Are You Buying This Apple Supplier IPO?

Back in January, a little company you've probably never heard of filed an S-1 Registration Statement with the SEC, voicing its intentions to go public. The company is called Audience (Nasdaq: ADNC  ) , and it makes hardware-accelerated digital signal processors, or DSPs, to improve voice quality in mobile devices.

The main reason people have been watching this company is that Audience is an Apple (Nasdaq: AAPL  ) supplier, which investors love to play nowadays to piggyback on Apple's incredible momentum.

What's that popping noise?
Audience's IPO was originally expected to price between $14 and $16, but the offer ended up pricing above that range last night at $17. Shares began trading today and promptly opened at $19 once the starting pistol popped.

The company has roughly 19.4 million shares outstanding, and the price reached as high as $20.20 on the day, valuing Audience just under $400 million. That's a roughly 19% pop from the offering price.

Can you hear me now?
Let's dig in to Audience's prospectus to see whether this company is worth keeping an eye on -- unlike Liquidmetal Technologies, a tiny company that licensed its unique alloy IP to Apple, making it a supplier, but one with dubious prospects going forward. Audience might be a company to have on your Foolish radar.

Audience uses auditory neuroscience to understand how the human auditory system works and implements that technology to make its processors function similar to human hearing. Its technology improves sound quality and suppresses noise interference in mobile devices. The human auditory system is able to isolate individual noise sources within complex sound mixtures (think talking in a busy restaurant or walking down a noisy street while having a conversation).

Source: Audience prospectus. Stages of Audience's CASA-based architecture.

Source: Audience prospectus. Stages of Audience's CASA-based architecture.

The company uses computational auditory scene analysis, or CASA, which maps out sound separation functions that humans use, and combines that into a computational framework. That allows its offerings to smartly recognize, group, and separate sounds to improve quality while suppressing noise.

In essence, Audience's chips replicate what your own ears naturally do to improve sound quality.

Listen up
The company was founded in 2000 but only began production shipments in 2008. Since then, its annual revenue has grown significantly from $5.7 million in 2009 to $97.7 million in 2011. Audience was profitable last year, clearing $8.3 million in net income. Apple comprised 82% and 75% of revenue in 2010 and 2011, respectively, via its contract manufacturers. Samsung also accounted for 7% and 20% of sales in those respective years, meaning that Apple and Samsung combined represented 89% and 95% of sales in 2010 and 2011.

% of Revenue

2010

2011

Q1 2012

Apple 82% 75% 62%
Samsung 7% 20% 36%
Combined 89% 95% 98%

Source: Audience prospectus.

Audience is growing its relationship with Samsung, as Sammy chalked up 36% of sales in the first quarter, while Apple's contribution decreased to 62%.

That level of reliance on Apple is on par with Cirrus Logic (Nasdaq: CRUS  ) , whose third quarter included 70% of revenue from Apple. The audio codec supplier just reported a strong fourth quarter, but it hasn't disclosed how much of sales were from Apple in that quarter yet (it hasn't filed its corresponding 10-Q yet).

Source: Audience prospectus. Illustrative voice and audio subsystem for a typical smartphone.

Source: Audience prospectus. Illustrative voice and audio subsystem for a typical smartphone.

Audience's chips work in conjunction with Cirrus Logic's codecs, shown in the dotted line above.

Sounds too good to be true
Here's the interesting part with Audience's business: It's transitioning its business with Apple from processor hardware sales to IP licensing. Audience's chips are found in older iPhones, including the iPhone 4 and 4S. The A4 in the iPhone 4 is paired with a noise reduction chip, while the iPhone 4S's A5 uses Audience's EarSmart noise-reduction technology to assist Siri.

The Google Nexus One, a now-retired Android flagship handset made by HTC, also carried Audience chips, so Apple wasn't the first to use this tech.

Audience will continue selling chips for older iPhones while they're still in production, but starting this year, Apple is simply licensing Audience's IP to integrate into the sixth-generation iPhone. The company received $11.7 million in licensing revenue in the first quarter to get the ball rolling. Apple will be paying a per-unit royalty to Audience, which is lower than the selling price of its standalone processors, so Audience's revenue could take a hit as a result as the mix shifts toward newer models.

A per-unit royalty sounds nice, since that means Audience should be able to ride iPhone unit sales, except there's a lifetime maximum on the royalties that Apple is required to pay, after which Audience "would not receive royalties for shipments of devices into which our processor IP has been integrated." Audience doesn't disclose what that maximum is, but there is a limit, and it's decidedly not the sky.

Meanwhile, Audience faces increasing competition from heavyweights that also produce voice and audio chips, such as Qualcomm (Nasdaq: QCOM  ) and Texas Instruments (NYSE: TXN  ) , both of which also pitch in ingredients to iDevices.

I'm all ears
I'll be listening to Audience's story, especially if its IP begins seeing increased adoption catalyzed by its relationship with Apple and Samsung, the top two smartphone makers in the world. I'd like a little more detail on that lifetime royalty ceiling, and I also need a deeper technical assessment of the competitive threat that larger players may pose.

I'd also hold off until there's more visibility on how its transition to an IP licensing model will affect its longer-term prospects. For now, it will remain on my radar.

Audience is trying to tap into The Next Trillion-Dollar Revolution, which is being led by smartphones and tablets. Meanwhile, there's another chipmaker that's gaining momentum powering the next generation of mobile devices. Grab a free copy to find out who.

Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Cirrus Logic, Qualcomm, Apple, and Google. Motley Fool newsletter services have recommended buying shares of Google and Apple and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (4) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 11, 2012, at 12:20 AM, Davidrit3 wrote:

    I've worked for companies having a substantial supplier relationship to a tier one customer, such as noted above, and it was never healthy for the supplier. When you consider the significant price pressures Apple has placed upon its supply base, you have to question what kind of long term profit viability the supplier (Audience) holds. This is not a healthy supplier-customer relationship, and I would not want to invest in a com

  • Report this Comment On May 11, 2012, at 12:21 AM, Davidrit3 wrote:

    ...pany having such a dependency on one or two customers. I'd be very hesitant.

  • Report this Comment On May 11, 2012, at 8:21 AM, demodave wrote:

    The exit from hardware manufacturing into a "pure" IP business has the potential to significantly reduce Audience' cost structure. If their chips are pure-play manufactured in a foundry, the foundry can benefit from economies of scale. Chip manufacturing equipment has very high fixed costs, so more wafers or chips means lower manufacturing costs on an individual wafer/die level, which is a win for the die. Design and development requires people, which are a variable cost (and sadly, easier to get rid of), which is a win for the IP development process. This *can* be win-win-win (IP-die-customer), but balance can, indeed, be a major constraint to the bottom tier of the supply chain (wafer/chip manufacturer) as Drite implies.

  • Report this Comment On May 11, 2012, at 11:17 AM, ccolemaninc wrote:

    Going from $5.7m to $98m in 2 years..and then straight into an IPO?!?!?! Hopefully they have strong management. Without strong and experienced leadership in place, that kind of overnight growth could actually be devastating. I would let them learn how to perform as a $100m+ publicly traded company for a little while and see how they do.

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