InterDigital management says the rates determined in the settlement also set royalty rates for industry giants Nokia and Samsung (44 percent of the worldwide market combined), both of whom who previously have signed licensing frameworks with InterDigital, leaving the royalty rate to be determined by an Ericsson settlement or a jury verdict. Nokia disagrees, however, and has invoked binding arbitration to determine its royalty status with IDCC

Ten years ago, InterDigital Communications Corp. (IDCC) filed a patent infringement lawsuit against one of the giants of the wireless industry, Sweden's L. M. Ericsson Telephone (Ericy). At that time, Ericsson was one of the top three cell phone manufacturers worldwide.

The lawsuit alleged that Ericsson was infringing InterDigital's U. S. TDMA and GSM related patents by its manufacturer of cell phones and infrastructure. (The lawsuit did not involve the CDMA technology championed by Qualcomm.) Ericsson responded that the patents in question either were not valid or did not apply to what Ericsson was manufacturing. InterDigital sought and received a pause in the litigation proceedings in order to seek revalidation of its patents and thereby strengthen its case. The U.S. patent office revalidated InterDigital's patents in 1999.

The case had been scheduled for trial in federal court May 15th 2003.

Investors in both InterDigital and Ericsson apparently viewed the settlement as a win-win situation. Share values rose significantly for Ericsson with the news that the settlement would remove uncertainty about the amount of patent infringement damages Ericsson might incur.

While the exact forward royalty rate in the Ericsson settlement was not disclosed, observers calculate the rate at .5 percent to .75 percent. At a typical cell phone price of $150, InterDigital will receive between 75 cents and $1.12 per unit, at a minimum, from its licensees. As of April, 2003, manufacturers of 70% of covered phones and infrastructure were licensed by InterDigital.

The principal reason many view this agreement as a "watershed" for InterDigital is not the amount of money Ericsson has paid for past infringement or will pay InterDigital in the future. Although they have the largest infrastructure market share (30%), Ericsson and its partner Sony have a market share in cell phones of only 5.2%. The agreement is momentous because - if an arbitration panel invoked by Nokia agrees with InterDigital - it establishes the royalty rate for two cell phone giants -- Nokia (over 37.2% market share) and Samsung (9.8%) and probably others as well.

In the Nokia - InterDigital licensing deal written in 1999, Nokia paid a blanket sum of $30 million covering past infringement and all future royalties through December 31st 2001. Nokia further agreed to pay royalties based on product sales beginning January 1st 2002 (15 months ago).

Since January 1st 2002 Nokia has been accruing royalties due to InterDigital, but the royalty rate was left open, to be determined , says IDCC, by what competitor Ericsson would pay InterDigital, based on the outcome of the Ericsson-InterDigital infringement lawsuit. The parties had expected the litigation to be concluded before January 1, 2002, when a rate structure based on actual unit sales would begin.

When the Nokia InterDigital licensing contract was signed, Ericsson was one of Nokia's chief competitors and Nokia did not want to establish a rate structure where it would pay more in royalties than Ericsson. It was also conceded that InterDigital could lose the lawsuit and no 2G royalties would be due at all. (That didn't happen, of course.) Samsung later piggybacked on this arrangement as well, following an arbitration ruling in 2002 in which Samsung agreed to pay the same rate as Nokia.

InterDigital management projects that Nokia's royalty obligation for 2002 could be in the range of $100 million to $120 million and Samsung's royalty obligation for 2002 could be in the range of $22 million to $27 million.

Is the determination of the Nokia and Samsung rate based on the Ericsson settlement a certainty? No! InterDigital management has said that it believes that Nokia and Samsung are bound by the Ericsson terms. But management also notes that if Nokia or Samsung balk, there is a provision in the licensing contracts for arbitration. The decision of the arbitrator would be final. Management says arbitration would be completed in about 12 months. Nokia, surprising InterDigital executives who thought they had a deal, invoked binding arbitration.

See: "Valuation Outlook," "Nokia’s Strategic Partnership with InterDigital," "Risk Factors," and at the InterDigital corporate web site see the April Investor’s Relations slide presentation on InterDigital’s prospects following the Ericsson settlement.

For years, InterDigital has closely followed the industry practice of requiring advance payment of royalties. The amount of the prepaid royalties is based on the licensee's estimates of its future sales. To make the pre-payments more palatable, InterDigital is granting a 20 percent discount for advance royalties. (InterDigital does not make prepayments optional. But if a licensee has greater sales than it estimated, royalty payments are made at a non-discounted rate, after the manufacturer's actual sales are reported.)

The prepayment terms negotiated in the Ericsson settlement (and which IDCC expects will ultimately determine future licensing agreements -- including the Nokia and Samsung existing licensing contracts) requires a prepayment two years in advance. Thus, when a company signs a license agreement (as Ericsson did) they estimate sales two years in advance. Ericsson is paying estimated royalties in early 2003 for both 2003 and 2004.

Prepaid royalties are an especially attractive part of a company's financial profile. They provide maximum visibility to investors because (1) a company's estimated revenue/earnings are based on what those who are paying the royalties estimate, and (2) collection of the revenues is no problem. The money, in fact, is already in the licensor's coffers.

As the licensees report numbers of units sold each month or quarter, InterDigital will move the money the Company has previously received from the accounting category "deferred revenue" over to actual earnings. When InterDigital is notified of a licensed manufacturer’s sales, a proportionate amount of revenues already on deposit at InterDigital becomes income, with much of it translated into bottom-line earnings. Prepaid royalties are not refundable, even if a manufacturer no longer sells products for which it has already prepaid royalties to InterDigital. "It would be hard to conceive a safer revenue projection than one based on pre-paid, non-refundable royalties," says CFP Dalglish. "How much more visible could revenue and earnings be than this?"

With significant discounts for prepayments of royalties, InterDigital is asking the arbitration panel to determine that "2003 royalty revenue from Nokia should be in the range of $80 million to $90 million, 2003 royalty revenue from Samsung should be in the range of $20 million to $24 million and the aggregate prepayments of royalties from Nokia and Samsung for 2003 and 2004 should be in the range of $180 million to $220 million." Once initial prepayments are exhausted, Nokia and Samsung would make supplementary payments to InterDigital, if InterDigital prevails with the arbitration panel.

Before 1Q 2003, existing licensees provided sufficient royalties to make InterDigital slightly profitable (maybe a dime per share earnings). Adding deep and wide revenue streams from Nokia, Samsung and Sony would provide a surge in revenue with almost no additional expenses except taxes -- and the Company has substantial accumulated tax credits to help significantly with that cost.

A major benefit of the Ericsson settlement is the expected $8 to $9 per share cash position the Company expects to experience some time in 2004. That's $460+ million divided by 57 million shares.

$8 to $9 per share in cash in the bank will be a phenomenal achievement and it appears entirely doable by the end of first-quarter 2004. Here's how:

In 1Q 2003, the company already had $100 million in cash. That's not quite a "cash cow" but certainly appears to be a "cash calf" already.

Over 100 million of the 400 million cell phones sold each year are still not licensed with InterDigital, even as a result of the Ericsson settlement. At an average cost of $150 and the royalty of 1 percent, that amounts to $1.50 per phone or $150 million annually in additional licensing revenue potential for InterDigital beyond what Nokia, Samsung and Ericsson-Sony may be paying. A realistic goal is probably 50 million extra units licensed annually from current non-licensees.

Even though InterDigital's license attorneys have been staying in touch with non licensees while awaiting a settlement or verdict in the Ericsson litigation, these new deals will not come immediately. They may probably start coming in late 2003 and be accomplished one at a time throughout 2003.

InterDigital and the prospective new licensees will be writing agreements covering hundreds of millions of products to be produced in the next few years. Licensing attorneys on both sides will be working out 2G back payments due and 2G rates going forward, including estimated sales and royalties (paid in advance) for 2003 and 2004.

It will obviously require more than one visit among license attorneys to work through these complex deals. But these new deals will get done. No more cut rate deals forced on InterDigital to stave off bankruptcy. Not with the cash reserve InterDigital now has -- and the solid place its patented technology has established in all flavors of the new 3G standards.

Here’s what an astute poster, Learning2Vest, wrote April 10, 2003 on this topic:

"There is a good chance that InterDigital is requiring FULL COVERAGE on any new license agreements (or updates) at this point in time. No more piece part licensing of a specific standard like was done in the past. InterDigital's position now may be more like "We want coverage and sales reporting on EVERYTHING you manufacture, we'll tell you if it has our IPR in it. If you think you got an "indemnity" on some of your narrowband products (i.e., CDMA2000), then go collect on it. WE are going to get paid for the IPR we know we have in each standard, and paid at the rates we believe are fair and equitable. Let us know when you get that squared away and are ready to go as we said. We are not going anywhere." LOL! Wouldn't that be a daisy?"

The settlement with Ericsson specifically excludes next generation 3G products and infrastructure (e.g. base stations/cell towers)

InterDigital says it is working on 3G licensing terms now.

Products that include 3G compatible technology are specifically excluded in the Ericsson settlement, even though the products may be also 2G or 2.5G compatible. Observors believe that InterDigital feels it is in an even stronger position for 3G royalties than 2G, so it is excluding combination 3G/2G products with the expectation that royalty rates will be higher than the .5% or .75% expected from 2G alone.

The stream of 2G and 2.5G royalties will be strong as a result of the Ericsson settlement and, if confirmed by the arbitration panel, consequent royalty rate setting for market leaders Nokia and Samsung. But the struggle to reach the success has been long and difficult for InterDigital. Many lessons were learned in the fight for 2G royalties and InterDigital greatly modified its strategy for the next generation 3G products just beginning to become available in 2003.

In the conference call following the announcement to March 17th 2003 out of the Ericsson settlement, CEO Howard Goldberg noted some critical differences between the Company's approach to royalty collections for 2G in the 1980s and '90s and the way it has been involved in 3G. "We were not a strong organization at that point in time," said the Goldberg. "We were a small organization. We were not participating in the standards bodies outside of the United States and we watched from the sidelines at the beginning of the 2G roll out. As we approach 3G, we are getting stronger in every important respect: financially; participation in the standards as an architect of the standards; the size of the patent portfolio is growing at an increasing rate; and increasingly we are getting validation as a holder and licensor of technology."

Goldberg continued, "So there are clearly points of differentiation. The Company is almost different in every respect and better in every respect when you look at InterDigital in the 3G -- the beginnings of the 3G environment -- as opposed to the beginnings of the 2G environment."

The 2G revenue/earnings stream looks very good over the next few years -- 3G looks even better for InterDigital.

In late 1999, the United States Patent Office revalidated key InterDigital patents at issue in the Ericsson case. Since then many InterDigital shareholders have been salivating over what they expected to be an extremely large jury award or cash settlement in the InterDigital-Ericsson patent infringement litigation. . Many shareholders anticipated a jury award or settlement of several hundred million dollars, possibly even enhanced by punitive damages for "willful infringement."

Shareholder expectations grew in October 2002, when Ericsson lost a patent infringement case brought by Harris Communications. The jury award to Harris was $61 million – for a much shorter period of infringement than in the InterDigital case and for fewer relevant patents. The jury also determined "willful infringement" meaning the federal judge could triple the $61 million award. Almost immediately, InterDigital share prices rallied up to $19 in anticipation of a far better outcome for InterDigital. (The final amount in the Harris case has not yet been determined by the judge, including whether or not enhanced damages for willful infringement will apply.)

Some InterDigital shareholders had been cautioning not to expect a huge cash settlement in the Ericsson case. They had pointed to the hazards of any jury trial, especially with a very complex set of issues surrounding extremely technical patents. Further there would be delay after a trial while the case would almost certainly be appealed.

They also pointed to guarded statements by InterDigital management. For several years, at annual shareholder meetings and quarterly conference calls, management has indicated they have been seeking a "creative solution" with Ericsson. They have spoken highly of Ericsson engineers and said they were more interested in forging alliances going forward than winning battles over past royalties. Management has also consistently claimed the Company's successful future lay with next generation 3G rather than with current generation 2G/2.5G.

Adding interest to the Ericsson-InterDigital negotiations, Ericsson increasingly found itself in a very difficult cash and profits position because of the severe economic downturns of 2000 to 2002.

Judging by the terms of the settlement, InterDigital clearly opted for a strong future over retribution for the past. InterDigital accepted a relatively modest sum of $34 million for infringement by Ericsson through December 31st 2002, not the hundreds of millions of dollars some shareholders had eagerly predicted. But this watershed agreement apparently accomplished more important Company objectives.

What was left unsaid in the Ericsson settlement will surely spark investor speculation.

InterDigital CEO Howard Goldberg, in the post settlement conference call, went out of his way to speak positively of Ericsson and its "integrity." Some observers wonder if the Ericsson deal implies a memorandum of understanding (MOU) or handshake arrangement for generous 3G royalties, which would also impact Nokia and Samsung and perhaps all 3G licensing deals in the future.

Ericsson is the world's foremost manufacturer of 2G and 3G infrastructure worldwide. Observers are asking if Ericsson and InterDigital are on the brink of a strategic relationships that would embed InterDigital's very strong TDD technology in 3G infrastructure much earlier than had been thought possible?

It is far too early to translate these speculations into firm revenue projections, but they are indicative of the rapidly increasing earning opportunities opened up for InterDigital since the March 17th 2003 watershed settlement with Ericsson.