Licenses
At December 31, 2002, ITC had granted to 28 licensees a total of 31 non-exclusive, generally non-transferable, royalty-bearing or paid-up licenses to use its patents covering 2G and/or 3G standards. These include, 18 licenses relating only to TDMA patents, 2 licenses relating only to 2G CDMA patents, 2 licenses relating to 2G CDMA and TDMA patents, 6 licenses relating to both 2G and 3G patents, 3 licenses relating to narrowband CDMA (TIA/EIA 95 and similar standards) and 3G and 1 relating to 3G patents only. In 2002, 2001, and 2000, respectively, 94%, 50% and 51% of our total revenue was derived from licensees in Japan. Revenues in 2002 from our Japanese licensees NEC Corporation (NEC) and Sharp Corporation (Sharp) were approximately 35% and 30%, respectively. Revenue from Denso Corporation, a Japanese licensee, relating to the discontinuation of their PDC and PHS businesses, constituted approximately 11% of our 2002 revenues.
Our license agreements are structured on a paid-up, prepaid, or current royalty-bearing basis, or a combination thereof. Prepayments are generally made as advances against payment of future royalties, and are non-refundable. As sales of covered products occur, the royalties due are calculated and either applied against any prepayment, or paid in cash. Sometimes, the royalties due are applied in full against the prepayment while other times they are applied in partial satisfaction (e.g., 40%). In the latter case, a royalty would be due for the remaining amount not applied against the prepayment (e.g., 60%). Additionally, royalties on sales of covered products under the license agreement are payable or exhausted against prepayments based on the royalty formula applicable to the particular license agreement. These formulas include flat dollar rates per unit, percentage of sales, percentage of sales with caps, and other similar measures. The formulas can also vary by other factors including territory, covered standards, quantity, and dates sold. Most of our license agreements provide for the payment of royalties on a convenience basis, where they are payable on all covered products built to a particular standard, although a few provide for payment on an infringement basis, where they are generally only payable when there is a patent issued in the applicable geographic region which the licensee’s covered products infringe. Revenues generated from royalties are subject to quarterly and annual fluctuations. Certain of our licenses are paid-up, and do not require the payment of further royalties, either in whole or in part. For example, with certain limitations, Siemens AG (Siemens) is paid-up under certain of ITC’s patents for 2G and 3G products, NEC is paid-up for PDC and PHS products, Nokia is paid-up for TDD products based upon the scope of technology delivered under the funded development plan, and Matsushita Electric is paid-up for TDMA-based 2 and 2.5G products.
ITC’s initial patent license agreement with Sharp was royalty-bearing, non-exclusive, and generally nontransferable. It covered Sharp’s sale of PDC and PHS products on a world-wide basis through March 19, 2003, at which time it expired. ITC and Sharp are currently engaged in negotiations to extend the term of this agreement. ITC’s other agreement with Sharp covers Sharp’s sale of GSM, narrowband CDMA and 3G products on a worldwide basis. This patent license agreement is royalty-bearing, non-exclusive, generally nontransferable, and expires upon the last to expire of the patents licensed under the agreement. The enforceability of the GSM, narrowband CDMA and 3G license agreement is not linked to the enforceability of the initial license agreement and, as such, has not been affected by the
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expiration of the initial license agreement. Almost all of our 2002 revenues attributable to Sharp have been generated under the PDC and PHS patent license agreement. The inability to extend this patent license will adversely affect our cash flow and could affect our ability to achieve or sustain acceptable levels of profitability.
Expenditures relating to maintaining our current licenses (other than enforcement proceedings) are minimal, being predominantly administrative in nature. Revenues are used for general corporate purposes.
We are in active discussions with companies on a worldwide basis regarding the licensing of our 2G, 2.5G and 3G-related patents.
In 2002, ITC entered into worldwide, royalty-bearing narrowband CDMA and 3G patent licenses with NEC, Japan Radio Corporation (JRC) and Tantivy. Under its agreement, NEC paid $19.5 million in advance royalties in 2002. Upon the exhaustion of the applicable prepayment, NEC is obligated to pay royalties on a convenience basis on all sales of products covered under the license. This patent license agreement is non-exclusive, worldwide, generally non-transferable, and expires upon the last to expire of the patents licensed under the agreement. The loss of revenues and cash payments under this license agreement would adversely affect our cash flow and results of operations and could affect our ability to achieve or sustain acceptable levels of profitability. Also in 2002, ITC entered into a worldwide, royalty-bearing 2G and 3G patent license with Hop-On Wireless, Inc.
In March 2003, we entered into a worldwide, royalty-bearing, convenience-based (2G) GSM/TDMA and 2.5G GSM/GPRS/TDMA patent license agreements with Telefonaktiebolaget LM Ericsson and Ericsson Inc. (Ericsson), and a worldwide, royalty-bearing, convenience-based (2G) GSM/TDMA and 2.5G GSM/GPRS/TDMA patent license agreement with Sony Ericsson Mobile Communications AB (Sony Ericsson). With the execution of these agreements, ITC has now licensed manufacturers representing approximately 70% of the worldwide 2G GSM/TDMA and 2.5G GSM/GPRS/TDMA terminal market, and approximately 50% of the infrastructure market. Under the terms of these license agreements ITC expects to receive aggregate payments of approximately $34 million from Ericsson and Sony Ericsson related to sales of terminal and infrastructure products through December 31, 2002. For periods thereafter through 2006, Sony Ericsson is obligated under the terms of its agreement to pay ITC a royalty on each licensed product sold. In addition, Sony Ericsson is obligated to make non-refundable advance royalty payments to ITC in 2003 covering Sony Ericsson’s projected sales in 2003 and 2004. In exchange for such prepayments, the Company estimates, based on currently available third party projections of Sony Ericsson’s sales of covered products and certain assumptions by the Company regarding such items as Sony Ericsson’s sales, sales mix, and selling prices, that Sony Ericsson’s prepayment to ITC for projected sales in 2003 and 2004 could approximate $20 million to $25 million giving effect to certain royalty rate discounts. Once this initial prepayment is exhausted, Sony Ericsson can either make additional prepayments (net of related discounts and any applicable credits) for 24-month periods or pay royalties at the base rate on sales through 2006. Consistent with the terms of the agreements, the above projections are net amounts after giving effect to applicable source withholding taxes paid on behalf of the Company by the licensees, but prior to consideration of U.S. Federal, state, and local taxes where applicable. Under the terms of its agreement, Ericsson is obligated to pay ITC an annual license fee of $6 million for sales of covered infrastructure equipment for each of the years 2003 through 2006. These license agreements expire upon the last to expire of the patents licensed under each agreement.
The license agreements with Ericsson and Sony Ericsson establish the financial terms necessary to define the royalty obligations of Nokia and Samsung Electronics Co. Ltd. (Samsung) on 2G GSM/TDMA and 2.5G GSM/GPRS/TDMA infrastructure and terminal units under their existing patent licensing agreements with ITC. Under the most favored licensee (MFL) provision applicable to their respective patent licenses, both companies are obligated to pay royalties on sales of covered products from January 1, 2002 by reference to the terms of the Ericsson and Sony Ericsson licenses. Our patent license agreement with Nokia, provides that, in exchange for a payment of $31.5 million, Nokia’s royalty obligation to ITC had been paid-up generally with respect to certain 2G and certain 3G covered products through the end of 2001. The MFL provision in this agreement provides that Nokia’s royalty obligations will be defined by and subject to specified risks and uncertainties of the relevant licensing terms applicable to other designated leading manufacturers of wireless telecommunications equipment. Ericsson and Sony Ericsson constitute such leading manufacturers under Nokia’s agreement. The Ericsson and Sony Ericsson license agreements apply to 2G GSM/TDMA and 2.5G GSM/GPRS/TDMA infrastructure and terminal unit products. Accordingly, one or more additional agreements with a designated leading manufacturer will be necessary, in the absence of agreement between ITC and Nokia, to fully define the full scope of Nokia’s obligations under its patent license agreement. The starting point for calculating Nokia’s royalty obligation will be January 1, 2002. In addition, Samsung elected to apply its MFL provision to ITC’s patent license agreement with Nokia as regards Samsung’s 2G and 2.5G TDMA-based products. Therefore, beginning in 2002 Samsung’s royalty rate should be determined in the same manner as Nokia’s royalty rate is determined. There is no assurance that either Nokia or Samsung will agree with ITC as to the applicability of the licensing terms between ITC and Ericsson and Sony Ericsson. The MFL terms include provisions for a period of review, negotiation, and dispute resolution with regard to the determination of royalty obligations of Nokia and Samsung.
In addition to our royalty-bearing 3G licenses, some of our older license agreements include selected rights as to 3G products. For example, our license agreements with Nokia, Siemens and Qualcomm, Inc. (Qualcomm) include a license under certain of our patents to manufacture and sell products compliant with 3G standards, with some limitations. Patents for 3G standards are licensed to Nokia as follows: The Nokia license arrangement was paid-up, generally, with respect to a number of 2G and a number of 3G covered products through the end of 2001 with a structure for determining the royalties thereafter. In addition, as part of our development project with Nokia (See, “Business Activities, Technology and Product Development”), Nokia is licensed on a perpetual, royalty-free basis under patents developed in the project. Generally, Nokia is also licensed on the same basis with respect to patents technically necessary to implement TDD technology; however, such license does not extend to non-TDD functionality. The Siemens and Qualcomm license agreements are fully paid-up with regard to the rights granted, which include selected rights as to 3G products. The Siemens agreement does not include any rights under patents issuing from patent applications filed after December 15, 1999. The Qualcomm agreement excludes, among other things, any rights under our patents as regards TDMA standards, any rights under our patent applications filed after March 7, 1995, as well as any rights to any patents relating to cellular overlay and interference cancellation. Based on these limitations, the Siemens and the Qualcomm agreements do not provide a license under all the ITC patents or IPR Holdings Patents which we believe to be essential to 3G, including CDMA 2000, or all of the inventions which we believe will be essential and which are contained in pending patent applications. The Qualcomm license agreement grants Qualcomm the paid-up right to grant sub-licenses under designated ITC patent and patent applications to Qualcomm’s customers. For some of the ITC patents, Qualcomm’s sublicensing rights are limited to those situations where Qualcomm is selling ASICs to the customer. For a limited number of patents as to which applications were filed prior to March 8, 1995, Qualcomm may grant licenses under such ITC patents regardless of whether the customer is also purchasing an ASIC from Qualcomm.
