO

Barney Cassidy - General Counsel

Mike Bereziuk - EVP Imaging and Optics

Craig Mitchell - SVP Interconnect, Components and Materials

Analysts

Kelly Anderson - Sidoti

Paul Thomas - Bank of America-Merrill Lynch

Kevin Vassily - Pacific Crest

Michael Cohen - MDC Financial Research

Tessera Technologies Inc. (TSRA) Q3 2010 Earnings Call October 28, 2010 5:00 PM ET

Operator

Good afternoon. My name is Doris and I will be your conference operator today. At this time, I would like to welcome everyone to the Tessera third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Ms. Shilton, you may begin your conference.

Moriah Shilton

Thank you, Doris, and good afternoon everyone. Thank you for joining us for the call today. 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 two business days 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 16336767.

I will now read a short Safe Harbor statement. During the course of this conference call, management will make a number of forward-looking statements, which are statements regarding future events, including the future financial performance of the Company. These forward-looking statements are made pursuant to the Safe Harbor provisions 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're cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this call. More information about factors that may cause results to differ from the projections made in these forward-looking statements can be found in Tessera's filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31, 2009 and its quarterly reports on Form 10-Q, especially the sections of these filings entitled Risk Factors. The Company disclaims any obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that occur after this call.

On the call today from management are Hank Nothhaft, Tessera's Chairman and Chief Executive Officer; Mike Anthofer, Chief Financial Officer; Barney Cassidy, General Counsel; Mike Bereziuk, Executive Vice President Imaging and Optics; and Craig Mitchell, Senior Vice President Interconnect, Components and Materials.

During this call today, management may discuss certain non-GAAP financial measures for comparison purposes only. The non-GAAP amounts of cost of revenues, research and development, selling, general and administrative expenses, net income, and earnings per share do not include the following, stock-based compensation expense; acquired intangible; amortization charges; charges for acquired in-process research and development; impairment charges on long-lived assets; and related tax effects.

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 2010 earnings press release and to the Company's website for a reconciliation of non-GAAP measures to GAAP. After management's brief opening remarks, we will open the call to your questions.

And with that, I'll turn the call over to Hank.

Hank Nothhaft

Thank you, Moriah. Good afternoon and welcome to Tessera's quarterly earnings call. Before I open the call for your questions, I wanted to remind everybody that we had changed the format of the call last quarter, and we are continuing to use the same format going forward.

In lieu of reading a long script and then answering Q&A, we're posting a detailed summary of the quarter on our website at tessera.com in the Investors section, so that we have more time for Q&A during the actual call itself.

I will offer a few thoughts on our third quarter of 2010 and recent activities. We had an excellent quarter. Our total revenues of $82.1 million were a record for revenue, excluding settlements, and were up 24% from last year's third quarter and 10% from the second quarter of 2010.

Our two business segments, Microelectronics and Imaging and Optics, also grew substantially. Microelectronics revenues of $72 million were up 22% from last year's quarter, and Imaging and Optics revenues of $10.1 million were up 42% from the third quarter of 2009.

GAAP net income for the third quarter of 2010 was $19 million, or $0.38 per share. Cash, cash equivalents and investments increased $36.2 million during the third quarter, resulting in $474 million at the end of the quarter.

In Microelectronics, we successfully renewed our license agreement with Fujitsu. We also took steps to protect our intellectual property by filing two lawsuits against companies who are using our innovative technology without making proper compensation to us.

In Thermal Management, we continue to make progress in our silent air cooling development efforts and are excited about the increasing level of interest for this technology from OEMs in our first target market, ultra-thin LED laptops.

In Imaging and Optics, our extended depth of field or EDOF technology continues to gain market adoption. And our Imaging and Optics EDOF royalties nearly tripled in the third quarter of 2010 as compared to the third quarter of 2009. Camera phones capable of still as well as video image processing are also gaining market share. We are participating in this growing market through our video tools technology.

Yesterday, we announced that Fujitsu licensed our video tools hardware acceleration technology for use in its Milbeaut chipsets. Before I conclude my remarks, I want to discuss the Wafer-Level Optics portion of our Imaging and Optics business. We conducted an exhaustive evaluation over the past few months of various strategic options for our Wafer-Level Optics for camera modules technology. Our findings are that though Wafer-Level Optics remains a competitive technology solution, improvements in cost and manufacturability of alternative technologies has diminished the disruptive nature of Wafer-Level Optics to such an extent that pursuing a licensing strategy further would not generate results consistent with our expectations.

We concluded the best alternative was to cease further development of this technology and pursue a long-term vision of generating revenues through more Imaging and Optics product opportunities. We will repurpose resources formerly dedicated to Wafer-Level Optics to high value product-based opportunities such as consumer Micro-Optics.

In conclusion, we are very pleased with our third-quarter results and we believe we will have a strong full year as well. Excluding settlements, we believe our full-year 2010 total revenue will be up between 18% and 19% over full-year 2009 total revenue due to the expected growth in our primary served markets of DRAM and mobile wireless devices. We are excited about our future and our long-term growth, and I look forward to reporting our successes in the future.

I’d now like to turn the call over for questions. Doris, can you take Q&A at this point in time for us?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). And your first question comes from Kelly Anderson with Sidoti.

Kelly Anderson - Sidoti

First, I just wanted to ask in terms of the recently announced Sony case, maybe it's just me but it seems like patent infringement is a bit harder to litigate against than a breach of contract suit. So, could you give us a sense of maybe the likelihood that you'll have to take this as high as the ITC again, or how do you see this playing out?

Hank Nothhaft

This is Hank speaking, and I'm going to turn it over to Barney Cassidy, our General Counsel, to answer your question. Barney?

Barney Cassidy

The case is in a very preliminary posture right now. We are not going to opine on whether or not it is brought further to the ITC. It is now in the District Court of Delaware, and it is a patent infringement case, not a breach of contract case. The reason for that is the contract, the license agreement, expired, and Sony continued to ship products covered by our license agreement, notwithstanding the fact that it had expired. So, we felt we had no choice but to bring the lawsuit.

Kelly Anderson - Sidoti

And just as a follow-on to that, would you be willing to share with us if there are any other significant licenses expiring in the next call it year or so?

Barney Cassidy

We have announced that there are 2,012 licensees that are up for renewal, but there are no material licenses between now and then other than the 2010 licensees that we've been working on.

Kelly Anderson - Sidoti

And then, just as an update on the silent air cooling portion of the business, I think we're expecting to hear some design wins in the second half of this year. Can you give us an update on what your progress has been there? And is this business also going to be following the outsource model?

Hank Nothhaft

So, we are very pleased with the interest in the marketplace, in the product. We are certainly in I would call a prototype stage with a couple of the OEMs in the office and our laptop marketplace. And we definitely decided that this is not a licensing business opportunity for us, and so our go-to-market strategy will entail some form of outsource manufacturing, probably on our own, but I wouldn't exclude the idea that we might partner with somebody as well in this area.

Operator

Your next question comes from Krish Sankar with Bank of America-Merrill Lynch.

Paul Thomas - Bank of America-Merrill Lynch

This is Paul Thomas for Krish Sankar. Hank, I was wondering. Since the cash balance is up to 474 million at this point and with a little bit of a strategic change in the Wafer-Level Optics, should we expect to see further IP acquisitions in the Optics space or is there going to be more of a focus now on the silent air cooling or what might we be expecting going forward?

Hank Nothhaft

We intend to use our cash in a series of activities. So, as you mentioned, we certainly are in the Intellectual Property acquire mode, but not just for Imaging and Optics, as you referenced. We actually are interested in procuring high-quality intellectual property that relates to our core businesses at this time, which are basically the Micro-electronics, Imaging and Optics. To the extent we would need any additional IP in the silent air cooling area we would acquire that as well.

But we also continue to spend very aggressively on in-house innovation development, and we have filed more than 200 patent applications year-to-date from our own internal research and development work. These patents have been filed broadly in the advancement of our core chip scale packaging. It continues to evolve in scale and support the higher performance requirements that we are seeing in the marketplace, and so we see that technology to be extensible over quite a period of time.

We're also investing in 3-D packaging, stacking, TSV technology and the like.

Clearly, we have invested a significant amount of effort in silent air cooling. Our patent portfolio there of issued and pending patents is approaching 90. Then of course we have a patent portfolio in excess of 800 patents in our Imaging and Optics area.

So we think that the high-quality Intellectual Property is the currency of international innovation. We see that as a broad indicator, not the indicator, but a broad indicator of innovation. And certainly, if you're either procuring or developing your own high-quality patents, then it has quite a significant value to the company.

So that's clearly one use of cash. The other thing that we have clearly been looking for would be to make one or more acquisitions of companies. We are a disciplined buyer. We spent a lot of time evaluating a number of potential acquisitions this year, but due to fit and/or pricing and/or strategic reasons, have decided not to consummate any of the deals that we've evaluated over the last nine months. Does that answer your question Paul?

Paul Thomas - Bank of America-Merrill Lynch

It does. Thank you, Hank. And maybe Mike, could you give us maybe a relative sense of the impact of the DRAM price break in the quarter since it came a little bit earlier this year, maybe what revenue might had been had that not occurred?

Mike Anthofer

Yeah, absolutely, Paul glad to do that. With respect to the difference or the impact from sort of second quarter to third quarter sequentially, it's a little over 4 million roughly speaking. And then sequentially from the third quarter to the fourth quarter, with respect to our guidance number, it's a little between $6 million and $7 million.

Operator

Your next question comes from the line of Kevin Vassily with Pacific Crest.

Kevin Vassily - Pacific Crest

First, on the Wafer-Level Optics wind-down, I guess you can you at all quantify what level of contribution to that Imaging and Optics line on the royalty side was coming from this part of the business?

Hank Nothhaft

Yes, we have not reported any royalties in our Imaging and Optics business from Wafer-Level Optics.

Kevin Vassily - Pacific Crest

And then kind of a follow on to that, if the disruptive nature, as you described it, of Wafer-Level Optics became less disruptive because of your cost reductions and the like in current technologies, as you look out to the next couple of years, what does that do to the opportunity for some of your other imaging technologies, is the market opportunity diminished at all, maybe you could just frame the lack of uptake of the Wafer-Level Optics side to the adoption of other technologies that you guys have in your portfolio?

Hank Nothhaft

Yes, Kevin, I'll be happy to answer your question. So let's take sort of the first part of the question and then I'll talk about our opportunities going forward. Pricing for lens technology in general, as it relates to the wireless market, has been very intense, and prices have come down very sharply. And so it diminished the value of a licensing model in that market. Also, glass and injected molded plastics have become much more competitive. And glass, traditional glass lenses in particular have become much more manufacturable and are able to be used in reflow environments. So I just want to make the point that we’re not saying that Wafer-Level Optics is not a competitive technology, because we believe that it is, but only in the sense if you were manufacturing those lenses and competing against the alternatives that I just mentioned.

So in evaluating our strategic alternatives, we could have integrated ourselves further into the supply chain, as an example, and become a manufacturer either through our own efforts or acquiring companies. That's certainly something we looked at and decided that our skill set is really more in lens design, algorithm development and that sort of efforts, and so finally, we decided it did not make sense and did not play to our core competencies.

So, we think there is a robust opportunity for all the technologies I've mentioned if you are in fact a product supplier in that arena. But it is a very competitive market. To the extent of where are our growth opportunities and are they impaired to any degree by this move, I don't believe they are. We see our major growth opportunities for the foreseeable future, certainly the next couple of years being in three major areas. One is our extended depth of field. Our business is growing, as we mentioned in our comments, that the royalties have tripled year-to-year. We see the market next year growing roughly three times to what it is this year and we believe we will command at least a commensurate market share going forward, or hopefully maybe improve our market share a bit going into next year. So we'll see strong growth from that area.

We created a very strong capability in our optical zoom. It's really a very disruptive technology, for lack of a better term in both size, cost and performance. There has been tremendous interest in the market in the product because it really makes high-quality optical zoom a reality on a smartphone, and without a technology or an invention like ours, frankly, it's not possible for me to assize on a cost basis to do it. And so we see that as a very strong area of growth. The pricing on that is several orders of magnitude higher than our accepted depth of field technology. So it's attractive from that point of view, but it does save on the cost side of the equation to the handset manufacturer. It represents maybe 20% of the cost of what it would be to put a mechanical zoom system in if you could in fact fit one in to a smartphone, if you want to draw that comparison.

Then finally, we’re very pleased with our acquisition of Siimpel. We think that our timing may have been very good in acquiring that company. We are very far along in completing development of the second-generation product, which is smaller, works quicker, faster, it auto-focuses faster and consumes less power than the previous model. There is tremendous interest in the market in that product and we believe we'll have revenue coming from MEMs starting in the second half of next year. So, that I think addresses the points that you raise, Kevin.

Kevin Vassily - Pacific Crest

And then maybe one last question, from an R&D standpoint, is it safe to assume that dollars involved in kind of further development are just going to be redeployed elsewhere in the business, and as such there wouldn't be any kind of change in the trajectory of R&D spend relative to revenues over time?

Hank Nothhaft

That's basically correct. We’ve been seeing the opportunity for a bit more of a product play in the Imaging and Optics side of our business now for some time. And we’re looking for high value, high IP intensive sort of products that play to our skill sets of algorithm development and lens design. And so what this is, is a cost avoidance in a way because had we not cancelled the Wafer-Level Optics program and continued forward with it, we would've had to do a fair amount of incremental hiring to support some of these other programs, which we believe have great promise. So by curtailing this program at this point in time, those personnel are being shifted off of this project and moved onto the new project, which is underway but would've required additional staffing to continue.

Operator

Your next question comes from the line of Michael Cohen with MDC Financial Research.

Michael Cohen - MDC Financial Research

In the Spansion bankruptcy, you submitted a disputed claim. Spansion released it on their conference call that it was $130 million that you were asking for. If we got a result back from the CSC and the ruling we’re all waiting for from the 605 investigation. Is there any reason that that disputed claim wouldn't very shortly settle?

Hank Nothhaft

This is Hank. I'm going to address your question to Barney Cassidy. Barney?

Barney Cassidy

The ability to settle is a two-way street. We would need the cooperation of the folks at Spansion and their creditors. It's difficult for me to say on a public conference call my views on how willing they would be to resolve the claim. So, I'm sorry that's sort of a non-answer, but we are in discussions with them, but we cannot predict what the outcome would be at this time.

Michael Cohen - MDC Financial Research

You also previously mentioned earlier in the call that there are no significant licenses expiring before 2012. I believe it came out in court that the Hynix license was a five-year license signed about five years ago. Is that not counted because it's not material enough or is it a longer license than I was thinking, or why wouldn't it be expiring either late this year or first half of 2011?

Barney Cassidy

The Hynix license is a 2012 expiration license.

Michael Cohen - MDC Financial Research

Can you share either the first half our second half of 2012?

Barney Cassidy

No, sorry.

Michael Cohen - MDC Financial Research

Okay. Thank you very much and I understand. And that's all my questions.

Operator

(Operator Instructions). Your next question comes from line of (inaudible) with Raymond James.

Unidentified Analyst

Just a little follow-up on the Wafer-Level Optics, are you able to sell that business to anybody?

Hank Nothhaft

Our intentions are to fulfill our contractual commitments in totality with our current licensees. At this point in time, we don't anticipate a sale. There's always the possibility something can happen in the future, but I'm certainly not anticipating that to occur at this point in time.

Unidentified Analyst

Are you able to give any color on what was spent on that business?

Hank Nothhaft

I don't and I can't, sorry.

Unidentified Analyst

And then, final question is there kind of a new sales goal or kind of some kind of guidance around what you expect for Imaging and Optics?

Hank Nothhaft

No, we only guide on a quarter-to-quarter basis, and that's the way we're going to keep it. I think we are very excited about our business there. As I said, we view our three major opportunities, though there are others, in zoom. Optical zoom, we have a very unique capability there. I said that field business now, we've invested a lot of time and effort and we're starting to reap the rewards from that, and we'll see strong royalty growth going forward as the number of EDOF equipped phones triples next year.

And then MEMs has tremendous benefit in the marketplace in terms of size, in terms of performance, in terms of power consumption, and so we need to complete development of our second-generation product, get through some customer acceptance programs, and move that to revenue sometime in the second half of next year.

If we can do that, we will have very good results coming out of the Imaging and Optics business, but we're not going to characterize anything but a quarter-to-quarter guide on the business.

Unidentified Analyst

Actually if I may ask one last question, could you give any color on how the wireless business did this quarter?

Hank Nothhaft

Wireless is related to the separation between our DRAM royalties and wireless?

Unidentified Analyst

Exactly.

Hank Nothhaft

Is that the nature of the question? We've always said that we wouldn't give a specific breakdown. We have said in the past that DRAM did account for more than half of our revenues. We have been as forthright as we possibly can be about the volume price incentives that we have in place with the two large memory licensees. Mike was very specific and now is even quantifying the quarterly impact on the revenue that those contracts have had on a sequential basis.

And that frankly is about as far as we can go with guidance on our own company. I'm sure you all are looking at now not at Tessera specifically, the industry in general, and you are seeing very differentiated results from various handset manufacturers depending on where they are at in the product cycle.

So, for example, a company like Motorola is finally getting traction out of their Android product and having strong results in their smartphones. Somebody like LG had issues and had a very dramatic downturn in their handsets having missed the quarter quite dramatically. Someone like Sony Ericsson, they apparently have a very good lineup of products, but part shortages are limiting their revenue. So, I would say that my observation on the market is smartphone sales certainly remain intact. There seems to be a lot of growth there. You can look at whether it's the iPhone, the Android based products, or even Windows 7 now coming out for Microsoft, there's a lot of very interesting new products coming into the market. It appears to be very solid demand. Various companies are having mixed results depending on their own product cycles.

Unidentified Analyst

All right. I appreciate all the color. Thank you.

Hank Nothhaft

You are welcome. Operator, do we have any other questions in the queue?

Operator

Yes sir. You have a follow-up question with Kevin Vassily with Pacific Crest.

Hank Nothhaft

Great. Kevin?

Kevin Vassily - Pacific Crest

Actually, the question was answered, so I am good. Thanks.

Hank Nothhaft

We're prescient today. Okay. Thanks, Kevin, for your interest. Do we have any other questions?

Operator

No sir, we have no more questions in queue at this time.

Hank Nothhaft

Okay. Well, thank you very much everybody for joining us for our call and we look forward to doing this again next quarter. Or if there is any news in the interim, hopefully of positive consequence, we will also be online again before then. But thank you very much and we appreciate it.

Operator

This does conclude today's conference call. You may now disconnect.

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