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Tessera Technologies (TSRA - Analyst Report) reported third quarter net income of 5 cents that beat the Zacks Consensus Estimate by 3 cents. Results included a one-time net gain of $79 million in lieu of past production payments. Excluding intangibles amortization on a tax-adjusted basis and including stock based compensation, earnings were 7 cents.
Tessera’s reported revenue of $72.7 million was up 18.3% sequentially and 22.5% year over year.
Tessera expects the Intellectual Property business to gradually become a smaller part of its revenue, while Digital Optics (its camera module business for smartphones) becomes a larger segment. Management is not providing guidance during the transition period due to the uncertainties involved (converting and equipping the facility, training, and building initial production capability).
In the last quarter, Intellectual Property continued to generate the bulk of Tessera’s revenue (80%) compared to just 20% for Digital Optics. Intellectual Property revenue was up 9.1% sequentially and 14.9% year over year compared to sequential and year-over-year increases of 75.4% and 64.7%, respectively for the Digital Optics line.
The year-over-year increase in Intellectual Property revenue was on account of the interim award from Amkor Technology (AMKR), as offset by lower royalties from Micron Technology (MU - Snapshot Report) and Powertech. Tessera stated that two DRAM customers renewed their contracts and its new XFD packaging technology saw its first OEM adoption during the quarter. Tessera is also developing other licensable technology beyond the traditional packaging area that would translate to additional revenue going forward.
On the digital optics side, Tessera is seeing some success with its new MEMS lens subassembly. The last quarter’s results benefited from the shipment of the company’s first camera modules from the recently-acquired facility in Zhuhai, China.
The segment has now transitioned from its imaging and optics focus to an ODM of camera modules for the mobile phone market. Tessera expects to make this the primary segment, which should simplify the protection of its intellectual property (since in this case its technology is not being licensed, but sold within an internally developed product).
The pro forma gross margin excluding amortization of intangibles was 79.5%, down 1,465 bps sequentially. A high gross margin is typical for a technology company that is largely dependent on the licensing model. However, the decline is related to the mix of business, because the product side (Digital Optics) grew very strongly in the last quarter.
Tessera’s quarterly operating expenses were $54.0 million, up 4.4% from the $51.7 million reported in the previous quarter. The operating margin shrunk 474 bps to 5.3%, impacted by the weaker gross margin, as both R&D and SG&A expenses dropped as a percentage of sales. Litigation expenses continued to increase however.
Tessera’s pro forma net income was $3.5 million, or 4.8% of revenue compared to $4.3 million, or 7.0% of revenue in the June 2012 quarter and $8.6 million, or 14.5% in the September quarter of 2011. This pro forma net income calculation excludes intangibles amortization charges on a tax-adjusted basis but includes stock based compensation. The pro forma estimates may not match management’s presentation due to the inclusion/exclusion of some items that were not considered by management.
Net loss on a GAAP basis was $1.1 billion ($0.02 per share) compared to net loss of $409 million ($0.01 per share) in the previous quarter and loss of $44.7 million ($0.87 per share) in the September quarter of 2012.
Tessera’s balance sheet remains strong, despite the $8.9 million reduction in cash and short term investments to $465.9 million. It also has no debt. Deferred revenue declined 33.4% sequentially.
Inventories were up 17.9% during the quarter, with turns going from 5.2X to 18.3X. DSOs jumped from 8 to 18.
Tessera remains a company with good intellectual property, which it has protected with great difficulty. Over the past year, the company has spent more than half its earnings for this purpose and we had our doubts about whether this was worthwhile. However, management has been discussing a refocusing of the business toward a lower-margin, but safer product-oriented model involving camera modules for mobile devices.
We think that this is the way to go, as it could reduce if not eliminate the significant litigation expenses it has been occurring. The fact that the target market is fast-growing is an added bonus.
Tessera’s performance in the last quarter is indicative of the possible success that awaits it and we are encouraged by its plans to transition the Chinese facility for volume production by the middle of 2013. The news is likely to translate into positive movement in share prices, which is the main reason that the Zacks Rank on Tessera shares recently moved up to #1 (Strong Buy).