Tessera Technologies, Inc. (TSRA) reported first-quarter earnings that beat the Zacks Consensus Estimate by 11 cents.
 
Revenue
 
Revenue of $64.3 million was up 13.8% sequentially and down 43.9% year over year, significantly better than management’s expectations of $58-61 million (up 3-8% sequentially). The revenue surprise was primarily on account of $3 million by way of a litigation settlement for past royalties recovered from United Test & Assembly Center Ltd. (UATC). Additionally, there was increased demand in the lithography market, which also contributed.
 
Royalty and License Fees continued to generate the bulk of revenue (92% in the last quarter). Segment revenue increased 13.8% sequentially and declined 47.4% year over year. Around 95% of the revenue came from micro-electronics solutions, which saw a sequential increase of 15.0%. However, this was a decline of 47.7% from the year-ago quarter. Royalty and license fees from the Imaging & Optics line was not much better, declining 5.0% sequentially and 41.9% year over year.
 
Product & Service comprised the remaining 8% of total revenue, witnessed an increase of 14.3% sequentially and 98.9% year over year. All of the product and service revenues were from Imaging & Optics.
 
Margins
 
The pro forma gross margin, excluding amortization of intangibles was 94.6%, up 46 bps sequentially from 94.1%. The very strong gross margin is typical for a technology company that is largely dependent on the licensing model.
 
The operating expenses were $39.9 million, slightly higher than the $38.5 million reported in the previous quarter. The operating margin was 32.5%, up 655 bps sequentially from 25.9%. The sequential increase in operating margin was due to lower R&D and SG&A expenses as a percentage of sales. The slight increase in gross margin was an added bonus.
 
Net Income
 
The pro forma net income was $12.5 million, or 19.5% of sales compared to $9.3 million, or 16.5% in the December 2009 quarter and $42.2 million, or 36.8% net income margin in the March quarter of 2009. Our pro forma net income estimate excludes intangibles amortization charges and tax adjustments but includes stock based compensation in the last quarter. Our pro forma estimates may not be in conformity with management’s presentation due to the inclusion/exclusion of some items that were not considered by management.
 
Net income on a GAAP basis was $9.8 million (20 cents per share) compared to net income of $6.4 million (13 cents per share) in the previous quarter and $39.5 million (82 cents per share) in the March quarter of 2009.
 
Balance Sheet
 
Tessera has a strong balance sheet, with $417.4 million in cash and short-term investments and no debt. Deferred revenue was $5.4 million at quarter-end.
 
Guidance
 
For the second quarter of 2010, management expects revenue of $67-70 million (up 4-9% sequentially). Micro-electronics revenue, all of which will be royalty and license-related, is expected to drop to 58.5-60.5 million. Management stated that the impact of volume-based pricing incentives to two of the top DRAM customers would have a positive impact on both second quarter and third quarter results.
 
Imaging and Optics revenue is expected to come in at $8.5-9.5 million, up double-digits from the year-ago quarter.
 
Non GAAP operating expenses, excluding litigation charges and one-time items is expected to come in at $32-33 million, of which COGS will be up 12%, R&D up 16-17% and SG&A up 2%. Stock based compensation and amortization charges are expected to come in at$ 6.9 million and $3.6 million, respectively.
 
Estimate Revisions
 
The encouraging results and guidance prompted seven out of the eight analysts covering the stock to raise estimates for fiscal 2010. However, analysts were more divided on their expectations for 2011. While 4 analysts raised estimates for 2011, 2 went the other way. The net result was a 10 cent increase in the 2010 consensus and a 3 cent decline in the 2011 consensus.
 
The reason for the revisions was as follows—Tessera has some wins that would significant boost product and service revenues in 2011, changing the mix of business. However, since the royalty and licenses business naturally generates higher margins, analysts appear to be working that into the estimates. Moreover, the company intends to gain a stronger foothold in China, where a fables model will be preferred to the current licensing model. This will be another factor telling on margins, with a corresponding pressure on earnings.
 
We currently have a Neutral rating on Tessera shares.
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