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Executives

Janet Point – EVP, Communications and IR

Scott McQuilkin – CFO

Bill Merritt – President and CEO

Analysts

Tom Carpenter – Hilliard Lyons

Michael Cohen – Pacific American Securities

Kevin Sharbatoni [ph] – Boenning & Scattergood

InterDigital, Inc. (IDCC) Q2 2008 Earnings Call Transcript August 7, 2008 10:00 AM ET

Operator

Good day, everyone, and welcome to today's InterDigital Communications Corporation second quarter 2008 earnings results conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Ms. Janet Point. Please go ahead.

Janet Point

All right. Thank you, Trisha. Good morning to everyone and welcome to InterDigital’s second quarter 2008 earnings conference call. With me this morning are Bill Merritt, our President and CEO, and Scott McQuilkin, our Chief Financial Officer. Consistent with last quarter’s call, we will offer some highlights about the quarter and the company and then open up the call for questions.

Before we begin our remarks today, I need to remind you that in this call we will make 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 such as the forward-looking statements. These risks and uncertainties include those set forth in our earnings release published yesterday and those detailed from time to time in our 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 no obligation to update or revise any of them whether as a result of new information, future events, or otherwise.

So with that, I would like to turn the call over to Scott.

Scott McQuilkin

Thank you, Janet. And good morning to everyone. Overall, we had a solid second quarter and first half with strong revenues, good expense control, and positive free cash flow. Total revenue was $58.7 million in the second quarter of 2008, an increase from $56 million in the first quarter 2008. Excluding royalties from past infringement in each period, revenue was $58.5 million in the second quarter of 2008, a $3 million increase from first quarter 2008 and a $5.3 million increase from second quarter 2007. Among the notable contributors to second quarter 2008 revenues were LG 25%, Sharp 18%, and NEC 13%.

Second quarter 2008 patent royalty revenues, excluding royalty revenue from past infringement, were $56 million, a $2.7 million increase from first quarter 2008 and a $3.4 million increase from second quarter 2007. Although there has been some concern about the impact of a weakening global economy on handset sales, our second quarter per unit royalties, which are based on first quarter sales by our licensees, were supported by sequential increases in handset unit shipments for several of our existing licensees including Sharp, NEC, Panasonic, RIM, and Toshiba, as well as the addition of Asustek and Pegatron, two related licensees that we signed in the second quarter.

Our per-unit royalties accounted for 63% of our recurring royalties in second quarter 2008 with the remainder being fixed fee and amortized royalties. In addition, our technology solutions revenue grew to a little over $2.5 million in the second quarter 2008 from $2.2 million in first quarter 2008 and $0.6 million in second quarter 2007. The growth in technology solutions revenue was due primarily to engineering services associated with the first quarter 2008 license of our SlimChip 3G modem technology to Spreadtrum, a leading Asian [ph] fabless company.

Consistent with past practice, we will provide revenue guidance for third quarter 2008 following the receipt and review of royalty reports from our major licensees. Net income totaled $5.8 million in second quarter 2008 or $0.13 per diluted share. Compared to first quarter 2008, this level of earnings reflected a combination of higher revenue, lower operating expenses, and lower patent litigation and arbitration costs, excluding the one-time benefit in the first quarter of an insurance reimbursement and an accrual adjustment for contingent litigation expense.

Note that second quarter 2008 net income does not include the favorable effect of our recent agreement with Nokia with respect to the United Kingdom actions since this agreement was concluded after the end of the quarter. Benefit of this agreement will be reflected in the third quarter as I will discuss in a moment.

Our cash position remains very strong. We ended second quarter 2008 with $238 million in cash and short-term investments representing $5.13 per diluted share. Our cash flow has remained strong even during this period of significant investment in our business. Free cash flow is $98 million for the first half of 2008, up from $91 million for the first half of 2007. Both of these periods include the receipt of royalty payments net of foreign withholding taxes from LG under our existing license agreement.

Turning to the expense side, second quarter 2008 operating expenses totaled $50.9 million. This represents a $2.3 million decrease from first quarter 2008 expenses, excluding the one-time benefit in the first quarter of an insurance reimbursement and an accrual adjustment for contingent litigation expenses. Second quarter 2008 expenses represent a $3.6 million increase over second quarter 2007 due primarily to higher litigation costs.

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 were $38.3 million in the second quarter 2008. Second, patent litigation and arbitration costs were $12.6 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 $38.3 million level in second quarter 2008 represents a $1.1 million decrease from comparable first quarter 2008 expenses and is below the range that we provided in our previous guidance. This reflects our ability to actively manage expenses during a period of significant investment in our business.

Looking forward, we expect sequential growth in third quarter 2008 expenses other than patent litigation and arbitration costs to be in the 8% to 12% range, due primarily to development expenses associated with future product releases as well as testing and customer costs as we move closer to full commercialization of our SlimChip product. In dollar terms, this range for the third quarter expenses is within about 1% of the range that we had previously provided for second quarter expenses.

With respect to patent litigation and arbitration costs, the $12.6 million in second quarter 2008 is less than the $13.8 million level in first quarter 2008, excluding the insurance reimbursement and the accrual adjustment contingent litigation expenses. 2008 number represents a $2.7 million increase from second quarter 2007 due primarily to the higher level of activities supporting the ITC litigation.

In third quarter 2008, the level of arbitration and litigation expense will be directly related to the level of activity we experienced during the quarter. While I’m not prepared to provide any specific guidance on litigation and arbitration expenses, let me comment on a few other factors that are likely to influence these expenses. First, we will recognize a $2.6 million one time benefit related to our recent agreement with Nokia with respect to the United Kingdom legal actions.

Second, the agreement with Nokia will also eliminate significant litigation expenses in the third quarter that we would have otherwise incurred. Third, we expect that the recent ruling by the US Court of Appeals for the Second Circuit will enable us to move forward with our ITC action against Nokia. Although we view this ruling as a positive development, it may cause us to incur additional expenses in third quarter 2008.

Finally, the recent favorable ICC arbitration ruling with respect to Samsung positions us to move forward with actions that we believe will enable us to collect over $150 million in royalties owed for Samsung sale of 2G handsets. These actions may also require additional expenses near term. As evidenced by these actions, 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 confidence in our ability to build value, our Board of Directors authorized a $100 million common stock repurchase program in fourth quarter 2007. As of July 31, we’ve repurchased a total of 3.1 million shares under this program for $62 million. For perspective, since the beginning of 2006, we have purchased approximately one-quarter of our expanding shares. Five years ago, our fully diluted share count was over 60 million. Today it is under 47 million.

In summary, our second quarter reflects solid performance in terms of revenues, expenses, and cash flow, and we are well positioned to aggressively pursue our objectives of securing revenue from every 3G device sold, maintaining a strong financial position, and building value for our shareholders.

Now I’ll turn the call over the Bill.

Bill Merritt

Thanks, Scott, and good morning to everyone. As Scott already mentioned, we had another very good quarter from a financial perspective. We also had an excellent quarter from the standpoint of strategic positioning, both with regard to our progress on signing 3G licenses as well as bringing our family of SlimChip products to market. I will discuss both of these as well as our development of the next generation technology, including our progress in our media independent hand-off technology (inaudible).

After adding new 3G licensees, the major news, of course, is the positive decisions we received last week from the Second Circuit Court of Appeals involving Nokia and from the ICC Arbitral Tribunal involving Samsung. These were very good results for the company, and let me explain why.

First, as to Nokia, we believe the Second Circuit decision clears the path for resuming the ITC investigation regarding Nokia’s importation into the US of WCDMA enabled products. While Nokia may attempt some additional legal maneuvers to avoid a near-term resumption of the ITC case, we don’t see any legitimate basis for Nokia doing so. As such, borrowing something unusual, we anticipate that the ITC action involving Nokia should resume in the near-term.

As for Samsung, the decision by the Arbitral Tribunal confirms what InterDigital has said all along. Samsung cannot use the Nokia-InterDigital 2000 settlement to avoid its payment obligation – its obligation to pay InterDigital over $150 million in royalties we are due based on Samsung sale of 2G products through 2005. The Arbitral Tribunal award also confirms Samsung’s obligation to pay royalties for its 2006 2G sales on the terms of the prior Samsung arbitration award without change.

We believe further challenges to Samsung’s 2G payment obligations are without merit. Should Samsung nonetheless press forward with its appeal of the awards of the second circuit, we are highly confident that the court will confirm the prior arbitral award and the amount secured by the bond will be promptly paid to InterDigital.

We are also reaching an important point in the dispute with Samsung on its sale of 3G products into the US. The evidentiary hearing at the ITC proceeded as scheduled in early July and the parties are now in the post-hearing briefing stage. ALJ has scheduled to issue its ruling in November 2008. Based on how the case has proceeded to date, we believe we have presented a strong case for why the ALJ should find that Samsung’s 3G products infringe the patents in the case and that Samsung’s importation of 3G products into the US should be banned.

All of these developments are very positive and are the types of things that can create a positive environment for reaching a favorable resolution of the disputes with Nokia and Samsung. I can assure you that InterDigital is bringing both its results and its creativity to its discussions with Samsung and Nokia in a conservative effort to reach agreements that will benefit our shareholders over both the short-term and long-term.

Now let me move on to the product initiative, an area of work that we believe will be a major value driver for customers and shareholders going forward. We continue to make excellent progress in bringing our suite of SlimChip products into the market and then growing our product revenues. In June 2008, we reached an important milestone when we secured our first design win for our SlimChip IC product. We continue to have strong interest in our product and are working on securing additional design wins this quarter. Assuming our customers achieve their product launch schedules, we anticipate commencing IC product shipments this year or early next year with those shipments ramping up as 2009 progresses.

Our target market remains the same. With our current baseband IC, we are directly targeting the data and embedded module market. This is the market in which we secured our first design win and where we would expect our next design win to be as well. For that market we have implemented a unique package-on-package design combining our baseband solution with memory into a small package for use in ultra-portable laptops, USB sticks, and other compact devices. We are seeing excellent market reactions for this product as it brings high-end performance to small low-cost devices.

We are also in productive talks on partnerships to combine our broadband modem with third party application processors that target the smartphone market. And we are also seeing good results with our mobile broadband modem IP customers, which today include Infineon, NXP, and Spreadtrum. As many of you have seen, based on the public paradigm reports, Infineon did secure the 3G baseband iPhone win and also has wins into Samsung.

Similarly, we see NXP now even stronger through its merger with STMicroelectronics. Moving forward with the marketing of its HSDPA chip that incorporates InterDigital’s HSDPA Layer 1 design, we have also successfully delivered our 3G IP to Spreadtrum and they are readying themselves for a WCDMA launch – product launch in key Asian markets. We believe each of these companies is positioned for success, which bodes well for us. When they ship 3G products that incorporate our technology, our product royalty revenue will increase as well.

Lastly this morning, I do want to spend just a little time on our new Media Independent Handover, our MIH solution. As many of you know, the common myth has been that a single air interface could satisfy oral communication needs. The reality is that a fabric of technologies from wide area networks to local networks to personal area networks will drive communications.

Having anticipated this phenomenon many years ago, InterDigital embarked on an R&D effort to create the critical technology connecting these different networks, allowing users to roam easily and seamlessly between networks at home, in the office, in the city, and on the highway. Think of it as network of networks. That work began in our research labs and migrated into the standard setting bodies. From there, we moved to refining and productizing the technology with SK Telecom, the largest operator in Korea.

Following the success of that program, we are now moving towards the launch of commercial devices incorporating this software. Indeed we are hopeful that products containing this innovative technology will enter the marketplace before this year is over. That process of future vision, invention, standardization, and productization is a good reminder of what InterDigital is all about.

For over 30 years, InterDigital has been a thought leader for wireless technologies. It all started with the vision of the basic architecture for digital wireless systems. We then dreamed that you could make those systems capable of transmitting movies and other large data files. Both of those visions are now a reality. Today we envision tomorrow’s network of networks. So, as you can see, InterDigital has always been out in front.

So, while at times the litigations involving the unlicensed use of our inventions, maybe headline material, the driving force behind the company’s financial success has been and will continue to be our ability to predict the future of wireless and get there ahead of others. Our early success with Media Independent Handover technology proves that this vision and innovation capability remains alive and well at the company.

With that, let me open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll go first to Tom Carpenter with Hilliard Lyons.

Tom Carpenter – Hilliard Lyons

Hello, Scott and Janet.

Janet Point

Are you there?

Tom Carpenter – Hilliard Lyons

Yes, are you?

Janet Point

Okay. (inaudible)

Tom Carpenter – Hilliard Lyons

Okay. Excellent. Like, where did you guys go? Congratulations on getting some clarity on Samsung 2G. Have Samsung’s 2006 sales reports been submitted to the Tribunal?

Bill Merritt

I think that information is with the panel or at least been produced in that litigation. And that’s really the remaining issue with respect to that case, is applying the rates that were established under the prior award to the determined royalty basis. So, that data is in.

Tom Carpenter – Hilliard Lyons

And just because some of us out there really don’t understand the ICC process, is there another need for an evidentiary hearing or is this something they can just meet for a couple of hours and resolve without going through the formal process?

Bill Merritt

I don’t know at this point. Typically you’ll have evidentiary hearings if there’s disputes of the fact. Right? So this may not – so if there is not a dispute of the fact, but there’s maybe a dispute as to how to apply those facts in particular situation. What you’ll instead have is they will just have an oral argument. And it’s a little looser because in the arbitration, the arguments tend to even be – they even mix law and fact type things. But we will see. I guess the panel will set a schedule for the remainder of the case and it will be helpful if it moves pretty quickly through the very few remaining issues in that case.

Tom Carpenter – Hilliard Lyons

Okay. Is your current thought process to try and crack all the years, ’02 through ’06 together, or because the ’02 through ’05 matter appears to be decided to collect that before you proceed with ’06?

Bill Merritt

Certainly in the context of working on an agreement with Samsung, we would collect all years. Right? And if it ends up being a situation where the litigation is forcing payment, then you would get the ’02 to ’05 presumably first because that’s already teed up. And then you would then move to collect on the ’06 amount.

Tom Carpenter – Hilliard Lyons

Okay. I think you brought up something that’s a nice segue to my follow-up question. What are your thoughts on using part of this award as a bargaining chip in your 3G negotiations with Samsung?

Bill Merritt

Certainly at the end of the day we have to look at an entire settlement and value that, and maybe not necessarily the individual components if the whole deal that makes sense. Certainly as, however, the 2G process moves forward, we have less and less and less flexibility with respect to that number. That’s certainly something we’ve communicated to Samsung. If you choose the litigator matter to the end, then you are sort of stuck with the litigation result to a large extent. So – as I indicated in the remarks, we are as always with these folks we try to be creative and flexible wherever we need to, but we also have to – if we become entitled to certain amounts, we’re not going to walk away from that stuff. So, given that their 3G liability is also pretty significant, I think again at the end of the day we’ll have to look at an entire settlement. But certainly on any 2G-only resolution, it’s going to be at the numbers that the panel has determined.

Tom Carpenter – Hilliard Lyons

Yes. And thanks for the update on trials with ST or SK Telecom on the MIH. Did you guys recently have some patents approved in this area? I know you have patents approved all the time, but I think you might have had five, six, or seven approved in the last couple of weeks.

Bill Merritt

I don’t watch the issuance (inaudible) rather than the US Patent Office –

Tom Carpenter – Hilliard Lyons

Pretty interesting medium let me tell you.

Bill Merritt

But you’re right that we have – this is an area where we did a lot of inventing on the front end, cover a lot of aspects of the design. And given the timing of when those filings would have been made, it’s not out of the question that they would start the issue at this point. And we’re very encouraged. We’ve got good traction not only in Korea, but other operators in Europe are very interested in the technology and the other vendors are interested. So it’s definitely another area where I think we can create some good value for the company.

Tom Carpenter – Hilliard Lyons

Okay. And can you help us understand better the type of products, if it’s just regular handsets, or if there are some smartphone, the type of products where we’d see your technology use and that there are certain parts of the world you’re initially focusing?

Bill Merritt

It would be used in any type of terminal unit. So whether it’s a data card, embedded modules, smartphone, feature phone, at the end of the day we believe it will all – it’s all capable of using the technology because it is a hand-off mechanism not just for data, but for data and voice. So that was the attraction of it. It’s pretty broadly applicable. As far as where we think it will launch, SK Telecom was a very good company to work with, one they tend to be leading at, they tend to want to push the envelope of which we like. They also have a combination of networks running in that country. They have CDMA 2000 network. They’ve got a WCDMA network, and they have a WiBro network. So it was a perfect testing bed for the technology. We do see good reaction in Europe on this. We see good reaction actually outside the cellular environment. We see good reaction, for example, in broadcast mobile television as well as another technology that maybe this would apply to. So we are definitely in at the stage in this process where people are very excited about the technology and our job is to get it out and get it into people’s hands and show them what it can do.

Tom Carpenter – Hilliard Lyons

Okay. So this is something you actually see being the real deal, not just an experimental technology. We all understand there is a disparate amount of networks out there and different technologies, but is this one you’re pretty certain it’s going to work and create revenue over the next couple of years?

Bill Merritt

We have a lot of confidence that this will get into the market. First is the standardized technology. So we’re not talking about some proprietary implementation. It’s standardized under 802.21. That standard size has basically migrated that technology out into the other standard’s body so that those other standards are creating the hooks needed to incorporate the 21 hand-off techniques. So we see a lot of positive – everything right now is positive on this. And it’s definitely a technology that’s needed. In fact, one other thing – one of the more recent developments have been on the LTE side, and the need to have hand-off techniques because of the way infrastructure networks are being deployed, there may be a need for this technology sooner or rather later on the LTE side. So we’re very encouraged right now.

Tom Carpenter – Hilliard Lyons

The revenue you receive, is it – are you going to transfer IP to companies, engineering services or products you’re going to have?

Bill Merritt

It would be a – it’s a software product that gets embedded in the internal unit. So that’s one – you’d have three types of revenue. Right? You’d have IP transfer of the software and royalty revenues associated with that. You may have some level of engineering services as you work through the incorporation of the technology into the handset. At this point, we think it’s pretty straightforward. And then the third piece would be to the extent other folks develop similar software we have patent coverage with respect to their technologies. So there could be people that are just patent licensees from us [ph].

Tom Carpenter – Hilliard Lyons

Okay. I’ve got two more questions and I’ll jump back in the queue.

Bill Merritt

Okay.

Tom Carpenter – Hilliard Lyons

Qualcomm and Nokia resolved their 3G dispute with a 15-year 3G and 4G license. Many of the terms are not public, but a lot of analysts have that backed into an applied Qualcomm number. For 3G we’re estimating that somewhere around 2%. What – Qualcomm’s rack rate has been north of 4% in the past. What impact if any of you think that does in your 3G discussions with Nokia and Samsung, with Nokia paying quite a bit lower rate for 3G and 4G than they were paying in the past?

Bill Merritt

I think there’s a couple of things on that settlement as it implies to us. One I think is that it shows that at the end of the day that you can work these things out. I think there is a concern maybe held by some that this becomes almost a religious worry and it doesn’t solve. And I think – I was never a believer in that. I always felt like at the end of the day these folks would work it out and they did, on terms that they are both obviously very happy with. And I think that bodes well for us, because I think at the end of the day, we also will work these things out on terms that makes sense for us. So I think it does show that there is a level of – there is a process you may have to go through with these folks. As we’ve seen obviously, that one is settled on the courthouse steps. And if you look at the timing of all litigations, we’re walking up to those courthouse steps with respect to the ITC decision in November and things like that. So I think that bodes well and we can never predict when these things are going to happen, but I think it bodes well for us. We’ve been positioned to get things done this year with those folks. As far as the rates that they got, when we – we’re like you – everyone is sort of guessing what the structure is at the end of the day and whether it’s a single rate for all technologies and whether there’s a different rate for WCDMA versus CDMA 2000, and whether it declines over time or – you know, there’s a thousand different ways you can structure these things. I think we are very comfortable that – if things are in the range that the people are predicting is where these folks landed. That’s what we’ve been – the rates that we’ve been using in our discussions with folks make a lot of sense in that context. So I don’t think that this Qualcomm, Nokia settlement creates an issue for us on that front. So, the other thing – next thing about Nokia settlement, Qualcomm is certainly there’s obviously a resource stream and people have that level of dispute going on. So, to the extent that more resources can get applied to working things out, with us, that would be great too. So all in all, I thought it was a pretty good thing.

Tom Carpenter – Hilliard Lyons

Great. One final area and then I’ll jump back in the queue. Samsung 3G at the international trade commission, the staff attorney finding indicated no violation, which could mean a lot of things. But I know there are some things you can tell us and you can’t tell us. What is the staff attorney basing his recommendation of no violation on? Is it the validity of the patents, is it infringement that they believe that the staff or judge believe that your all patents are in the phone? What exactly is the issue here?

Bill Merritt

As you mentioned, we can’t get into the details of the report. But let me give you a sort of three bullet points with respect to the staff opinion. One is obviously we strongly disagree with where the staff landing on this. Second, I think this is a very, very complicated case. And staff is not blessed with a lot of resources. And it’s – I think it can be – it’s not unusual in a complex case without sort of enough resources to bring to bear that you can kind of get on the wrong track. And third, actually we would – I think it would be helpful at the end of the day if the staff opinion actually got published, because I think we would love to answer your questions because I think we’ve got some very compelling reasons as to why staff went off track. And so maybe that happens at some point and we could be a little bit more upfront about it. But fortunately we are kind of tied to the protective order the case. But I can assure that having read the opinion and heard the evidence at trial, and heard our own assessment of the case, we are very confident that case went in well and we’ve got a really good position going forward.

Tom Carpenter – Hilliard Lyons

I was there for part of the first day and heard the staff brief one or two sentence. Statement on his opinion and we were there for most of the Samsung opening presentation. Unfortunately for the IDC presentation we were asked to leave the room. But based on what the staff and Samsung said when I was in the room, that there was – perhaps there was a violation or infringement on some matters, but in overall summary, the staff was not recommending a 337 ban. I know the judge has the final say, but can you respond to those things that were at least publicly available?

Bill Merritt

I think that – again, that’s correct that the staff is not recommending a 337 violation, but again you probably also had an opportunity to observe the judge. He’s a very, very good judge. We’re in front [ph] down there, who is a type of person who is definitely going to make up his own mind on things, was very prepared, has lots of good questions. And I was at least – for the period of time when I was observing things down there, I was very encouraged with what I saw going on there. At the end of the day, I think these cases – the biggest in these cases and this is typical of any type of litigation. It’s claim construction at the end of the day. And you get the right claim construction, everything falls into place. And we think we’ve got very good position with respect to claim construction. And if the judge agrees with us on, and he doesn’t have to agree with us on every patent. He just has to agree with us on one. I think given that, as I said, we remain very confident in that case going forward because I think our case went in nice. I think our experts did a real good job, and these patents were picked because they are that we think particularly strong patents.

Tom Carpenter – Hilliard Lyons

Okay, fantastic. I’ll get back in the queue. Thank you.

Operator

We’ll go to Michael Cohen, Pacific American Securities.

Janet Point

Are you there, Michael?

Michael Cohen – Pacific American Securities

Can you hear me?

Bill Merritt

Yes, we hear you.

Michael Cohen – Pacific American Securities

I said congratulations with regard to Samsung getting clarity on the 2G amount. Switching to the 3G amount, if hypothetically you weren't able to get an exclusion order through the ITC, I imagine your next step would be probably go forward with the district case – that’s in the district of Delaware. Have you sent any letters of infringement on regard to any patents that aren’t in the district court of Delaware? Yes?

Bill Merritt

With respect to Samsung, you have a couple options. You have – certainly the district court is one option. And you’re right that there is an infringement component in that case. And so we could – that could move forward. There’s always an opportunity for our subsequent ITC case. So we have a lot of different avenues left. Frankly at this point that will – again we remain pretty confident that ITC case is going to go well for us and those other things will not be necessary. As far as the communications you sent out to prospective licensees, and it can from time to time not aware at this point since other folks are handling that, what exactly has gone out. But there’s all sorts of discussions that take place with parties as to different patents and how those patents they relate to the standards.

Michael Cohen – Pacific American Securities

You mentioned just now the possibility with subsequent ITC action. Are there other areas of 3G technology that you think are in the standards that are likely infringed that you haven’t yet asserted to either the ITC or district court?

Bill Merritt

First of all, the portfolio we have is a good portfolio with respect to its coverage of 3G products. And that’s both with respect to WCDMA and CDMA 2000. In respect – certain patents to bring it to the ITC, certainly – and does not represent all the patents that we have. You pick patents in litigation for lots of reasons, but there certainly are others that we can bring. As Tom Carpenter noted, we have patents issuing all the time as well. And so that they become additional material for those cases. So again, we’re not – at this point, we feel good that the case should – that’s currently before the ITC should be the driving force for resolution between the parties. But if not, there is more to come.

Michael Cohen – Pacific American Securities

Okay. And your typical licensing practices that you did choose to settle with Samsung and at some point you typically licensed the entire portfolio?

Bill Merritt

That’s typically what we’ve done with folks.

Michael Cohen – Pacific American Securities

And I guess that answers my questions at this time. Thank you.

Bill Merritt

Fine, thank you.

Operator

(Operator instructions) We’ll go to Kevin Sharbatoni [ph] with Boenning & Scattergood.

Kevin Sharbatoni – Boenning & Scattergood

Good morning.

Bill Merritt

Good morning.

Kevin Sharbatoni – Boenning & Scattergood

I know you don’t want to give guidance as to the legal expenses. I was just wondering if you could give us a little bit of color with the Nokia case rolling out of the Second Circuit Court and most likely heading back into the ITC. Are we likely to see more of an offset there? Are the ITC fees expected to be hire just given the scope? Can you kind of give us any color there?

Scott McQuilkin

I think it – the reason we normally don’t provide specific guidance there is because the timing and amount of expense related to actions that are not yet fully underway is difficult to predict. I think I was able to comment on our United Kingdom because that’s something where we clearly anticipated some costs in the third quarter that are not going to be there. So – and those were significant. In terms of any additional costs related to our actions with Nokia and Samsung that are not currently underway, as I indicated in my remarks, there is certainly the potential for those costs that we incurred in the third quarter. But it depends a lot on the timing and kind of what happens next. So it is very difficult I think to provide a firm guidance on that number in terms of something we would have confidence at this point.

Kevin Sharbatoni – Boenning & Scattergood

Okay, understood. Can you give us an idea of what the pipeline looks like for the SlimChip product line? I guess both that – and in terms of IT, any additional fabless customers in the pipeline and whether or not you see – you mentioned that a lot of the growth this quarter was through the engineering and services revenues. Do you see those continuing or were those more related to startup costs?

Bill Merritt

Okay. Couple of things on the pipeline. Certainly we see strong interest with respect to the data card product, in particular this package-on-package design that we’ve implemented that is allowing the laptop manufacturers to fit this wireless capability to a fairly small package. So, very encouraged by what we saw there. I think it was an area where we sort of led the market with respect to packaging the technology. So we have a number of companies that are looking at that product and we would hope to see if we can secure design wins on that this quarter or the following quarter. As I mentioned, with the customers – one customer we have signed up and other folks that we are sort of in an advanced stage of negotiation with. Their product launches are scheduled for year-end or beginning of next year. So if they can hit those schedules, we would begin shipping product in some quantity at the end of the year, the quantity growing at the end of the year, that quantity growing in 2009. So that would be – if you look at the revenue line, you’d start to see contributions somewhat in the fourth quarter but probably more in the first quarter 2009 and growing. The other line with respect to revenue coming in from engineering services and royalties from our IT customers, as I mentioned, we have three – we have NXP, Spreadtrum, and Infineon. Those numbers will vary. Certainly at the front end of the contract, you have delivery of the IP and to the extent you have non-recurring engineering charges with respect to that. You will see those charges or that revenue early on in the deal. And then what you want to see then is the revenue – the royalty revenue pick up thereafter. We’re very encouraged by the successes of 3G iPhone. So we would expect to see those contributions coming in and – as well as other wins that Infineon has. And we are hoping for similar success with NXP and then Spreadtrum I think a little later, but again a very well positioned company.

Scott McQuilkin

If I could just add I think on the expense side, what you have seen over the last couple of years is kind of a gradual increase on the development spending related to the product programs. And that was as planned. We have said before that we are kind of at the point, very close to the point where we think that increase will begin to stabilize, and any additional increases above that should be associated with customer opportunities that are revenue generating. And I think I would still make that same point today that if we see material increases in the level of spending going forward, it’s going to be driven by revenue opportunities with customers. One point I would say is we’re also very careful about non-development expenses and work very hard to keep those under control. And also I would add that we are not penny wise and pound foolish that our spending program, although we’re very cautious about the expense line in our capital spending, we are also very strategic in terms of assessing investment opportunities and evaluate our spending levels accordingly.

Kevin Sharbatoni – Boenning & Scattergood

Okay. And you touched on the Apple, Infineon relationship. Is there any additional kind of information you can give us on Apple, Infineon, or even RIM in terms of licensing revenues going forward, what your expectations are for those?

Scott McQuilkin

First of all, in terms of the near-term impact of any royalties that we might earn from Infineon related to the Apple iPhone, we will report those on a one-quarter lag. So in the second quarter, you really didn’t see much, if any, royalty revenue impact because that is really related to Infineon shipments in the first quarter. So we expect to see that ramp up in the future. We haven’t specifically made any projections about the amount of that, but I think we will start to see the effect of that over the next few quarters.

Kevin Sharbatoni – Boenning & Scattergood

Okay. That was all I have. Thanks.

Bill Merritt

Great, thank you.

Operator

And we have a follow-up. We’ll go to Tom Carpenter, Hilliard Lyons. Your line is open, please go ahead.

Janet Point

Are you there?

Tom Carpenter – Hilliard Lyons

Janet?

Janet Point

Yes.

Bill Merritt

Yes, we’re here.

Tom Carpenter – Hilliard Lyons

Scott, could you help me understand the UK legal payments a little bit better? I think in the fourth quarter of 2008 you guys had $7.8 million on the income statement, is that correct?

Scott McQuilkin

That’s correct.

Tom Carpenter – Hilliard Lyons

Now, was that an expense that you paid for InterDigital’s legal services or are you reserving for maybe the losing party pays like they have in the UK, but you lost, you have to pay Nokia’s?

Scott McQuilkin

That was primarily the latter. And that was our best estimate at that time. In the first quarter, we did a reversal of that based on some additional information, down to $6.6 million.

Tom Carpenter – Hilliard Lyons

Yes.

Scott McQuilkin

And in terms of the third quarter impact that I talked about the $2.6 million, that also will relate to that accrual.

Tom Carpenter – Hilliard Lyons

Okay. So let me make sure that I understand this correctly. Are you paying 4 point [ph] million of Nokia’s legal fees in the UK? Is that what it nets out?

Scott McQuilkin

No. I mean, it’s – that’s really a reflection of the overall settlement.

Tom Carpenter – Hilliard Lyons

Okay. And switching gears, on a follow-up on one of the questions that the last gentleman asked. Have you guys come out and explicitly said that Apple is a 3G licensee?

Bill Merritt

I think we did.

Janet Point

Yes, I did.

Bill Merritt

Here we go. (inaudible)

Janet Point

Yes, the deal, Tom, was that we were allowed to say, as products began to launch, whether they had a license or not, and now that they have officially launched a 3G phone, we can say that that’s under a license.

Tom Carpenter – Hilliard Lyons

Well, I’m glad that’s out of the bag. So when you first announced the agreement, I know there was a lot of uncertainty in the investment community about the deal and how it was structured. With 3G, will they have a pay-as-you-go license or will it be structured more like the 2G deal with them or kind of like that in the LG deal?

Bill Merritt

If you go back to the original disclosure we did on Apple, that’s really the extent of what we can see with respect to the financial arrangements there. So – and off the top of my head, I don’t remember specifically what we said back then. But that’s the financials that we can disclose at this point.

Tom Carpenter – Hilliard Lyons

I can tell you what you said, but I’ll just confuse everybody. So I’ll leave it at that. Thanks guys.

Bill Merritt

Very good. Thanks.

Scott McQuilkin

All right.

Operator

And with no further questions in queue, I’d like to turn the call over to Ms. Point for any additional or closing remarks.

Janet Point

All right. Thank you everyone for a nice call and quarter. And I’ll be available if anybody has any follow-up questions and we’ll talk to you guys soon.

Operator

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect at any time.

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Source: InterDigital, Inc. Q2 2008 Earnings Call Transcript
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