This first full quarter of the merger of the two leaders of the embedded space, complicated by negative insider selling signals, was a good quarter to get behind us. Under the circumstances (which we just learned included upheaval in Japan), the performance was good, very good. As predicted, revenues continued accelerating and margins began to improve, with the promise of steady improvements to come – as far as the eye can see (or at least until operating margins approach 20%).
The Conference Call was well organized with lots of delicious tidings about important deals and design wins. By far, this was the best CC during TSD’s reign, and I think the market expressed its appreciation, not just on Friday but in holding the pre-announcement run-up in after-hours on Thursday. If your level of analysis is just to observe that revenue should continue to increase, along with improving margins, you will probably be awarded accordingly. On the other hand, the point of this thread is to look deeper, so here goes.
There are a lot of interesting things going on with the numbers. Let’s start with the easy one: Professional Services. One of the major mysteries bugging me is why Dr. Design services has been so lackluster for well over a year. ISI passed it off as needing to divert manpower away from paying customers for Java internal development. But even as WIND began to push services prior to the merger, actual performance lagged expectations. While Q2 growth in services at 20% year-on-year is showing healthy acceleration compared to Q1’s 12% growth, keep in mind that last year was an easy comparison year.
I recall my summary post of the June 19 Analyst Day included an expectation of 40% to 50% growth in services, starting soon. The gating factor was felt to be capacity to deliver rather than demand. The drop in gross margin for services to 51% from Q1’s 54% suggests either demand is at least price sensitive or there remain organizational problems in delivery.
On the other hand, Q2’s 18% sequential increase in service revenue over Q1 is impressive and hints of greater things to come. Consequently, I’m satisfied as long as growth continues to accelerate with gross margins held at or above the stated goal of 50%.
But why do we care at all about services? I doubt that any investor ever bought a share of WIND because of the existence of Professional Services. Well, every time I think that way, I have to reach around and give myself a kick. Not only is Professional Services important, it is a critical indicator of the future of smart consumer products, namely through virtual design, development, production and fulfillment (VDDPF). I believe most consumer products will be developed in this virtual mode in the future. Sony and similar giant consumer product companies will dominate the mainstream using their own in-house engineering teams, but many other companies will bring probably a larger number of innovative products to market sans any internal engineering or production capability. Everything will be outsourced, and at the software level this implies Professional Services.
If WIND’s professional services fails to meet expectations, I will need to reexamine profoundly my view of its role going forward. (VDDPF may not become as fashionable as I expect, or it may be provided best by partners like eSIM or RapidLogic, who supply the final ingredient: high-level software modeling on top of a fully integrated, reliable hardware/software platforms. The latter definitely is WIND’s primary reason to be, yet does not necessarily imply professional services.)
See the next post for an analysis of a truly interesting mix of product and royalty figures.
Allen |
