Tessera Technologies, Inc. (TSRA) reported fourth quarter earnings that beat consensus estimates by 4 cents.
 
Revenue
 
Revenue of $56.5 million was down 14.6% sequentially and 18.3% year over year, missing management’s original expectations of $60-62 million (down 6-9% sequentially) and in line with management’s pre-announcement of around $56 million on Jan 6. The lower-than-expected revenue was primarily on account of lower microelectronics revenue, as two of the company’s larger customers had lower-than-expected sales.
 
Royalty and License Fees continued to generate the bulk of revenue (92% in the last quarter). Segment revenue declined 17.5% sequentially and 17.2% year over year. Around 94% of the revenue came from micro-electronics solutions, which had a particularly bad quarter. Royalty and license fees from the Imaging & Optics line was also weak, declining 11.5% sequentially and 9.7% year over year.
 
Product & Service comprised the remaining 8% of total revenue, an increase of 40.0% sequentially and decline of 26.9% year over year. All of the product and service revenues were from Imaging & Optics.
 
Margins
 
The pro forma gross margin excluding stock-based compensation and amortization of intangibles was 94.5%, down 242 bps sequentially from 96.9%. The very strong gross margin is typical for a technology company that is largely dependent on the licensing model. The significant decline in the last quarter was therefore, entirely on account of the decline in royalty and licensing revenue.
 
The operating expenses were $31.2 million, higher than $34.3 million reported in the previous quarter. The operating margin was 39.2%, down 588 bps sequentially from 45.1%. The sequential decline in operating margin was due to lower revenues, particularly royalty and licensing. While higher COGS was the largest contributor, higher R&D and litigation expenses and flattish SG&A expenses (as a percentage of sales) also contributed.
 
Net Income
 
The pro forma net income was $8.5 million, or 15.1% of sales compared to $12.3 million, or 18.6% in the Sep quarter and $13.1 million, or 19.0% net income margin in the Dec 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 GAAP basis was $6.4 million ($0.13 per share) compared to net income of $12.1 million ($0.24 per share) in the previous quarter and $7.7 million ($0.16 per share) in the Dec quarter of 2008.
 
Balance Sheet
 
Tessera has a strong balance sheet, with $388.0 million in cash and short-term investments and no debt. Deferred revenue was $5.3 million at quarter-end.
 
Guidance
 
For the first quarter of 2010, management expects revenue of $58-61 million (up 3-8% sequentially). Micro-electronics revenue, all of which will be royalty and license-related, is expected to drop to $50-53 million. The continued weakness is due to the impact of volume-based pricing incentives to two of the top DRAM customers. Wireless customers are reporting mixed results, which caused management to lower its royalty expectations.
 
Imaging and Optics revenue is expected to come in at around $8 million, similar to the fourth quarter of 2009. Royalties and license fees and products are expected to contribute more or les equally to Imaging and Optics revenue.
 
Non GAAP operating expenses, excluding litigation charges and one-time items are expected to come in at $32-33 million, of which COGS will be up 15%, R&D up 15% and SG&A up 13%. Litigation expenses are expected to be significantly higher than the fourth quarter, although it is likely to be lower than a 100% increase.
 
Estimate Revisions
 
Ever since the company pre-announced results, virtually all of the analysts covering the stock have lowered their expectations for the Mar 2010 quarter and fiscal year ended Dec 2010. Although management did warn us about its pricing incentives, it appears that they underestimated the impact, which was the reason for the large number of revisions.
 
However, management has provided conservative guidance in the past and the company has had a history of positive earnings surprises. The current Zacks Consensus estimate for the Mar quarter is $0.14, an 83.7% decline from Mar 2009 and representing an upside potential of 7.14%.
 
However, with so many analysts lowering estimates, we doubt that there will be any positive movement in the shares. Consequently, the Zacks Rank for the stock is #5, signifying a strong sell recommendation over the next 1-3 months.
 

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