GMP research on Intrinsyc Q3 results

Here is the research note published this am by GMP Securities on Wellington Financial Fund II portfolio co. Intrinsyc Software (ICS:TSX):

“Intrinsyc reported $4.5 million and a net income loss of $4.1 million (or $0.03 loss per share), higher than our estimates of $4.2 million and a loss of $5.0 million (or $0.04 loss per share).

Consensus estimates were $4.4 million and ($0.04). Reported Q4 revenue declined approximately 11% from Q3, in-line with previous management guidance of a 10%-20% decline as the company is in the progress of migrating out of its legacy embedded services business. Soleus accounted for $0.08 million in revenue during the quarter. Gross margins of 49% were better than our estimates of 47%, largely due to an improvement in sales execution engineering services engagements as well as higher margin system integration business.

From an operational expenditures perspective, the company reported lower Administration and
Research and Development of $1.3 million and $2.8 million versus our estimates of $1.6 million and $3.1 million, respectively. During the quarter Soleus’ development costs accounted for $2.7 million in opex and continue to account for the majority of Research and Development costs.

This line item highlights the development nature of the business. Cash used from operations was $3.3 million and the company ended the quarter with $20 million in cash and cash equivalents.

Intrinsyc opened its Asian operation in Taipei in late September. The new offices will house research and development efforts and improved engineering services. In addition management is in the process of possibly closing its UK operations for engineering services as the company is expected to reorganize this business to its Taipei and Vancouver offices. A preliminary analysis indicates that the company would incur a one-time charge of $0.8 million (most likely in the next quarterly financials) and an annual savings of $2.0 million in operational expenditures. The company has proposed to shutdown its UK operations by the end of 2007.

Management announced that the company will be transitioning its year-end from August to December and its reporting currency from Canadian to US dollars as these adjustments will better align the company’s business cycle with its customers. Intrinsyc accounts for the majority of its revenue base from professional services and licence revenue in US$ and has a substantial portion of its operating expenditures in C$. The company is in the process of receiving regulatory approvals from the TSX and Canada Revenue Agency. In the table below we provide a summary of our financial estimates for the 4-month stub period ending December 31, 2007. In this report we are making the adjustment to the new fiscal periods now, however, we await the formal change to US$ reporting so that we can make the adjustment to both historical and future financials.

Intrinsyc management was upbeat when discussing sales prospects to OEMs, ODMs and silicon
vendors (Marvell, Texas Instruments, Intel and Freescale). No financial guidance was provided,
however, management re-iterated its customer guidance of one Soleus design win per quarter (note that this does not necessarily mean a new customer per quarter as it is possible to have multiple design wins per client). From a product development perspective we are bullish on the company’s engineering execution since our launch of coverage earlier this year. The release of the Soleus 1.01 software platform is an extension of the existing application with added functionality including multimedia, camera, language switching features as well as seamless integration of Microsoft Windows Mobile 6.0.

The combined effect of a rising Canadian dollar (still relevant in current model), shifting fiscal period, and lowered costs from the UK facility result in a minimal overall impact to our estimates. Our F08 (ending Dec) estimates of $23.8 million and ($0.14) remain materially unchanged. Our unit assumptions for F08 and F09 are 0.8 million and 4.4 million units, respectively. Our unchanged F09 estimates are $33.4 million and ($0.11).

Google announced the development of an open and comprehensive mobile platform called Android, due out in the second half of 2008. The new open-source strategy aims to enable faster innovation and lower barriers to entry in the competitive handset market, specifically targeting lowering software costs within the handset. Google, T-Mobile, HTC, Qualcomm, Motorola and 29 other companies have formed the Open Handset Alliance, a group dedicated to improving user experience as well as promoting new technologies and the development of wireless technology. The new software will provide a developer-friendly, open-source platform that will consist of a mobile operating system and middleware and a user-friendly interface and applications.

In the past we have discussed the fundamental implications to our coverage universe when/if Google enters the mobile industry via the US spectrum auction (Google is attempting to become the commerce and search backbone for the computing industry to go wireless). Recall that in July 2007 Google announced its intentions to bid at least $4.6 billion for the upcoming 700 MHz spectrum auction.

Our preliminary assessment on Google’s entry is that it will likely take the company longer to penetrate the mobile market than most anticipate. Other large technology suppliers such as Apple and Microsoft have shown that false first starts are a common theme. Apple’s first gen ROKR handset joint venture with Motorola was a failure from a product and sales perspective. It took Microsoft’s Windows Mobile business near ten years to reach current levels of 160 mobile operators in 55 countries (Microsoft is expected to sell about 12 million Windows Mobile phones this year, accounting for about 10% of the smartphone market, according to IDC). We have provided research in the past on mobile Linux which shares the open sourced characteristics of Google’s Android platform. However, our research has shown that the largest users of mobile Linux (e.g. Motorola) do not find that open sourced code is necessarily cheaper when considering all-in costs such as the development of tools.

There are several fundamental differences between Google and others discussed above. First,
Google’s commitment to wireless is significantly higher as evident from its $4.6 billion initial bid for wireless spectrum. Skeptics who claim that Google is employing game theory with no intention to bid for the spectrum underestimate the significance of Google’s industry reputation and culture. Second, Google is facilitating the lowering of software costs on the handset. Third, Google can make money simply from mobile search (an application that we view will gain increasing traction as users request information on the go).

Overall we believe that Google’s entry is fundamentally different than other market entrants. We also believe that it will take longer for Google to succeed in this market than is generally expected. Therefore, we view Google and Android as more significant to the market in the 2009/10 timeframe. Based on our initial checks we believe that events related to Android are expected to gather momentum heading into February 2008 3GSM. In our view, the impact to Intrinsyc is minimal over the near term, however, we are concerned about the impact to license pricing for future design wins. Management believes that Google represents an opportunity as the platform could disrupt handset OEM’s design cycles (something we have seen with touch screen products at all major OEM’s post the iPhone). For now we are not adjusting our forward ASP assumptions as we have modelled a 18% decline in F09 versus F08.

We apply a 3.5x P/S multiple to our unchanged F09 revenue estimate of $33.4 million to arrive at our price objective of $0.95 and maintain our BUY rating. A replay will be available at 866-245-6755 or 416-915-1035, passcode: 845884#.”

MRM