Ramsey, you have the direction of causality wrong. The CFO isn't trying to hit my estimates. I try to hit his numbers, which no longer proves difficult. Incidentally, understand that this does not mean my near-term estimates are better than the analysts, who all missed by a penny or two. It would have been inappropriate of the analysts to estimate 18 cents like I did. If all this seems contrived, it is WIND's inventive way to disengage the long-term development of the company from the insanity of quarterly earnings announcements.
Now, let's look deeper at the quarterly statement. The precise $24,000,000 in revenues , like last quarter's precise $22,000,000, tells us that this figure is sufficient to produce the targeted 18 cents in EPS.
But look closer and the first thing that pops out is the acceleration in services revenues. This is not surprising, since WIND has long indicated that demand of application development assistance has been growing. You might recall that INTS last quarter reported rapid growth in services, but in that case with a decrease in margins, which indicated they are hunting for applications development consulting contracts. WIND's margins on services are getting less volatile over time while also steadily increasing, up to this quarter's 62.3%, which is huge for services. In FY 1995 and 1996, the gross margin on services was around 57% - 58%. FY 1997 raised it to 61%, and this year is raising it up past 62%. This means the service business is pursuing WIND, rather than WIND having to maintain revenue growth by stalking services.
You probably have already realized that management cannot postpone services revenues like they do product sales. Services revenues generally are earned on a percentage completion of work, or on hours charged, or on a pro rata allocation of maintenance revenues. Occasionally a wrap up of a fixed price job can bring in a chunk of revenues. But the point is that none of the events that triggers services revenues is subject to being slowed down purposely by management - ever. Therefore, services revenues growth is true, unabridged growth, and now is growing at a 64% clip year on year.
Because of the ramp up in services revenues, we can't know exactly how fast product revenues are increasing, because total revenues are managed. We do know that royalty revenues (run time license fees) continue to increase rapidly, probably even more rapidly than services. With 64% services growth compared to 38% growth in products, the increase in the overall gross margin to 82.4% can best be explained by rapidly increasing zero-cost royalties. (If a relatively low-margin item (services) is out growing higher margin items (products), but overall gross margins increase rather than decrease, then the highest margin sub-item (royalties) must be growing rapidly enough to more than compensate. Of course increasing services margins help, as would increasing margins on product licenses, which may be occurring due to economies of scale.)
Even with the numbers reported, product license revenues are probably growing at about 25% to 30% year on year. Add the postponed revenue and product revenue growth rate would probably be about 35% to 40% for this quarter.
Costs were controlled more tightly than I would have expected. In particular, the sequential drop in Sales and Marketing, Development and G&A suggest that WIND continues to execute according to a budget, even when the coffers are stuffed with cash. The reduction in Development is easily explained by the rapid increase in services, since services hides a significant amount of development. For example, contracted ports to new processors is service income, even though it is viewed internally as development, because WIND is a direct beneficiary of the port, along with the semiconductor company providing the initial funding. As a result of watching where the money goes, WIND's operating margin jumped to 30%, at the upper end of Ron Abelmann's comfort level. Following suit, net profit jumped to 21.7%, which is indicative of a company developing a strong franchise.
Even without I2O royalties kicking in significantly, WIND continues executing according to plan, with revenue growth continuing around 45% and EPS growth converging to about 50%. Note that revenues reached the 45% range at the start of FY 1997, and have continued at that pace ever since. I2O should ratchet revenue growth another 10 percentage points starting next February, while pushing EPS up even more.
I am sure that WIND management indeed hopes that investors will come to expect 45% revenue growth and 50% EPS growth, finding the consistency boring, but credible. Bonds are boring too, but even a boring 6% yield guaranteed by the U.S government is prized by conservative investors. Imagine what they would pay for a zero-coupon 30-year tax-free Treasury bond yielding a compound 50% per annum.
Another great quarter!
Allen
This reminds me of what someone reportedly said about the weather in Kenya. (If you have ever spent time in Kenya, then you know that the weather can be extraordinarily nice seemingly forever.) The person said, after awakening and looking out at the morning sun, "Oh no, not another $#@&** beautiful day!" |
