Tessera Technologies (TSRA) reported second quarter earnings that beat the Zacks Consensus estimate by 6 cents, or 26.1%, despite the fact that revenue came in well below the guided range. This also prompted management to defer the announcement of guidance to the second month of each quarter for future quarters.
Revenue
Tessera’s reported revenue of $70.7 million was up 4.4% sequentially and down 5.2% year over year, missing management’s expectations of $75.5-78.5 million (up 11-16% sequentially).
The faster-than-anticipated transition to denser technologies in the DRAM market (1GB to 2GB) hurt volumes, which impacted DRAM units in the last quarter. Since Tessera gets paid on a per unit basis, this was a significant negative for the company.
Additionally, revenue continues to be 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 in the near term.
Royalty and License Fees continued to generate the bulk of Tessera’s revenue (92% in the last quarter). Revenue was up 5.0% sequentially and down 4.3% year over year. Around 85% came from Micro-electronics solutions, which saw a sequential increase of 12.8% and a year-over-year decline of 7.1%. However, royalty and license fees from the Imaging & Optics line (the remaining 7%) were down 43.1% sequentially, although up 50.7% from last year.
Product & Service comprised the remaining 8% of total revenue, representing sequential and year-over-year declines of 3.4% and 14.4%, respectively. All of the product and service revenues were from Imaging & Optics.
The pro forma gross margin excluding amortization of intangibles was 94.8%, up 45 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 $46.3 million, up 11.1% from the $41.7 million reported in the previous quarter. As a result, the operating margin shrunk to 29.3%, down 354 bps sequentially due to lower volumes. Significantly higher SG&A and higher litigation expenses as a percentage of sales were responsible for the softer margins, with both cost of sales and R&D down slightly as a percentage of sales.
Net Income
Tessera’s pro forma net income was $14.7 million, or 20.8% of revenue compared to $16.2 million, or 23.9% of revenue in the March 2011 quarter and $17.7 million, or 23.7% in the June quarter of 2010. Our pro forma net income estimate excludes 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 $11.6 million ($0.23 per share) compared to net income of $11.2 million ($0.22 per share) in the previous quarter and $15.0 million ($0.30 per share) in the June quarter of 2010.
Balance Sheet
Tessera has a strong balance sheet, with $527.1 million in cash and short-term investments and no debt. Deferred revenue declined again in the second quarter by over 35%, having declined 32% in the first.
Additionally, inventories were up 11.5% during the quarter, with turns going from 9.5X to 8.2X. DSOs went from 11 to around 9.
Guidance
Presumably because of the bad miss in the last quarter, Tessera has now decided to provide guidance only after the second month of the quarter, when most of the royalty reports will have been received and reviewed.
Summary
At this point, Tessera should be viewed with extreme caution in our opinion.
First, the company’s revenue growth has been far less than satisfactory in recent times, as significant licenses were not renewed. Although Tessera took the matter to court, there has been no positive outcome to date.
Second, three major microelectronics licenses for DRAM are coming up for renewal by May next year and management did not provide an update regarding renegotiations. Therefore, there is increased uncertainty over the next year or so and revenue could come under significant pressure.
Third, 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. Tessera’s small size and limited resources make defense of its IP difficult, although the company has managed thus far. Still, we note that settlements have not been announced yet, so expenses may be expected to continue in the near term.
Fourth, some of Tessera’s more promising technology (zoom and MEMS autofocus) are not expected to have a significant impact on revenue until next year and we don’t see any other catalyst for the imaging and optics business right now.
Tessera shares currently carry a Zacks #5 Rank, implying a Strong Sell recommendation in the short term (1-3 months).
