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InterDigital, Inc. (NASDAQ:IDCC)

Q1 2008 Earnings Call

May 7, 2008 10:00 am ET

Executives

Janet M. Point - Executive Vice President, Communications and Investor Relations

William J. Merritt - President, Chief Executive Officer and Director

Scott A. McQuilkin - Chief Financial Officer

Analysts

Michael Ciarmoli - Boenning & Scattergood, Inc.

Tom Carpenter - Hilliard Lyons

Amit Kapur - Piper Jaffray

Ben Mackovik - Rivana Capital

Bill Nasgovitz - Heartland Advisors

Bennett Notman - Davenport & Company

Operator

Good day, ladies and gentlemen, and welcome to today’s InterDigital Communications Corporation first quarter 2008 earnings results conference call. As a reminder, today’s call is being recorded. At this time I’d like to turn the conference over to your moderator for today, Ms. Janet Point.

Janet M. Point

Thank you, Anthony, and good morning, everyone, and welcome to our earnings call. With me this morning are the call are Bill Merritt, our CEO, and Scott McQuilkin, our CFO. Consistent with last quarter’s call, we will offer some highlights about the quarter and the company and they we will open the call up for questions.

Before we begin our remarks, I need to remind you that in this call we will be making forward-looking statements regarding our current beliefs, plans, and expectations which are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results and events to differ materially from results and events contemplated by any of the forward-looking statements. These risks and uncertainties include those set forth in this morning’s earnings press release published today and those detailed from time to time in other filings with the SEC.

These forward-looking statements are made only as of the date today hereof and except as required by law, we undertake on obligation to update or revise any of them whether as the result of new information, future events, or otherwise.

With that I would like to turn this call over to Scott.

Scott A. McQuilkin

Thank you, Janet, and good morning to everyone. Since I expect that you have read the press release that we issued this morning, I will only highlight a few key areas. Total revenue was $56 million in the first quarter 2008, an increase from $54.9 million in fourth quarter 2007. Importantly, recurring revenue from core customers was $55.5 million in first quarter 2008, a $4.1 million increase from fourth quarter 2007 recurring revenue and a $5.7 million increase from first quarter 2007 recurring revenue excluding the runoff of 2G royalties from Sony Ericsson.

Among the notable contributors to first quarter 2008 recurring revenues were LG at 25%, Sharp at 19%, and NEC at 10%. As I mentioned on our last earnings call, the fourth quarter 2007 reflected some softness in royalties from a few of our Japanese licensees, which declined from a relatively high level in the third quarter 2007.

As expected in the first quarter 2008, we saw a rebound in royalties from these Japanese licensees as well as solid increases from several other licensees including Rim, HTC, Sierra Wireless, and Option. In addition, our technology solutions revenue increased to over $2 million in first quarter 2008 from $1 million in fourth quarter 2007 and first quarter 2007.

The doubling of our technology solutions revenue was due primarily to engineering services associated with the first quarter 2008 license of our SlimChip 3G modem technology to a leading Asian semiconductor manufacturer. Overall we are pleased with the continuing contributions from our diverse and growing base of licensees. We’re also very happy to have completed new patent license agreements with Asustek Computer and Pegatron Corporation, two related companies based in Taiwan.

Consistent with past practice, we will provide specific revenue guidance for the second quarter 2008 following the receipt of royalty reports from our major licensees. Although we have not received all of these reports, those that we have received show a sequential increase in recurring patent license royalties.

Our net income was $7.3 million in the first quarter 2008 or $0.15 per diluted share. This level of profitability reflects solid revenues and expense control in addition to certain non-recurring expense adjustments. Specifically, first quarter expenses included a reduction in the litigation contingency associated with the ongoing UK2 case of $1.2 million and reduction in patent litigation and arbitration expenses of $6.9 million related to an insurance recovery for expenses associated with our defense costs for litigation involving Nokia.

In addition, our net interest and investment income included a $0.7 million write down of our investment in Kineto which reflects a lower valuation based on recent financing.

It’s worth noting that although we described certain portions of our revenue as non-recurring, this characterization is really from an accounting perspective. In fact, this element of our revenue stream, which is driven by our efforts to identify and collect past sales royalties from existing and new licensees, is a normal and material part of our business. As a result of our diligence, we have recognized past sales royalties from a variety of licensees in seven of the lat nine quarters. Going forward, we expect that we will continue to recognize this type of revenue from time to time.

We’d also make the same point with respect to our periodic recognition of insurance reimbursements for certain legal expenses. Although these reimbursements do not recur on a regular quarterly basis, they are in fact a normal part of our business and a direct result of our efforts to maintain prudent levels of coverage and obtain reimbursements when appropriate.

It is also worth repeating that while we have accrued a total of $6.6 million for legal expenses associated with the UK2 case, we intend to argue to the UK Court that having defeated Nokia in it’s attempt to have all of our UK 3G patents declared non-essential, e should not have to reimburse Nokia for the costs associated for the issues where Nokia may have prevailed.

Our cash position remains very strong. We ended the first quarter 2008 with $240 million in cash and short term investments representing $5.07 per diluted share. Our cash flow has also remained strong during this period of significant investment in our business. Free cash flow was $77.7 million for the first quarter 2008. This includes the receipt of the final royalty payment net of foreign withholding taxes from LG under our existing license agreement.

Turning to the expense side, first quarter 2008 operating expenses totaled $45.1 million. This represents a $12.5 million decrease from fourth quarter 2007 and a $1.5 million increase over first quarter 2007. To better understand the trends in our operating expenses, it’s useful to break these expenses into two basic components. First, operating expenses other than patent litigation and arbitration costs which were $39.3 million in first quarter 2008, and second, patent litigation and arbitration costs which were $5.8 million.

Let me address the fundamental trends for each of these components of our operating expenses in more detail. With respect to operating expenses other than patent litigation and arbitration costs, the $39.3 million level in first quarter 2008 represents a very modest $0.3 million increase over comparable fourth quarter 2007 expenses and is below the range that we provided in our previous guidance. This reflects the company’s commitment to actively manage expenses during the period of significant investment in our business.

Looking forward, we expect sequential growth in second quarter 2008 expenses other than patent litigation and arbitration costs to be in the 4% to 8% range. This increase is due primarily to the development activities associated with testing and the continued evolution of our SlimChip product family.

With respect to patent litigation and arbitration costs, the $5.8 million level in first quarter 3008 is significantly below the $18.3 million level in fourth quarter 2007; however, the costs in both periods are affected by certain adjustments including expense accruals for UK2 legal costs in both fourth quarter 2007 and first quarter 2008 as well as the insurance reimbursement in first quarter 2008. Excluding these adjustments, patent litigation and arbitration costs were $13.8 million in first quarter 2008 compared to $10.8 million in fourth quarter 2007. The increase in the first quarter reflects a higher level of activity supporting our ITC proceeding.

Looking forward, the level of arbitration and litigation expense will be directly related to the level of activity experienced during the quarter. Because our first quarter 2008 arbitration litigation costs were offset by an insurance recover, we expect these costs to increase in second quarter 2008. Importantly, we will continue our practice of vigorously defending our strong and well-diversified patent portfolio. These costs will continue to be a necessary element in the execution of our business for the foreseeable future and will vary over time depending on the level of activity.

As you know, our investment activity also includes the repurchase of our stock. Based on our strong balance sheet and our high level of confidence in our ability to build value, our Board of Directors authorized a new $100 million common stock repurchase program in fourth quarter 2007. During the first quarter of 2008 we purchased approximately $1 million shares under this program for $17.5 million. As of March 31, we have purchased a total of 1.9 million shares under this program for $36 million.

In summary, our first quarter financial results represent a good start for the year and we are well positioned to aggressively pursue our objectives, securing revenue for every 3G device sold, maintaining a strong financial position, and building value for our shareholders.

Now I’ll turn the call over to Bill.

William J. Merritt

Thanks, Scott, and good morning to everyone. Let me briefly comment on the quarter and the continued success of our product and licensing programs. I will also address the current status of our litigation with Nokia and Samsung and the settlement discussions.

As Scott mentioned already, the quarter was very solid from a financial perspective. We continue to grow our recurring revenue line, delivered strong positive cash flow, posted solid earnings, and controlled our product development expenses while still meeting all of our milestones. All in all, a very good start to the year.

Indeed, the first quarter was an exceptionally strong quarter for the launch of our SlimChip products. As reported earlier in the year, we had a very strong showing at the 3G SM trade show, with many prospective customers visiting the booth, seeing our SlimChip modem in operation, and expressing significant interest in purchasing the product.

In February we signed an important technology licensing deal for our SlimChip IP with a growing Asian semiconductor company. That agreement delivered nice revenue contributions in the first quarter and positioned the company well within the high volume Asian cell phone market. We also completed our delivery of HSDPA technology to NXP and ASIC is now moving into production. Infinium also continued to see growth in its communications business including a design win at Samsung and based on public reports, good positioning for the iPhone 3G business. This is good news for us as we derive software licensing revenue on every 3G ASIC shipped by Infinium.

In March, Signals Ahead, an independent research firm, published their annual review of the 3G modem market. In that report, InterDigital was one of just three companies with a working release eight compliant terminal unit ASIC product, and among that small group, our chip performed better than our competitors in many tests, including in high-interference environments typically associated with Cell Edge. We believe this performance advantage gives us a significant marketing edge as operators want their users to experience uniform service across the entire cell.

There in the first quarter we also continued in our operability and performance testing of our SlimChip product with major infrastructure vendors, data card manufacturers, and other prospective customers. In each of those tests we continue to show solid performance and progress towards commercial launch.

Our technical success is driving marketing success. We are in regular and productive dialogue with a broad range of prospective customers and are on track to secure one or more design wins in the first half of this year. Assuming we hit that target, we would expect to begin shipping product by year end and when you combine that success with the expected success from NXP, Infinium, and our new Asian semiconductor partner, the end result is much more meaningful contribution to revenue and profitability from our product programs.

Based on all that, we are very proud of our achievements. We are equally confident in the future of the product program. We have produced a product that most other semiconductor manufacturers have yet to do. Our development teams are functioning extremely well and our next product is well into development with scheduled launch in the mid 2009 timeframe. That product will lower costs, increase performance, and position us for continued success in both the data card and embedded module market and also the more lucrative smart phone and high-end feature phone space. We are excited about the prospect of product and our prospective customers are as well.

Moving to the patent license side of the house, we announced earlier this week the addition of two more patent licensees in Taiwan. That brings our total number of 3G patent licenses to over 25. It also continues to expand our license coverage in this key manufacturing region. We also continue to have good negotiations with other prospective licensees and believe that additional deals can be closed during the year.

Lastly, let me address the topic of Nokia and Samsung. To bring folks up to date on where things are, we were scheduled to be at trial IT/ITC during late April and early May. As we previously reported, Nokia was able to secure a decision from a Federal Judge that any ITC action against Nokia be stayed pending resolution of Nokia’s claim that it is somehow licensed under the patents involved at the ITC. That decision is on appeal and being heard on an expedited basis by the Second Circuit Court of Appeals. We continue to believe strongly that Nokia’s license claim is unfounded. Indeed, the ALJ at the ITC had refused to delay the trial on that basis. Moreover, the Judge in New York specifically stated that no stay was being opposed as to Samsung. However, since the Nokia and Samsung cases had been consolidated, the ALJ at the ITC nonetheless delayed the trial date for Samsung, presumably to see how the Nokia issue would work out before the Second Circuit. However, he has not changed his date for the initial determination. We have since moved to sever the Nokia and Samsung cases and to move forward on the Samsung trial. We are awaiting further information from the Judge as to whether he will sever the cases and when the trial against Samsung will commence.

I appreciate that all the legal maneuvers can get pretty confusing and sure, a delay is not often welcome news. However, delay in litigation is not uncommon. The key thing for parties involved in litigation is to maintain your focus on what you are trying to achieve and not let the ups and downs of any one event color your thinking. In that regard, our objective is to sign favorable license agreements with both Nokia and Samsung, as well as the other top five manufacturers. We remain very confident that we can do that. Indeed, as we previously reported, we had made substantial progress in reaching a settlement with Nokia. We, of course, have not reached a final resolution with them. Without getting into the specifics of what transpired since that announcement, it is commonplace for the momentum of deals to ebb and flow. This can be driven by a number of factors, including the ability of the parties to identify creative solutions to close gaps as well as external factors such as the timing of litigation.

However, there is another important factor at play. We are simply not willing to accept the deal that Nokia is offering because of where we have come as a company and where we want to go. As to where we have come, we already have solid earnings, we have solid cash flow, and we have a solid balance sheet. These are tremendous assets that will allow us to avoid doing a deal simply because it is a bird in hand. Instead, we are leveraging those assets and the strength of our patent portfolio and licensing program to execute on a very specific plan on how to license the entire industry. That plan has been tested in the market for over five years and with more than 25 other licensees. Time and time again that plan and the economics we seek have been found to be reasonable and achievable. We see no reason to deviate from that plan for it is proven and will drive what we believe to be substantial value. So instead, we simply intend to execute on that plan.

That means we will dive licensing success with other parties just like we did this week with new agreements at rates consistent with that plan. More licensees provide further credibility as to the strength of the InterDigital patent portfolio and the creativity and resolve of the company as a licensor. We also will continue to drive the product program to create not only independent value from those programs but also provide more tools to bring into patent negotiations. We will also continue to grow the company, its revenue, its balance sheets, and its strength to provide added incentive to unlicensed companies to settle as that should ultimately realize that delay is working against them, not for them.

As always, we appreciate the support of our shareholders. The company had a very solid first quarter and is working hard to deliver a great 2008. With that, let me open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Ciarmoli - Boenning & Scattergood, Inc.

Michael Ciarmoli - Boenning & Scattergood, Inc.

Hey guys, nice quarter, thanks for taking my call. Bill, can you just elaborate a little more? I’m still kind of confused about the 8-K that you guys issued that mentioned substantial progress with Nokia. It seems to be a little bit of a deviation from the way you guys have communicated in the past and you know your words that you just said, a lot of these deals can ebb and flow with the momentum, so it seems like what could be progress one day could kind of fall apart the next day. Can you just elaborate what kind of progress you’re seeing with Nokia and at the time you did put out that 8-K, were you guys feeling that there was a deal that was close and that’s kind of gone back to the drawing board?

William J. Merritt

A couple things. It certainly as we indicated in that 8-K, we did make and have made substantial progress in closing the economic gap between us and Nokia, and that remains a fact, that we did do that. The deals do have a bit of ebb and flow to them and I think from our perspective as I said, there was probably a time five years ago when InterDigital was a different company, when what we have in hand had been something that we said, “You know what, this is probably good enough.” We’re just not there as a company anymore. We’re much stronger. We intend to build a corporation of significantly higher value. We have a path to get there. We have been executing on that path I think exceptionally well and I think we’re just going to maintain our resolve and get the result that we want, so we certainly did make good progress with Nokia and I am confident that as we move forward here that ultimately the deal that we put together with them will be one that hits our strategic plan.

Michael Ciarmoli - Boenning & Scattergood, Inc.

Okay, fair enough, and then two other quick questions. One on LG. With Motorola really kind of collapsing in their handset business, LG grabbing more market share, you know, hypothetically, if LG really started to climb the ladder and grab some market share, what kind of language is in your contract? Can you guys grab additional revenues from that kind of prepayment schedule if they really start to ship more units and volume out there in the marketplace?

William J. Merritt

Without getting into the specifics of the LG deal, let me just talk about how one typically structures a five year paid up deal. What you typically do in those types of deals is in exchange for some payment and you’re getting the benefit of the guaranteed payment, and so that’s your benefit, and typically what the licensee is getting is the benefit of being able to produce more volumes without having to pay additional amounts of money, so that’s a fairly well balanced structure. What you typically protect against is a dramatic change like acquisition or something like that. We’re pretty far down the path now with LG so we’re three years into that deal, I guess it’s this year or next year --

Scott A. McQuilkin

It’s 2010.

William J. Merritt

-- in 2010, so to the extent there were some added value that they get because they pick up some sales, that certainly becomes an element of the next discussion with them on the renewal. It’s a pretty traditional way of doing business.

Michael Ciarmoli - Boenning & Scattergood, Inc.

Okay and then last question and I’ll jump back into queue. Your recurring royalty growth on a sequential basis and year-over-year, the progress you’re seeing there, is that attributable to growth with some of your individual licensees or is it a function of adding licensing? I guess what I’m trying to get at is are you seeing consistent growth from some of your guys like Sharp or NEC or is that base of revenues growing because you continue to add more licensees?

Scott A. McQuilkin

Michael, this is Scott. It’s really a combination of both. Or course we added Apple in the fall of last year and then extended and expanded our agreement with Rim, so there are new sources of revenue and when you put them together it certainly contributes to growth, but at the same time, I would say there are a number of licensees that have been doing very well in the marketplace, number one, and number two, the 3G market overall which for the running royalty agreements that we have also drives growth, has been a significant contributor and from quarter to quarter, we’ve seen some ups and downs, particularly with a few of the Japanese licensees, but you look over a year, four to six quarters, and I would say there’s pretty consistent growth there. It’s driven by the addition of new licensees but also significantly by growth from not just one or two but a number of our key licensees and we expect that trend to continue.

Operator

Your next question comes from Tom Carpenter – Hilliard Lyons.

Tom Carpenter - Hilliard Lyons

A couple questions for Bill and then one for Scott of course. Bill, could you give us an update on the Samsung third arbitration at the ICC? This thing seems to be dragging on forever about 1.5 years.

William J. Merritt

I think when it was filed, the last I think in the 10-K we had reported that the panel had a decision to make with respect to some key issues in the case which were in fact case dispositive for us if they go the right way. We are waiting for a decision from the ICC on that. Their typical schedule is they meet a couple days each month because they have this sort of ICC governing body that reviews those decisions so we would expect a decision... It’s certainly timely for a decision to come in now, I can’t tell you it would come in this month or next month, but certainly, they have had it for a sufficient period of time where we could expect it at any time at this point.

Tom Carpenter - Hilliard Lyons

So this is a decision on whether they will move forward or not?

William J. Merritt

I would say it’s equivalent to like a Motion for Summary Judgment in a litigation so if the Summary Judgment goes in our favor, then the case could end at this point. If it doesn’t go in our favor, then the case would proceed with respect to some further issues and factors.

Tom Carpenter - Hilliard Lyons

I believe next week at the Second Circuit Samsung’s appeal of your 2G award and subsequent confirmation is under submission meaning there will be no oral argument.

William J. Merritt

I think what that is is there’s two aspects to the Second Circuit Appeal. One is the sort of substantive appeal and I think a briefing on that is either just about concluded or concluded and so that would be then set up for a decision by the Court at some future date. The second aspect of the Second Circuit case is a request by Samsung that the Second Circuit stay its activities pending the result in the third arbitration, so in fact, they are asking for a stay of their own appeal, kind of a unique thing they’ve asked for. I think that’s what is maybe teed up next week for consideration by the Judge on the papers. Certainly I think when we file the 10-Q tomorrow we’ll have a pretty good outline of the legal update.

Tom Carpenter - Hilliard Lyons

Switching gears to the case at the ITC, is my understanding correct where Judge Lucken didn’t rule on a stay, he suspended it unilaterally pending the outcome of your all’s appeal at a Second Circuit which is different from the Second Circuit we just talked about, this is a different Second Circuit case where you’re appealing Judge [Batroling’s] ruling allowing Nokia to go to arbitration.

William J. Merritt

That’s correct. Judge Lucken’s order was simply that the trial date was put off. He did not put off his date for the initial determination and as I indicated, presumably that was, and I think this was a logical step by the judge, he wants to see if the case is going forward against both parties or against one because if it can go against both parties, I think he would prefer to do that from an efficiency standpoint. But we have also asked to sever the cases because obviously the Federal Court judge in New York specifically stated that no stay should be imposed against Samsung so I think that Judge Lucken is being very practical here.

Tom Carpenter - Hilliard Lyons

I guess maybe you can help me with this. The lawyers I know are all somewhat surprised that a Federal judge can what looks like intervene in an ITC case. I thought the ITC case was supposed to be totally independent, the only Court that would have jurisdiction over them is the Federal Circuit Court of Appeals and I was surprised that they handed off your appeal to Judge [Batroling] who I don’t see how she can intervene in an ITC case where a judge has already ruled on an issue and then in the Federal... your appeal of her ruling, first you appealed the Federal Circuit and then they transferred it to the Second Circuit. This is all kind of confusing, how it’s worked. Can you enlighten us on some of this?

William J. Merritt

I’m dusting off my law diploma here. I share your observation that it is confusing. I think certainly that our papers before the Second Circuit also share your observation that it seems like this issue has been tried at the ITC and that the path for appeal is that path, up through the Commission and up through the Circuit, that’s the issue that the Second Circuit’s going to have to engage in to determine if that is in fact correct. I think there is a logic to that. There’s other legal factors in play as well at the Second Circuit so I think we certainly share your view that the Judge in New York was incorrect in her ruling and we’re hoping that the Second Circuit reverses her.

Tom Carpenter - Hilliard Lyons

It looks like the ready week is later this month around the 26th. Does that mean there will be a hearing with the Second Circuit that week and a ruling in the next month or two? What have the lawyers told you about a time frame for a decision on this matter?

William J. Merritt

I don’t believe that a time frame for a decision, that’s typically not something that the circuit would put out. What they typically put out is a brief schedule and then after the briefing is completed, then they put out a hearing schedule and then once a hearing is had, then you wait for a decision, so we have our briefing schedule and we will get a hearing schedule once the briefing is done and typically once they kind of flip through the papers and get an understanding of what they’re dealing with.

Tom Carpenter - Hilliard Lyons

One final question for you and then the promised question for Scott. One of your customers who has been paying 2G royalties since September of ’07 has recently announced 3G agreements that will ramp the countries where its products are sold from 4 to 11, this company being Apple of course, and pending 3G iPhone. With that in mind, when they start talking about a 3G iPhone, will your handset licensing revenue from this customer increase as it sells 3G phones, and I’m going to emphasize handset licensing revenue as opposed to product revenue.

Scott A. McQuilkin

I think that we with respect to the Apple deal, the disclosure we put out back when we did that deal a while ago, sort of contains the limits of what we can speak to with respect to that deal. As I think I mentioned, Tom, to you before, I felt the negotiation on the 8-K took longer than the negotiation on the agreement so I don’t want to... They’re a good customer of ours and so certainly we don’t want to move away from that agreed text. I think the more interesting thing about Apple for us is if Infinium can secure that win and we think obviously getting the 2G win so they have an inside track there and there have been some articles, there’s an EETimes article about what’s inside the 3G iPhone. If that ends up being the Infinium chip with our software, we think that’s not only a good revenue contributor but I think also a very big step for the company to moving into a very popular product and frankly will help the brand of InterDigital as well so we’re very focused on that.

Tom Carpenter - Hilliard Lyons

I might revisit that at a later day. Scott, it’s a comment, then a question. Nice job buying back shares at an average price of $17.50. Can you walk me... I think I got a little confused with some of the legal dollars and the offsets and the insurance adjustments last quarter. I think you’d either reserved or wrote down, not wrote down in an accounting sense, but there are 7.8 million on the income statement that you’re trying to recover in the UK in the 2G case with Nokia. Is the 1.2 million an offset against that so that takes it to 6.6?

Scott A. McQuilkin

Yes, that’s correct, Tom. The 7.8 million is a contingency and it was an estimate that we made in the fourth quarter based on the information we had available at the time. We will continue to re-assess that as we did at the end of the first quarter and basically we had the benefit of a little more information on Nokia’s legal expenses. That’s really the only new piece of information is those expenses came in lower than we originally estimated. We made the same kind of assumptions otherwise and determined that our accrual for those expenses, rather than being 7.8 million, would be 6.6 million.

Tom Carpenter - Hilliard Lyons

Has the judge ruled on that matter?

Scott A. McQuilkin

No.

Tom Carpenter - Hilliard Lyons

Time frame?

William J. Merritt

I think that that a time for a decision will typically not be laid out by a judge. I think in the Q we may give an update as to further hearings on that topic. As you know, the judge in that case has changed from the prior judge, so I’d refer you to the Q when we file it before the deadline.

Scott A. McQuilkin

Tom, can I just correct you on something? On the stock buy back you gave me a nice compliment about buying the stops cheap. The $17.50 is the amount of money that we spent. The average price was something close to $19, $19.50.

Tom Carpenter - Hilliard Lyons

Okay. I thought it was 1 million shares at $17.5 million.

Scott A. McQuilkin

It ends up being close to that.

Tom Carpenter - Hilliard Lyons

You said there was an insurance adjustment this quarter? Where was that in the expenses? Was that patent administration and licensing?

Scott A. McQuilkin

That’s correct and that’s $6.9 million and it relates to a recovery that we received for certain expenses relating to a Nokia litigation that we had insured.

Tom Carpenter - Hilliard Lyons

Fantastic, thanks, and good luck this quarter.

Operator

Your next question comes from Amit Kapur - Piper Jaffray.

Amit Kapur - Piper Jaffray

Maybe just anther question on the OpEx. Just to clarify, I know you’re not guiding to anything for patent and litigation costs, but as we look into Q2, should our benchmark be the $13.8 million that you incurred in Q1 before the insurance recoveries or should we think differently?

Scott A. McQuilkin

The point I made was that if you look at it as a base including the insurance reimbursement, that’s probably not the right way to look at it. I would look at it before any kind of insurance recoveries and we’ve gone from a level of about $10 million to $11 million per quarter over the third and fourth quarter up in the fourth quarter primarily because of the ITC litigation and at this point we’re not providing any more specific guidance than that.

Amit Kapur - Piper Jaffray

That’s fair enough. Maybe turning to SlimChip, if you can talk a little bit about, are there any updates on how you view the competitive environment there, any kind of what you’ve heard over the quarter from some of your potential competitors and then any change in the target markets you’re focused on for SlimChip?

William J. Merritt

I think we remain pretty confident that our point of entry into the market that the data card space that what we’re looking at as far as competitive environment we have a pretty good shot at that space and I think that’s being confirmed by the level of discussions that we’re having with folks in that market, so I think we’re well positioned for a design win or two within that data card or embedded module space. You know, the SlimChip, the first chip also is applicable into the smart phone market. They key for us there is frankly the partnerships with the right AP, Application Processor folks, because that’s really, it’s a combination of those two components that really drive the function of those phones, so that’s a situation where with the right partnership it won’t necessarily be our modem against the Qualcomm modem or some other competitor’s modem. It’ll be our modem plus our AP or our AP partner’s processor against that combination of another competitor, and given the importance of the Application Processor in smart phone devices, it could be that the capability of that device or that portion of the modem rules the day so I think from a competitive position there in the smart phone space, the key for us is the right partner and we’re certainly in discussion with folks on that basis.

Then with respect to the modem offering at IP to the semiconductor space, frankly, there’s no one else that has the solution that we’re offering into the market. There are people that have pieces of the solution but no one has a fully proven ASIC from 2G up through HSUPA that they can offer as a complete solution and we’re finding that to be a very interesting proposition with a number of customers.

Amit Kapur - Piper Jaffray

Thanks, that’s helpful. As you ramp SlimChip, are you going to need to make any more working capital investments, hold any inventory as you kind of build that out, or is that all going to be handled with your foundry partners?

Scott A. McQuilkin

I expect that we will over time as the volume ramps up and the revenues ramp up, we will also have some working capital. I don’t expect that that will be a huge cost for us. The larger cost is just development and customer support activities that’ll be presumably covered by incoming revenues as well.

Amit Kapur - Piper Jaffray

Maybe one final question. You kind of had a little bit of a nice pick up in the technology service revenue in Q1. How should we think of that business going forward? Is that still kid of lumpy quarter on quarter?

Scott A. McQuilkin

It tends to be lumpy and it’s a function of activity that we have with a number of different partners and again we will provide guidance in total but not for that specific piece. It does tend to move up and down quarter to quarter.

William J. Merritt

One thing, Amit, I would say on that is I think it’s more lumpy now because it’s to a large NRE driven. I think as for example Infinium has got the win with Samsung. We expect them based on published reports to get additional wins so if they begin to really drive some success with that t3G business, that becomes a more stable number within that so the lumpiness starts to go away. Same thing with NXP. They were showing the chip at 3G SM show so we’re hoping that they can do a good job penetrating with that device. Frankly we looked at the combination of ST Micro and NXP and said, “Great, they’re getting stronger and they have our IP” and we love our licensees to be strong and pushing hard into the market so I think as the per unit revenue ramps, the lumpiness of that line should go away.

Operator

Your next question comes from Ben Mackovik with Rivana Capital.

Ben Mackovik - Rivana Capital

The free cash flow of $77 million, how much of that came from the LG settlement?

Scott A. McQuilkin

From the LG payment we get $95 million from them on an annual basis but then there are foreign withholding taxes so it ends up being a number in the high 70s. So excluding that in the first quarter, our cash flow would have been pretty neutral.

Ben Mackovik - Rivana Capital

If I look to the interest income, is there a reason that was down so much versus Q4? Cash balance actually looks higher than it was.

Scott A. McQuilkin

There’s two reasons. One is just the Federal Reserve bringing rates down and we keep our investments very short term so as the short term rates came down, the yield on that investment portfolio came down. The second thing is I talked about a write off of $0.7 million from Kineto, our investment in Kineto, based on a lower valuation in a recent financing that they did. That gets recognized in that net interest and investment income line. So that’s included there. If you add that back, you’re still at something in the range of $1.2 million which is still down from the fourth quarter because of the lower yield on the portfolio.

Ben Mackovik - Rivana Capital

Okay, that makes sense. Any update on the Japanese market?

William J. Merritt

The Japanese market, interestingly, and our Japanese licensees seem to be doing fine. They go up and down from quarter to quarter, sometimes due to changes between wholesale shipment and retail sales so they build up inventories over time and then draw them down. Also move up and down quarter to quarter based on new products that they bring to market. So we see normal quarterly ups and downs but again if you look at it over multiple quarters, I think the licensees that are key to us overall are doing quite well and we haven’t seen yet any real weakness in the Japanese market overall.

Scott A. McQuilkin

I don’t think you’re going to see the kind of growth in that market in 3G volume but you’ll see elsewhere just because it tends to be a more highly developed, more mature market but certainly our key licensees seem to be doing fine.

Operator

Your next question comes from Bill Nasgovitz - Heartland Advisors.

Bill Nasgovitz - Heartland Advisors

You should be proud. Congratulations on a great quarter. Did I hear that through the year to date repurchased 1.9 million shares this year 2008? Was that correct?

William J. Merritt

That’s cumulative from when we initiated the program last year. So the $36 million, the 1.9 million shares, is what we purchased under the $100 million authorization program to date.

Bill Nasgovitz - Heartland Advisors

How about some color for this quarter in terms of share repurchases?

William J. Merritt

I can tell you through May, the beginning of May, we’ve purchased about 2.5 million cumulative program to date and maybe $48 million. So we’ve continued to purchase stock.

Bill Nasgovitz - Heartland Advisors

We hear a lot about, we’re waiting on the end of our chairs of course for Samsung and Nokia, but could you give us, Bill, some color on other licensee opportunities over and above those two and just some color in terms of rates. What shareholders might expect in terms of royalties.

William J. Merritt

As far as those other opportunities, I think we continue to work hard with the top five and I think a lot of that is fairly visible to people with the litigation and other things. Outside that environment, we’re doing a pretty good job working within Taiwan. We see Taiwan as a very key market for two reasons. One, historically, a very strong manufacturing center where we think a lot of the cell phone manufacturers will end up being, and interesting, it’s a way to actually get a portion of the top five handsets before you actually license the top five customers because some of the manufacturers actually service the top five, so we actually have some revenue in from top five people are actually otherwise unlicensed directly so it’s a good market for us to go after so we’re very active there. Given some success we’ve had with respect to growing on our reputation as a technology provider in places like China, that’s a move we are now starting to make to start to sort of move that process because there are some significant manufacturers there. That’s probably going to be a long process as you would expect but I think it’s one that’s a high value for us at the end of the day and then there’s a smattering of others. Actually when you get right down to it, we’ve got other than the top five folks, the remaining four of those that are unlicensed, you’ve got a big majority of that Tier 2 and Tier 3 already under license but still very active, still feeling very positive about additional deals in those Tier 2 and Tier 3 ranks through the rest of the year.

Bill Nasgovitz - Heartland Advisors

Then lastly, you still have a [poison pill], I think it’s 10%. Why don’t you drop that so we can buy more stock?

Janet M. Point

We made an exception for you, so...

Bill Nasgovitz - Heartland Advisors

Good luck and we’re looking forward to resolution here.

Operator

Your next question comes from Bennett Notman - Davenport & Company.

Bennett Notman - Davenport & Company

I apologize if you already went through this in part anyway, but on the Second Circuit Appeal of the Nokia ruling that is holding up the ITC action, is there a date for that expedited trial yet?

William J. Merritt

I think there was a briefing schedule set. Beyond that I don’t recall. I don’t believe that there’s a hearing date set, but as I said, I think the 10-Q will obviously give you an update on all that stuff and that will be out... It’s due pretty shortly at the SEC.

Bennett Notman - Davenport & Company

In terms of that, I think you said in the ITC action they haven’t stayed their date for initial determination yet but it’s probably on hold until the Nokia or the Second Circuit action can be completed. In terms of that impacting or delaying the ITC action, do you expect that to happen, that the calendar’s not going to be fast enough to get it in in time for that first ITC date or is it too early to know at this point?

William J. Merritt

I think it’s too early to know and because you don’t know how much, if it ended up being just a case against Samsung, you don’t know how much of the schedule the judge had built in to deal with two different sets of products, and if he’s only dealing with one, can you pull in his schedule a little bit? But it really is too early to tell. We’ll see what Judge Lucken comes out with.

Bennett Notman - Davenport & Company

When would we hear whether or not you’re able to get the two cases severed at the ITC?

William J. Merritt

We’ll know when the judge issues his ruling.

Bennett Notman - Davenport & Company

In the Infinium/Apple one that you guys alluded to, would that revenue recognition be sort of one quarter in arrears like it happens with your regular handset manufacturers, or would it have to be even a little more delayed because it’s sort of one step removed. How should we think of the way that would ramp into your numbers?

William J. Merritt

We recognize revenue from anytime it’s sort of per unit. We do that on a one quarter lag. So the Infinium contract would work no differently than our patent license agreement with Sharp. It would be a one quarter lag.

Bennett Notman - Davenport & Company

I know you guys can’t get too specific but in terms of just trying to think of what that means, would that be a significantly less per unit contribution than if let’s say you were licensing one of the handset guys directly, or how should we try to think about that in terms of the potential scope of the impact?

William J. Merritt

We obviously can’t get into the per unit rate that Infinium pays us for that, but I would say that when they begin to ship in meaningful quantities then that revenue line for us will become meaningful as well. So if they get the success that we hope that they get, it will be a nice contributor to revenue.

Operator

Your next question is a follow up from Tom Carpenter - Hilliard Lyons.

Tom Carpenter - Hilliard Lyons

I think we’re setting a record for the longest IDC conference call ever. Just two quick follow ups on the SlimChip. I just wanted to make sure that I have it clear. On this phone platform, let’s just call this Version 1, for SlimChip, are we just targeting modems and data cards, and then Version 2, for next year, is that when it can make more entry way to smart phones?

William J. Merritt

This version can address both markets. What I would tell you is that from a couple of perspectives, it’s probably not optimized for that market, but we actually have had discussions with both with respect to the current chip in it and it would work reasonably well. The next version of the chip, because it’s going to be at reduced cost, reduced size, and some increased performance, it’s better positioned for that smart phone market, but the first one could go into that market as well and we were having those discussions.

Tom Carpenter - Hilliard Lyons

As you enter this market, can you talk about cross licensing issues that you may face?

William J. Merritt

Sure. A couple things on that. One, as part of our licensing program, over the years we have actually secured licenses back from many of our licensees with respect to the production of chips, so we have some level of coverage already. It is certainly a topic of discussion with other folks when we are in licensing discussions, so to the extent that there are folks whose patents we need who are not yet licensed under our patent, that will be part of the discussion with them. Typically I would say that it doesn’t have any economic affect on the licensing deals because anybody that has patents that they want to use to generate revenue in the market is not really interested in generating that revenue at the semiconductor level, they want to generate it at the handset level, so you could typically get what’s called a non-assert which means that they simply will not assert their patent against you and it’s only the handset that they go against and that tends to work out pretty well. I think also from a cross-licensing perspective it’s one of those differentiators that we have because we have such a strong patent portfolio versus some of the other competitors in this market. We can actually generate higher margins because we should have a lower IP licensing cost.

Tom Carpenter - Hilliard Lyons

I know in the past there’s been little licensing at the chip level because of the Nokia and Qualcomm issues. There’s been talk that may change. Are you saying that you’re seeing little or no change?

William J. Merritt

In fact, I’m seeing, if I’m thinking of change, I’m seeing more concern about licensing at that level and by folks. From our standpoint it’s a good trend. We’ve always licensed at the handset level for the patents and to the extent that the licensing at the chip level is not really something that you worry about too much because the folks with patents in that space tend to want to do it at the handset level. That’s great because it lowers your cost.

Operator

With no further questions left in the queue, I’d like to turn the conference back over to Ms. Point for any additional or closing remarks.

Janet M. Point

Thank you, Anthony, and thanks all for, that was a long call, but feel free to give me a call afterwards if you have any further follow up questions. I am available, and thanks.

Operator

This does conclude today’s presentation. We thank everyone for their participation. You may disconnect your lines at any time.

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Source: InterDigital, Inc. Q1 2008 Earnings Call Transcript
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