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Tessera Technologies, Inc. (NASDAQ:TSRA)

Q4 2009 Earnings Call Transcript

January 28, 2010 4:30 pm ET

Executives

Moriah Shilton – IR

Hank Nothhaft – Chairman, President and CEO

Mike Anthofer – EVP and CFO

Analysts

Olga Levinzon – Barclays Capital

Raj Seth – Cowen & Co.

Paul Thomas – Bank of America

Mehdi Hosseini – FBR

Operator

Good afternoon. My name is Natwinda and I will be your conference operator today. At this time I’d like to welcome everyone to the Tessera fourth quarter earnings call. (Operator instructions) Thank you. Ms. Shilton, you may begin your conference.

Moriah Shilton

Thank you, Natwinda, and good afternoon everyone. Thank you for joining us for the Tessera Technologies fourth quarter 2009 results conference call. This call is being broadcast live over the Internet. A webcast replay will be available at Tessera.com for 90 days after the call. In addition, a telephone replay of this call will be made available for two business days, beginning approximately two hours after the completion of this call. To listen to the replay in the US, please dial 800-642-1687 and internationally dial 706-645-9291. The access code is 49699757.

I will now read a short Safe Harbor statement. During the course of this conference call, management will make a number of forward-looking statements, which are statements regarding future events, including the future financial performance of the company. These forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual results to differ significantly from those projected.

You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this call. More information about factors that may cause results to differ from the projections made in these forward-looking statements can be found in Tessera's filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31, 2008, especially in the sections of these filings entitled “Risk Factors”. The company disclaims any obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that occur after this call.

On the call today from management are Hank Nothhaft, Tessera's President and Chief Executive Officer; Mike Anthofer, Chief Financial Officer; and Barney Cassidy, General Counsel. During this call today, management will discuss certain non-GAAP financial measures for comparison purposes only, and they will be using non-GAAP numbers in their prepared remarks. The non-GAAP amounts of cost of revenues; research and development; selling, general and administrative expenses; net income; and earnings per share do not include the following: stock-based compensation, acquired intangibles, amortization charges, charges for acquired in-process research and developments, and related tax effects. Management believes the non-GAAP amounts provide a more meaningful comparison, measure of quarter-over-quarter and year-over-year financial performance. Please refer to the company's fourth-quarter 2009 earnings press release and to the company's website for reconciliation of non-GAAP measures to GAAP.

After management's opening remarks, we will open the call to your questions. So that management is able to respond to as many of you as possible, please restrict yourselves to an opening and a follow-on question. Please reenter the queue if you have additional questions. And with that, I will turn the call over to Hank.

Hank Nothhaft

Thank you, Moriah. Good afternoon to all of you, and welcome to the Tessera quarterly earnings call. On today's call, we will discuss our fourth-quarter and full-year 2009 results and recent developments. We will then open the call for your questions.

Total revenue for the fourth quarter of 2009 was $56.5 million. $48.5 million was Micro-electronics royalties and license fees, and $8 million was Imaging & Optics revenues. Our full-year 2009 total revenues were $299.4 million. We signed six new strategic licensees in 2009, two in our Micro-electronics business and four in our Imaging & Optics business.

In Micro-electronics we announced licenses with Motorola for our patented Tessera compliant chip packaging technology and (inaudible) for our MicroPILR interconnect platform. In our Imaging & Optics business, we have two types of intellectual property that we license. The first is infrastructure IP, consisting of our wafer-level packaging and wafer-level optics technologies. The second is design-in IP, which includes our optical and embedded image enhancements technologies.

In 2009 we signed a new licensee for each of these categories. We licensed our wafer-level packaging IP and know-how to JCAP, a Chinese semiconductor assembly services provider; our wafer-level optics technology to Qtech; our extended depth of field for EDOF technology to a leading provider of wireless networking and imaging processing solutions, and our FaceTracker technology to a major cell phone supplier.

On the research and development front in 2009, we developed one of the industry's first 3 megapixel wafer-level optics solutions that includes or integrates EDOF, extended our EDOF and ultrafast lens solutions to support resolutions of up to 14 megapixels, and announced our face recognition technology which performs automatic identification of specific human faces in camera-enabled devices. We also expanded our Imaging & Optics portfolio with the acquisition of certain assets of Dblur Technologies Ltd. This acquisition gave us one more entry point into the Chinese market. In addition, through this acquisition, we now have STMicro as one of our optical imaging enhancement licensees.

Regarding our financial status, we ended 2009 with over $400 million in cash, cash equivalents, and investments and zero debt. Our strong balance sheet will provide the foundation for future investments in our business. We are confident we can grow our recurring revenue base in 2010 as compared to 2009. Recurring revenue excludes discrete nonrecurring items such as initial license fees, fees from settlements and fees from our ongoing auditing program. In general, we are comfortable with our covering analysts' total revenue expectations for 2010. We encourage you to evaluate Tessera on an annual basis. Our quarterly revenue will vary due to the timing of non-recurring discrete items and the volume-based pricing incentives we have with two of our larger DRAM customers. The impact of these volume-based pricing incentives is reasonably predictable. All things being equal, they will have a disproportionately positive impact on our second and third quarters.

Turning to our Microelectronics business, the annual growth forecast according to Gartner Dataquest for our served markets, DRAM and wireless, are favorable. The overall DRAM market is expected to grow 16%. Wireless is expected to grow 13%. We expect our micro-electronics royalties will be up significantly in the second quarter, reflecting this growth and the impact of the volume-based pricing incentives. Through 2010, we expect the DRAM industry to continue to make progress towards a formal specification for DDR4. The industry's current understanding of the likely DDR4 architecture is that DDR4 will use packaging similar to DDR3 with certain performance enhancements. If so, we will be well-positioned to take advantage of the transition to DDR4 when it occurs. We have built early prototypes that indicate we can extend the performance of our existing DRAM packaging technology.

Another innovation in our micro-electronics business is silent air cooling. We made considerable progress in 2009 and demonstrated solutions for key technical challenges. Today we are engaged in technology evaluations with two major OEMs, conducting feasibility studies and demonstrating prototypes. We expect to reach key product development milestones for initial commercialization by year-end.

Now let’s discuss our imaging and optics business, which includes wafer-level packaging, wafer-level optics, optical image enhancement, embedded image enhancements and micro-optics. With regard to wafer-level packaging, by the end of 2009, we had six licensees: Zentek, China WLCSP, AWLP, Nemotek, Qtek and JCAP. Zentek and China WLCSP are in production. Nemotek and Qtek have begun wafer-level packaging shipments. Our newest wafer-level packaging licensee, JCAP is expected to be in production or be production ready soon. We, therefore, expect additional wafer-level packaging royalties beginning in the second quarter of this year. In wafer-level optics, our product launch services surpassed the 1 million lens shipment mark in early January. This comes after a record shipment quarter in the fourth quarter of 2009. We continued to see the market and demonstrate the viability of our innovative wafer-level optics technology. In addition to our product launch services, we have two wafer-level optics licensees. Nemotek is production ready. Qtek is expected to start production later this year.

In optical image enhancement, at year-end 2009 we had four licensees for our extended depth of field technology, as we call EDOF, and those licensees were Toshiba, Samsung, STMicro and one not formally announced. One of our licensees began shipments of traditional camera modules with our EDOF technology for use in camera phones in October last year, and they increased production each subsequent month. This will generate our initial EDOF royalties in the first quarter of 2010.

To date all our current EDOF licensees are deploying or anticipate deploying EDOF technology in traditional camera modules. We have contracts to provide our EDOF technology for traditional camera module projects from 2 megapixel through 8 megapixel. We anticipate EDOF will be deployed in wafer-level camera modules in the future as well.

There is significant interest in our non-mechanical Zoom technology. Zoom is our first integrated smart solution and is a combination of our optical and embedded image enhancement technologies. We expect it will generate higher royalty per unit than standalone optical or embedded image enhancement technologies. We expect to announce our first licensee for this technology in 2010.

In micro-optics we expect a recovery in the served markets of lithography and communications. We expect this will be one of the main growth drivers of our Imaging & Optics revenues in 2010, along with increased EDOF royalties. We anticipate continued revenue growth from EDOF and micro-optics plus revenues from our wafer-level optics and Zoom will assist us in reaching our goal of $100 million in revenue in 2011 in this segment.

Looking longer-term, today's 1 billion plus image sensor market, which includes camera phones and devices such as PCs, surveillance devices and toys, is forecasted to grow to more than $2.6 billion by 2013, according to Gartner Dataquest.

Now I am going to discuss our patent portfolio. We continue to foster innovation and dedicate research and development resources in its development. In the fourth quarter, we were granted 14 US and nine foreign patents and filed 36 US and 32 foreign patent applications all based on our internal development efforts. We also selectively acquired additional patent assets. We now own more than 1800 domestic and international patents and patent applications in our portfolio. Roughly 1,150 patents and patent applications are for technologies in our Microelectronics segment. Approximately 650 patents and patent applications are for technologies in our Imaging & Optics segment.

I would now like to turn the call over to Mike. Mike?

Mike Anthofer

Thank you, Hank. Total revenue for the fourth quarter was $56.5 million, which was slightly above the updated $56 million guidance we provided in our January 6, 2010 pre-announcement.

Total Micro-electronics revenue for the fourth quarter was $48.5 million, and as previously disclosed, actual royalties for the fourth quarter of 2009 from two of our larger Micro-electronics customers came in lower than our expectations. With respect to fourth-quarter 2009 Imaging & Optics, revenue was $8 million. Royalties and license fees were $3.3 million. Fourth-quarter royalties and licensees were down 10% year-over-year and 11% quarter-over-quarter. As we have previously indicated, quarterly revenue for this line varies due to the timing and amount of license fees, which can be significant relative to the ongoing royalties.

Our underlying royalty growth was up sequentially in this segment by approximately 43% to approximately $1.5 million in the fourth quarter. Imaging & Optics products and services revenue was $4.7 million composed primarily of our micro optics business, which grew 45% over the third quarter driven by a strong recovery in lithography and a recovery and consistent growth in our communications and other photonics businesses. Included in the products and services revenue was $0.7 million of NRE related primarily to work we do for our design-in services with our embedded image enhancement and optical image enhancement customers. Although the lithography and communications markets did have sequential growth, they were impacted by the year-over-year slowdowns in semiconductor equipment purchases and weakness in the communications sector. As a result, our products and services revenue in the fourth quarter was down 16% compared to last year's fourth quarter.

Total GAAP operating expenses were $45.1 million and are broken out as follows: cost of revenue $5 million, research and development $15.6 million, SG&A $18.6 million, and litigation expense of $5.9 million. Fourth quarter total GAAP operating expenses were 2% lower than the prior quarter, which included approximately $1.1 million of expenses related to corporate development activity. Total GAAP operating expenses were 21% below last year's fourth quarter, which included $17.7 million in litigation expense.

Stock-based compensation expense was 7.5 million. Amortization of acquired intangibles was 3.3 million. In the fourth quarter, other income net of expense was $1.1 million, which included a benefit of approximately $0.5 million related to a one-time contingent liability adjustment. GAAP tax expense was approximately $6 million, representing a 49% effective tax rate for the quarter. Our effective tax rate for the fiscal year of 2009 was 43%. GAAP net income for the fourth-quarter 2009 was $6.4 million or $0.13 per share on a fully diluted weighted average share count of 50.1 million shares.

I will now make a few comments regarding our non-GAAP results. As you may recall, the difference in the non-GAAP results is the exclusion of stock-based compensation and intangibles amortization and its related tax effects. We have included a detailed reconciliation between our GAAP and non-GAAP net income in both our earnings release and on our website for your convenient reference.

Total non-GAAP operating expenses were $34.3 million. Sequentially our total non-GAAP expenses were down 5% quarter over quarter and lower by 27% year over year due to the much higher litigation expense in the fourth quarter of 2008. Excluding litigation expense, non-GAAP operating expenses totaled $28.4 million in the quarter. Non-GAAP cost to revenue was $3.1 million, research and development $12.5 million, SG&A $12.8 million and the $5.9 million of litigation expense.

Cost of revenues were up 53% sequentially. The increase in cost of revenue was primarily the result of the commercialization of our wafer-level optic product launch services in the quarter and the incurrence of related production costs. Product launch services is a strategic initiative to support our infrastructure licensees with proof of high volume manufacturability and enables customers access to our new technology.

R&D expense was down 9% sequentially due to lower personnel costs resulting from heavier vacations taken during the holidays in the fourth quarter and a shift of some resources and depreciation to cost of revenue as a result of the commercialization of our wafer-level optics products.

SG&A expenses were down 11% sequentially, due largely to the aforementioned corporate development expenses that occurred in the third quarter of 2009. Tax adjustments for non-GAAP items were approximately $1.1 million, resulting in non-GAAP net income of $16 million or $0.31 per share on a fully diluted weighted average share count of 51.5 million shares.

For the fiscal year of 2009, our total revenue was $299.4 million, a 21% increase over 2008. Excluding the Amkor settlement recorded in the first quarter of 2009, full-year revenues were 4% below 2008. Although our revenue as adjusted for the Amkor settlement was lower, our new customers somewhat mitigated the negative impact on our business, resulting from the year over year decline in the semiconductor device and equipment markets.

Royalty and license fees from both our segments of $286.2 million were 30% higher than 2008 and 2% higher, excluding the effect of the Amkor settlement. Products and services of $13.2 million was 53% below last year or 2008. GAAP net income for 2009 was $69.8 million or $1.42 on a fully diluted weighted average share count of 49.3 million shares. This compares to GAAP net income of $4.6 million or $0.10 per share in 2008. The very favorable comparison largely results from much lower litigation expense in 2009, which totaled $26.1 million lowered by $58.2 million or 69% year over year, and the Amkor settlement.

Non-GAAP net income for 2009 was $101.5 million or $2.02 per share on a fully diluted weighted average share count of 50.4 million shares. This compares very favorably to the 2008 result of $36.2 million or $0.74 per share. We ended the quarter with $403.6 million in cash, cash equivalents and investments, which represents a $6.5 million increase over the third quarter. We used $11.8 million for tax payments and $5.7 million for the payment of acquired patents that are intended to support our ongoing innovation and licensing in the Micro-electronics segment of our business.

Year-over-year cash, cash equivalents and investments are up 105 million. In 2009, $15.3 million was used for purchases of capital equipment, $16.5 million for IP-related purchases of patents and assets and $51.9 million for tax payments.

Before turning to our first-quarter 2010 guidance, I would like to make a few comments regarding our guidance practice in order to clarify possible confusion resulting from the fact that we report our royalty revenues one quarter in arrears. In general, our licensees' royalty reports are due 30 to 60 days after quarter-end. When we provide guidance for the upcoming quarter, we typically do not have most of the reports in hand. Our practice is to rely upon public financial reports, industry data and our own understanding of our licensees’ businesses to determine our guidance for the upcoming quarter.

Looking to the first quarter of 2010, we expect the following

Total revenue for the Company will range between $58 million and $61 million. This compares to between $59 million and $61 million as previously guided on January 6. Recent industry trends have generally been positive. We are seeing strength in the memory portion of our micro-electronics business, although, as you know, we do have volume-based price incentives with two large DRAM manufacturers. With regard to wireless, we are seeing mixed results. For example, some companies are announcing handset shipments below expectations. With that backdrop and without having received most of our royalty reports yet, we assessed recent public announcements and we lowered our range based on cautious evaluation of those announcements.

Micro-electronics’ revenue will range between $50 million and $53 million and is all royalty and license related. This compares to the previous guidance given on January 6 of $51 million to $53 million. As a comparison, first-quarter of 2009 micro-electronics royalties and license fees were $106.5 million, which included $60.6 million from Amkor as a result of our successful arbitration. So net of this Amkor award, royalties and license fees were $45.9 million in the first quarter of 2009.

First quarter of 2010 Imaging and Optics revenue in total is expected to be approximately $8 million. Royalties and license revenue is expected to be approximately $4 million, and products and services will also be approximately $4 million. This compares to Imaging and Optics’ royalty and license revenue of $5.3 million, and products and services revenue of $2.7 million in the first quarter of 2009, which also totaled $8 million for this segment. In the first quarter of 2009, Imaging and Optics royalty and license revenue included approximately $3.6 million in license fees.

We are providing non-GAAP operating expense guidance, which includes non-GAAP cost of revenue, research and development and SG&A less litigation expense. Our first-quarter 2010 non-GAAP operating expenses are expected to range between $32 million and $33 million. Non-GAAP cost of revenue is expected to be up approximately 15% sequentially, of which 5 points or one-third of that relates to the annual payroll tax reset with the balance due to increased expenses related principally to product launch services.

Non-GAAP R&D is expected to be up approximately 15% sequentially, of which approximately 6 points relates to the annual payroll tax reset with the balance due to increased development resources primarily aimed in the Imaging and Optics and silent air cooling areas.

Non-GAAP SG&A is expected to be up approximately 13% sequentially, of which 3% or 3 points relates to the annual payroll tax reset from a fringe standpoint and then increased marketing expenses is primarily related to first-quarter tradeshow activity, which is heavier than in the balance of the quarters of the year. We expect our litigation expenses to be significantly higher than the fourth quarter, but less than a 100% sequential increase. This anticipated sequential increase is due in part to lower-than-expected expenses in the fourth quarter that resulted from litigation delays and reflects an expected increase driven by the scheduled March 1 trial with UTAC, increased efforts related to the recently initiated Amkor arbitration and the Hynix anti-trust action and the ongoing Appellate activity related to both the ITC 605 and 630 cases now pending in the Court of Appeals for the Federal Circuit.

We expect stock-based compensation to be approximately $6.6 million and amortization charges to be $3.5 million. I thank you very much, and now I turn the call back to Hank.

Hank Nothhaft

I will briefly summarize the status of our current intellectual property protection effort. Earlier today, we filed a notice of appeal in our DRAM International Trade Commission action or our ITC action. This initiative our appeal in the Court of Appeals for the Federal Circuit and figures an approximate 100 days process leading up to the filing of our initial brief, a public version to be available shortly thereafter.

In the wireless ITC action, we filed our brief in the respondent's appeal in front of the Federal Circuit on January 15. The respondent’s reply is due in mid-February. We expect oral argument to occur in midyear. The Amkor arbitration in the International Chamber of Commerce is still in its initial phases with Amkor filing its response to our counterclaim on January 15.

The trial in our case against UTAC in the Superior Court of the state of California and Alameda County Oakland has been set for March 1, 2010. We are alleging breach of contract because of their failure to pay us the full royalties due under their license agreement with us.

Our antitrust case against Hynix in the Superior Court for the state of California in San Francisco County has been coordinated with the Rambus versus Hynix antitrust case. This means we have the same judge but separate trials. The trial in Rambus' case has been rescheduled to begin no sooner than March 22, 2010. We expect our trial against Hynix to start 30 to 60 days after the Rambus trial ends.

One other area that is important for our intellectual property protection efforts is patent reform. We continue to devote time and resources, including meeting with decision makers in various branches of the US government, to help strengthen and improve the efficiency of the US patent system. Even though IP licensing makes an enormous positive contribution to the US economy and standard of living and is perhaps the key to our nation's economic recovery, some elements of the proposed patent reform bill would make IP licensing significantly more difficult than in the past, especially for small companies, universities and individual inventors, the sources of so much of our current innovation based economy. It is vital that innovation for all Americans is projected and inventors compensated.

In summary, in 2009, against a backdrop of a challenging economic and industry conditions, we generated full-year non-GAAP net income of $101.5 million. GAAP net income of $69.8 million, and we increased our cash, cash equivalents and investments by $105 million over 2008. Looking at 2010 and beyond, we are focused on building on this success. First, we are devoting resources to extend and expand our Micro-electronics packaging and interconnect business and renew applicable licensees. Second, we enter the year with strong momentum in our Imaging & Optics business. Third, we continue to progress towards productization of our silent air cooling technology. And finally, we continue to pursue strategic acquisitions of intellectual property, technology and complementary businesses.

I thank you for your time. And I would now like to open the call and welcome your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And your first question is from the line of C.J. Muse with Barclays.

Olga Levinzon – Barclays Capital

This is Olga Levinzon calling in for C.J. Just a couple of questions. Given the multiple litigation front you have open, can you talk about the linearity of your litigation expense throughout the year?

Hank Nothhaft

Hi. Olga, this is Hank. I'm going to ask Mike to address that question.

Mike Anthofer

Sure. Okay. So our expense again we only got a quarter in advance, so we have I think given appropriate guidance for the first quarter. I don’t know at this point that I could speak to linearity because it's going to depend on the various decisions made by our adversaries or potential adversaries. So it would be very difficult for me to say that it would be linear, and I would not say that it would be linear. In other words, second quarter would not be similar to first quarter. It will depend on several actions. So we are not prepared to guide beyond the first quarter, nor would I want you to think that each quarter would be similar to the first quarter necessarily. So I know it's a vague answer, but basically we really can't give you guidance beyond the first quarter.

Olga Levinzon – Barclays Capital

Okay. And then I guess with regard to the second quarter uptick now that the volume discounts will be over at least for this year, can you talk about if we were to compare it to the second quarter of 2009, if there were any one-time items included in the second quarter results, which we should exclude if we are assuming certain year-over-year growth rates?

Mike Anthofer

So the question is, is there one-time non-recurring revenue in the second quarter of 2009?

Olga Levinzon – Barclays Capital

Yeah.

Hank Nothhaft

Okay. So before I have Mike answer that question, I just want to make it clear on the volume discounts, if I may take this opportunity. I think you said they were over for this year. And then --

Olga Levinzon – Barclays Capital

Yeah, I guess.

Hank Nothhaft

And I want to be absolutely clear on that, and as I said in my written script, the way the volume discounts work they have a distorting effect on our revenue, and they disproportionately cause our revenue to be higher in the second and third quarters. So with that sort of qualifier on your question, I will turn it over to Mike. Mike?

Mike Anthofer

Sure. Okay. So to answer your question, in the second quarter of 2009, there were, I guess, a couple of discrete items that are worthy of mention that you should factor in when developing a model. So one would be we did have the Motorola off-balance and Motorola option fees before they became a licensee. So that is one element. And then we have had -- we did have some benefit from audits both in the second and third quarter that were in roughly the $3 million range each quarter roughly speaking. So those were really the only discrete items, and there were no discrete items in our fourth-quarter 2009 numbers.

Olga Levinzon – Barclays Capital

Okay, thank you very much.

Mike Anthofer

Thank you for the question.

Operator

Your next question is from the line of Raj Seth with Cowen & Co.

Hank Nothhaft

Hello Raj, how are you today?

Raj Seth – Cowen & Co.

I am good, thank you very much. Thanks for taking the question. Hank, can you talk a little bit about your 2011 optics target? I know it’s still a ways off but your confidence level there? And maybe comment on what you think the shape of the trajectory is? I don't know exactly, but we are doing what, annualize the guidance sort of eight times four, a little bit less than 40 now. You are talking about a 100. Where do you think the inflection point – I know some people start shipping – have already started shipping, but where do you really think the inflection point is there?

Hank Nothhaft

Yes, thank you, Raj. That’s a fair series of questions. So we have set a goal sometime ago, as you know, for $100 million in 2011. And currently we have a plan that gets us there, and we are executing against that plan. Clearly, our current run rate in the current quarter and given our guidance certainly is, as you said, less than a $40 million run-rate. So, there is clearly a rapid revenue growth required from now till then to make the number, and we are quite cognizant of it.

So I think it’s fair to say the real trajectory that would be visible to outsiders to our success in this area would be in the second half of 2010. So, as we indicated all along, there will be symptoms of success occurring prior to that where we start getting royalties from EDOF and what have you starting in the first quarter of this year. And, so I would say it’s clearly was an ambitious plan when we announced it. It certainly looks that way today but right now we have a plan that gets us there. We are executing against the plan, we have had excellent booking success. I mentioned in my script we felt we had very strong momentum exiting the year and going into this year. One key element of making the number is a recovery in our mature micro-optics products business. I think you guys are all cognizant of the forecast for the semiconductor capital equipment market, which would be somewhat of a barometer for our potential there. A lot of the forecast I have seen have an 80% growth year to year in that area.

We have some new businesses and new markets that we are going after with some of our micro-optics technology. So we think our chances of succeeding in that arena are pretty good. That would be additive. And then there are some technology changes that are going on with immersion scanner technology that would require more lenses. And so that would be also an underlying positive trend for the micro-optics business. So if I may summarize and go in the order of how we are going to try to talk about the business so, in wafer-level packaging, we have licensees in place that are shipping, others coming online. The royalty rates are low there. So as we have said, pennies per unit but we have had great success in the market, and we have very high market share as far as wafer-level package sensors.

In regards to wafer-level optics, we mentioned we are working very hard to seed the market, ship the million units. We have strong demand on our pilot manufacturing facility down in Charlotte from prospective and current licensees, frankly, and we have two licensees coming up to speed. So it's not a demand problem in wafer-level optics. It’s really a transfer of technology, go into production to meet demand. So, it's always good to be in a market where demand is very high, and you're trying to run hard and catch up with the market factor. So that’s very positive.

And then in the image enhancements, and I’ll just combine those two categories where we have our EDOF, Extended Depth of Field ultra-fast lens, and then our image enhancement technologies. In general, we booked a number of contracts during the last year. The first one started shipping in October. Others are coming online. We see multiyear roadmaps from our licensees to use EDOF. So we see that as a real opportunity that came to a realization for us, and we see strong growth there. And then key to all of this is recovery, a strong recovery in our micro-optics business, and then also addressing some new markets there.

So if you roll all that up, we have a plan, we are executing that gets us to $100 million in 2011, and there has to be a strong ramp in the second half of 2010 for us to realistically get there. So I hope that answers your question, Raj.

Raj Seth – Cowen and Company

Yeah, that’s helpful. Just to be clear, you are talking run-rate as $100 million, or are you talking about $100 million for the full year? And I've got –

Hank Nothhaft

Actually, we drove that stake in the ground, Raj. It was $100 million for the full year. So it really is a steep hill to climb, but we are not backing down.

Raj Seth – Cowen and Company

Okay. And just so I am clear, one more if I might, you talked about strength in micro-electronics in Q2, so am I correct in reading you that the seasonality that one might expect in Q1 -- industry Q1 which you reflect in Q2, will be more than offset by the cessation of the breakpoints in DRAM?

Hank Nothhaft

I am not sure if I understood the question, Raj, so –

Raj Seth – Cowen and Company

In other words (inaudible) will you be up sequentially, I guess, in Q2 in that micro-electronics line, because I am assuming, you see, industry Q1 weakness, just seasonal weakness in that line, because units are usually down a bit, but you also have the breakpoints which disappear in that quarter.

Hank Nothhaft

I will defer to Michael. Michael?

Mike Anthofer

Sure, Raj. So, we would expect significant sequential growth in that segment in the second quarter relative to the first quarter.

Raj Seth – Cowen and Company

Great, thank you.

Hank Nothhaft

You are welcome.

Mike Anthofer

You are welcome.

Operator

(Operator instructions) Your next question is from the line of Krish Sankar with Bank of America.

Hank Nothhaft

Hi, Krish.

Paul Thomas – Bank of America

This is Paul Thomas for Krish.

Hank Nothhaft

Hi guys. First, on the guidance, is it fair to assume that the two customers that came in below forecast in Q4, are those guys going to stay in their lower ranges going forward, or do you see some product mix shift there kind of helping you maybe boosting revenues in Q2 when the DRAM contracts reset?

Mike Anthofer

Paul, this is Mike. We don't really get into specific -- addressing specific customers and their growth patterns within the Micro-e segment. But, I would say in general that we are expecting just modest growth within those two customers specifically. And with respect to the comment I made about the second quarter sequential growth over first quarter, I wouldn’t attribute that to those two in particular. It’s really more about the reset, if you will, and the volume-based pricing where we get the benefit in the second and third quarters, which are the industry first and second. So, that is going to be the bigger -- the biggest sequential driver.

Paul Thomas – Bank of America

Okay. That makes sense. And then on the imaging and optics, you are guiding sequentially flat, right, $8 million, but I know there were some one-time items in the Q4. Toshiba is going to be in there in Q1 right now, so I am assuming that that means it’s not a big number. It’s a small part of that $8 million?

Mike Anthofer

That is correct. It is a small part of the $8 million, and the other thing that I would say in terms of looking at it sequentially is there are some things that are difficult to predict, for example, like our NRE activities with certain of our optical or embedded image enhancement customers. Those are oftentimes more difficult to predict. So we won’t know until we proceed through the quarter. That could help us. And also on the micro-electronics -- excuse me, on the micro-optics side with litho and comps, it’s very much purchase order driven, and we get increased visibility almost literally on a weekly basis because it’s, you know, we receive orders and we produce. So it’s, much different sort of business, and say, roughly so over the quarter we’ll hopefully gain more visibility there. But at this point the major shift is, yes, the EDOF royalties are fairly insignificant relatively speaking to the number in the first quarter, but, of course, growing throughout the year.

Hank Nothhaft

And, Paul, while you are on the line -- this is actually Hank following up on something I forgot to mention in Raj’s call. So we are on the imaging and optics. So, if I may be, able to insert this into the train of thought here, so in addressing also the 2011 number and how do we get there, one really important new product that I mentioned in my script that we are out marketing it pretty heavily at the moment and anticipate, we are getting good traction in the market and that is with Zoom. Zoom is a good example of these higher value capabilities that we can produce that provide a significant benefit to the licensee. So Zoom is a product that would replace an electromechanical alternative.

So it is a 3:1 optical zoom, no moving parts, would have a significant cost advantage. And, therefore, we believe that whereas we are getting very low royalty rates for central packaging and even the lower end products in wafer-level optics. And then as you move up the supply or value chain, EDOF, you command a higher rate, but Zoom, we believe would be several orders of magnitude higher than what we are getting for, I would say, an extended depth of field licensee. So that way when you are driving that kind of unit revenue is maybe the $100 million sounds less daunting than it might without that thought. So, if I might just add that in there.

Paul Thomas – Bank of America

Okay. Thanks, guys.

Hank Nothhaft

You are welcome.

Operator

(Operator instructions) There is a question from the line of Mehdi Hosseini from FBR.

Hank Nothhaft

Hi, Mehdi.

Mehdi Hosseini – FBR

Hi. Thanks for taking my question.

Hank Nothhaft

You are welcome.

Mehdi Hosseini – FBR

Going back to Raj's question, can you please help me understand how we should think about the mix of royalty and products and services for imaging, especially as you accelerate towards the $100 million run-rate?

Hank Nothhaft

Yes. This is Hank and thank you. The way we are looking at it, we believe in 2011 certainly as we exit the year that the product component of that revenue stream, which is primarily in the micro-optics business but there is some product revenue being generated by our product launch services, that would be about 30% of that number. And then the other 70% would be predominately royalties. The license fees are generally modest upfront one-time fees sort of in the $1 million to $2 million range. And then we do, as part of many of these projects, there is a NRE component because there are specialized lens for each one of these applications for example in EDOF, etcetera. And those are modest fees in the $500,000 to $1 million per engagement. So, therefore, in summary, you should look at it about 30% product about 70% royalties and license fees with the vast majority of it associated with ongoing royalties.

Mehdi Hosseini – FBR

I see. And then in terms of these opportunities, how long is it going to take or the required design wins or customer licensing agreements to be realized? Or do you really have those agreements in place; it is just a matter of and private ramp-up of your customers start ramping?

Hank Nothhaft

It's a combination of both. We do have a number of contracts that we have won. As I said, we have projects right now for EDOF engagements from 2 to 8 megapixel, and we have licensed a broad range of companies that are coming up to ramping up where we haven't really received significant royalty revenue. So even in the image sensor business, which is our most mature design-in IP, only a couple of the guys are in what I would consider mass production though the others are coming up real fast. So we’ll be getting royalties from people existing licensees that are in production. We will be getting royalties from existing licensees who are not yet in production.

New projects we have booked that haven't shipped yet will go into shipment. And then on top of that though, even though the names may be the same, in other words they may be the same companies that we would be licensing, we have to go and get some wins, and particularly we need to go and get wins with the Zoom technology. And then keep in mind, all of this is contingent on a recovery to historic levels of our -- well, our diffractive optics litho communications lens business and capturing some modest percentage of new business there that we are currently pursuing. So it's a combination of those. I hope that answers your question.

Mehdi Hosseini – FBR

Sure, and then one last question going back micro-electronics, what is the current mix of logic and memory especially DRAM? And how you are going to track at least a year from now?

Hank Nothhaft

Okay, I am going to refer that question to Mike. Mike?

Mike Anthofer

So what I can say Mehdi on that is that a majority of our Micro-electronics royalties is DRAM based, and going forward we are not guiding beyond sort of the current quarter, if you will. So based on our current view and with the way the royalties are mapping out, is the majority is DRAM, but I am going to be careful when I say a majority because I don't want you to think it's 90% either. There is a substantial amount that’s logic or wireless-related. And going forward we are not offering a prediction on that mix shift. I think you would have to -- just refer to the industry and our licensees to make your own judgments in that regard.

Mehdi Hosseini – FBR

I am sorry; you said the majority is DRAM, right?

Mike Anthofer

Majority.

Mehdi Hosseini – FBR

Okay, the majority is DRAM. And then the volume discount, for the purpose of modeling a year out, should we think about an annual decline in ASP or once a year volume discount kicking in?

Mike Anthofer

Well, what we've said is that the way the volume pricing discount works is that we would have disproportionately higher revenues in the second and third quarter.

Mehdi Hosseini – FBR

Okay.

Mike Anthofer

In other words, basically for the licensees in particular here basically by on or around midyear at sort of current rates, it has an impact on us for their midyear, which we’re again on a quarter lag. So it would be then our second and third quarter, their first and second, our second and third. So after their second quarter, our third quarter, the pricing -- the volume pricing has impacted us. So I hope that helps to answer your question.

Mehdi Hosseini – FBR

Sure. So, in other words, the pricing impact for Tessera is -- should be material by third quarter?

Mike Anthofer

Well, yes. In other words, after -- sequentially the fourth quarter would be lower than the third quarter as a result of that.

Mehdi Hosseini – FBR

Okay. Got it.

Hank Nothhaft

All non-things being equal.

Mike Anthofer

All non-things being equal and non-recurring items and current industry unit volume. That is correct with those qualifiers on it.

Mehdi Hosseini – FBR

Got it. Got it. Thank you.

Mike Anthofer

You welcome.

Operator

There are no further questions at this time. I would now like to turn the call back over to Mr. Hank Nothhaft.

Hank Nothhaft

Well, thank you very much. I appreciate your spending some time with us this afternoon to get the quarterly results. We enjoyed reporting. We appreciated the good questions we had today, and we look forward to talking to you again in the near future. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Tessera Technologies, Inc. Q4 2009 Earnings Call Transcript
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