Tessera Technologies, Inc. (TSRA) reported first quarter earnings that beat the Zacks Consensus estimate by 16 cents, or 50.0%. Despite a significant revenue decline, Tessera beat the Zacks Consensus due to lower-than-expected expenses and a much lower tax rate.
Revenue
Tessera’s reported revenue of $67.8 million was down 15.8% sequentially and up 5.5% year over year, at the high end of management’s expectations of $65-68 million (down 16-19% sequentially). The sequential comparison was hurt by the non-renewal of major licenses. Tessera has taken the matter to court, which has ruled in its favor.
However, licensees could appeal, so the negative impact is likely to continue for another quarter at least. If the one-time litigation settlement gains were excluded from the year-ago quarter, revenue would be up 10.6%.
Royalty and License Fees continued to generate the bulk of Tessera’s revenue (92% in the last quarter). Revenue was down 18.5% sequentially and up 5.8% year over year. Around 86% of this revenue came from Micro-electronics solutions, which saw sequential and year-over-year declines of 24.6% and 3.8%, respectively.
However, royalty and license fees from the Imaging & Optics line (the remaining 14% of segment revenue) were very strong, increasing 64.8% sequentially and 179.1% year over year.
Product & Service comprised the remaining 8% of total revenue, representing a sequential increase of 35.5% and a year-over-year increase of 2.0%. All of the product and service revenues were from Imaging & Optics.
Margins
The pro forma gross margin excluding amortization of intangibles was 94.4%, up 98 bps sequentially. The very strong gross margin is typical for a technology company that is largely dependent on the licensing model and quarterly fluctuations are largely mix-related, as Tessera also generates some revenue from products, which have much lower gross margins.
Tessera’s quarterly operating expenses were $41.7 million, down 9.8% from the $46.2 million reported in the previous quarter. However, the operating margin shrunk to 32.9%, down 306 bps sequentially due to lower volumes.
Significantly higher R&D and litigation expenses as a percentage of sales were responsible for the softer margins, although SG&A also increased slightly as a percentage of sales. The increase in gross margin helped offset these negatives.
Net Income
Tessera’s pro forma net income was $16.2 million, or 23.9% of revenue compared to $14.5 million, or 18.1% of revenue in the December 2010 quarter and $12.5 million, or 19.5% in the March quarter of 2010.
Our pro forma net income estimate excludes restructuring charges and intangibles amortization charges on a tax-adjusted basis but includes stock based compensation. Our pro forma estimates may not match management’s presentation due to the inclusion/exclusion of some items that were not considered by management.
Net income on a GAAP basis was $11.2 million ($0.22 per share) compared to net income of $9.5 million ($0.19 per share) in the previous quarter and $9.8 million ($0.20 per share) in the March quarter of 2010.
Balance Sheet
Tessera has a strong balance sheet, with $499.5 million in cash and short-term investments and no debt. The 32% sequential decline in deferred revenue to $3.9 million was because of the significantly lower revenue levels in the quarter.
Additionally, inventories were down 13.9% during the quarter, with turns going from 11.5X to 9.5X. DSOs went from 13 to around 11.
Guidance
For the second quarter of 2011, Tessera expects revenue of $75.5-78.5 million (up 11-16% sequentially, up 1-5% from the June 2010 quarter). Micro-electronics revenue, all of which will be royalty and license-related, is expected to come in at $65-67 million (including $6 million to be received from UTAC for breach of contract).
Volume pricing adjustments with the two major DRAM customers will result in a $10-12 million benefit in the quarter. However, the non-renewal of five important license will continue to weigh on results.
Imaging and Optics revenue is expected to come in at around $10.5-11.5 million, of which $5-5.5 million will be related to royalty and license fees.
Non GAAP operating expenses, excluding litigation charges are expected to come in at $35-36 million.
Summary
While we believe Tessera has some solid technology, protection of its IP has always been a significant challenge, especially considering its size. OEMs continue to infringe its technology and even ship products using it after the expiration of their license agreements.
As a result, Tessera has always spent a considerable amount on litigation, which have negatively impacted earnings and not resulted in significant revenue thereafter. Some of the ongoing lawsuits are against big names, such as Sony Corp (SNE), Qualcomm Corp (QCOM), Freescale Semiconductor and Renesas. However, the courts are ruling in Tessera’s favor, which should result in a renewal of licenses and/or generate one-time revenue in the form of settlements.
Tessera shares currently carry a Zacks #2 Rank of #2, implying a Buy recommendation in the short term (1-3 months).
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