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Applied Micro Circuits Corporation (NASDAQ:AMCC)

F3Q 2013 Earnings Conference Call

January 30, 2013 17:00 ET

Executives

Bob Gargus - Senior Vice President and Chief Financial Officer

Dr. Paramesh Gopi - President and Chief Executive Officer

Analysts

Ambrish Srivastava - BMO

Rick Schafer - Oppenheimer

Sandy Harrison - Wunderlich

Hans Mosesmann - Raymond James

Christopher Longiaru - Sidoti & Company

Patrick Wang - Evercore

Vijay Rakesh - Sterne Agee

Krishna Shankar - ROTH Capital

Brian Thonn - Kingdom Ridge Capital

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 Applied Micro Circuits Corporation Earnings Conference Call. My name is Ayisha and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to your host for today Mr. Bob Gargus, Senior Vice President and Chief Financial Officer. Please proceed sir.

Bob Gargus - Senior Vice President and Chief Financial Officer

Good afternoon, everyone and thank you for joining today’s conference call. On the call with me is Dr. Paramesh Gopi, our President and CEO.

Before turning the call over to Paramesh, I want to remind you that forward-looking statements discussed on this call, including guidance we will provide on revenue, non-GAAP gross margins, non-GAAP operating expenses, and certain other financial targets are based on the limited information available to us today. That information is likely to change.

There are numerous risks and uncertainties that affect our business and may affect these forward-looking statements. These risks include items such as the completion and performance levels of 40-nanometer and 28-nanometer ARM 64-bit X-Gene server on a chip, the TAM and market acceptance of such products, the amount and timing of payments under the Veloce merger agreement, product development and introductions, design wins, manufacturing and supply availability, product demand and mix, the impact of personnel reductions and departures, employee relations, and the integration of new or moved operations, risk resulting from macroeconomic conditions and markets, and other risks as set forth in our SEC filings, including our Form 10-K for the year ended March 31, 2012.

Our actual results may differ materially from these forward-looking statements. Applied Micro assumes no obligation to update forward-looking statements made on this call. I want to point out that Applied Micro has several analysts to cover our stock and this creates a range of variability relative to the Street financial models. When we say Street estimates, we mean the consensus of the major analyst models and not necessarily the guidance that was given by the company.

With that, I am going to turn the call over to Paramesh. Paramesh?

Dr. Paramesh Gopi - President and Chief Executive Officer

Thanks Bob. Let’s start with an overview of our third quarter ending December 31, 2012. Before I get into the details by individual product lines, let me first talk to the status of our X-Gene ARM 64-bit product.

First of all, we are extremely pleased to share with you the progress of our X-Gene ARM 64-bit product development. In December, we taped out our first generation 40-nanometer product and the chip is now in our labs. Preliminary lab test indicate that the X-Gene ARM 64-bit processor core is running at 2.4 gigahertz and industry first for any ARM processor. We believe this makes X-Gene the world’s first and only ARM 64-bit based silicon platform with this level of performance in a standard bulk CMOS process.

I would also like to emphasize that the X-Gene core is designed to have a full setup enterprise security and management features that are a basic requirement for servers. To contextualize, we believe the current highest performing 32-bit ARM processors run between 1.5 gigahertz and 1.8 gigahertz at 40-nanometer and lack important enterprise class features. We also taped out our X-Gene 28-nanometer test chip in January at PSMC. This isn’t keeping with our plan to provide a product roadmap showing current and next generation products, which is a requirement for competitiveness in the server market. While awaiting results of the actual 40-nanometer silicon, correlated simulation have cost us to believe that the X-Gene performance will far exceed our earlier expectations. This enhanced performance of our X-Gene platform will allow Applied Micro to actively drive the adoption of the ARM architecture in the larger enterprise Cloud server market in a much more meaningful fashion.

Interest for the X-Gene product continues to exceed our expectations. The ARM 64-bit platform continues to garner additional partners and support for the evolution of the ecosystem continues at a very rapid rate. Currently, we have several prospective customers eagerly awaiting samples. On January 16th, Applied Micro’s ARM 64-bit based micro server design was showcased by Frank Frankovsky, Chairman of the Open Comupte Foundation and Vice president of Hardware Design and Supply Chain at Facebook, during his keynote at the Open Compute Summit. Ours is the first ARM 64-bit based reference design released for Open Compute Project common slot architecture specification, a specification that can accommodate all SOC architecture types that was also announced at the Summit.

Further at Open Compute Dell Vice President and Senior Fellow, Jimmy Pike showcased Dell’s Iron server concept with X-Gene as well as demonstrated an X-Gene based ARM server managed by the Dell DCS software suite illustrating real commitment from a resourcing and software ecosystem perspective towards the ARM 64-bit cloud server market and more importantly towards X-Gene.

We plan to launch a development partnership program with a sub-$1000 ARM 64-bit cloud scale server blade platform that can be used by the open source community as well as infrastructure and data center OEMs to rapidly accelerate market deployment of ARM based cloud servers. The better than expected performance levels for X-Gene has caused us to update the total estimated cost for Veloce under the Veloce merger agreement. We are now projecting that the total estimated cost for Veloce will range from $117 million to a contractual maximum of $178.5 million. Payout of which is dependent upon the achievement of multiple product development cycles and technical performance results. Bob will cover the range expected timing and manner and method of payments related to the Veloce transaction later in this presentation.

While we are very excited about X-Gene, I am very pleased to say that our other new products are steadily contributing towards our top line and are in line towards helping us breakeven next quarter. To contextualize, the base business without X-Gene generated $0.11 EPS on a non-GAAP basis for the quarter ended December 2012. We believe that the combination of a solid base business and the X-Gene growth engine with first mover and category leadership advantage gives us a basis to scale our company.

Now to review our financial results for the December quarter, revenues of $51.7 million and non-GAAP EPS of minus $0.10 compared to street estimates of negative or minus $0.12 that is we are $0.02 ahead of street consensus. Book to bill of 1.3, this includes some end of life orders. If adjusted for these end of life orders, our book to bill is still a very solid 1.1. We are entering the March quarter with 76% in backlog compared to 78% entering the December quarter. We ended the quarter with approximately $84 million in cash and we have no debt. Looking ahead we believe we will achieve breakeven on a non-GAAP basis in the March quarter.

Connectivity, our connectivity revenues were $21.3 million and were flat compared to the September quarter. However, the book to bill is very healthy at 1.3 and we expect this should result in double-digit growth this quarter. We are very encouraged by the continuing strong design win traction. Last quarter we garnered more than 15 design wins with more than $60 million in expected lifetime value. The design successes of our advanced 100 gig CMOS PHY products that we talked to you about last quarter have continued in a positive direction. We made strong progress on the 10 GBASE-T front and continued to gain traction with key customers in both switching and server adopters. I am very happy to announce that we have achieved wins with two key module customers who have chosen Applied Micro for our performance and service. We expect meaningful contributions to our top line from their ability to ramp quickly with our 100 gig PHY products in the latter half of FY ’14.

Although we continued to make significant inroads with our connectivity products, we have not yet seen increased CapEx by carriers such as AT&T, Verizon affect our backlog as of yet. This will be upside to our base business if and when it materializes. In the data center space edge routers continued to be the fastest growing part of data centers of all sizes. Applied Micro’s strong design position on OTN line cards continues to drive growth and this resulted in our OTN revenues growing 5% sequentially to $13.1 million for the December quarter.

Finally, we just announced a partnership with Volex plc, a global provider of electrical, digital, and optical connections. Volex will leverage three years of Applied Micro research and development, purpose for high-performance, low-cost datacenter interconnects based on next generation photonics. The companies will share ownership of the associated active optical patent portfolio allowing each company to continue development of the technologies and forming the basis for the two companies to collaborate on next generation optical interconnect products and solutions.

Now, let me turn to our computing business. Computing revenues were $29.5 million for the quarter and were up sequentially by 24%. Book-to-bill was a robust 1.4, but within this, there were end-of-life network processor orders, that if backed out would result in a book-to-bill of 1. Given that the revenues increased 24% sequentially, our book-to-bill of 1 in our view is very good. Last quarter was comparatively slow regarding design wins as several customer decisions were pushed into the fourth fiscal quarter of 2013. Despite this, we were still able to get several design wins with LTV of $33 million. We won a significant design win in the Cisco CAT3K program with revenue expected to begin as early as FY ‘14. We find our Catalina product line showing strong traction in the network-attached storage and the access point markets due to differentiating factors such as integrated quality of service, USB 3, superior NAS performance, and data path offloads and acceleration.

Our silicon solution integration and bundling with partners on physical layers, radio processors, switches, and other active components is leading to increased market penetration and demand creation between the consumer and enterprise access point and NAS markets. We are also very excited about the number of our embedded PowerPC customers who have been engaging us on X-Gene derivative discussions for the embedded processor space. We believe that the combination of ARM 64-bit with our connectivity assets should lend significant power and feature performance advantages for our customers.

Finally, I’d like to quantify our new product revenue contribution. These new products defined as products introduced in or after fiscal year 2009, represented 15% of our revenues in Q1 2013, 20% in Q2, 21% in Q3, and we expected to be around 25% in the March quarter. New product revenue growth has been and is expected to be the main contributor to our quarter-to-quarter revenue growth.

With this, let me turn the call over to Bob. Bob?

Bob Gargus - Senior Vice President and Chief Financial Officer

Thanks, Paramesh. Third quarter revenues were $51.7 million, up $5.4 million or 12% compared to the prior quarter and down 8.3% compared to the same quarter a year ago. I will remind you that the consensus was $51.0 million. Sales to North America accounted for approximately 45% of total revenues, sales to Europe contributed 18%, and sales to Asia contributed 30%.

Wintec, a global logistical support vendor, accounted for approximately 21% of December quarter revenues versus 20% in the September quarter. There was one distributor that was more than 10% and that was Worldwide Avnet which accounted for 27% and the September quarter was 28% by comparison.

Distributor revenues for the last quarter were approximately $33 million compared to $30.2 million for the prior quarter. Inventory in the channel based on sell-through numbers increased to 61 days compared to 51 days for the September quarter.

Turning to the P&L, our third quarter non-GAAP net loss was better than the Street consensus and was a loss per share that was $0.10 per share compared to the Street consensus of a loss of $0.12 per share. Our non-GAAP net loss for the quarter was $6.9 million or minus $0.10 per share compared to a non-GAAP net loss of $10.5 million or $0.16 per share for the prior quarter.

Our non-GAAP operating margin was a negative 15.1% of revenue and improved 9.8 points from the negative 24.9% achieved in the last quarter. Our non-GAAP EBITDA for the quarter was a negative $3.9 million or negative 7.6% of revenue compared to a negative $8 million or negative 17.2% of revenue for the prior quarter.

The third quarter non-GAAP gross margins, including licensing was 57.2%, which was slightly lower than the 57.5% for the September quarter. This was consistent with our guidance of 57.5% plus or minus half a point. Looking forward to the March quarter, we are expecting licensing revenues to be approximately $1 million and we are expecting overall gross margins for the March quarter. And by this overall I mean including licensing to be approximately 59.5% plus or minus half a point. This is mainly due to favorable mix, which includes the end-of-life shipments that Paramesh talked about earlier that we will see going into the March quarter.

We expect gross margins to return to the more normal 57% to 57.5% range going forward. Non-GAAP operating expenses were $37.4 million, which compares favorably to our guidance of approximately in the range of $38 million to $38.5 million. These operating expenses were lower than our guidance mainly due to the timing of certain R&D project related costs. For the March quarter, we are expecting our non-GAAP operating expenses to be in the range of $34 million to $35 million. This includes the benefits realized from the restructuring plan that was implemented in the December quarter. Our non-GAAP interest and other income was $0.7 million.

Interest and other income is expected to be approximately $0.5 million for the March quarter, and we expect our tax rate to continue at the 3% rate for the next several quarters. The share count for EPS purposes was 66.0 million shares. Looking forward at the March quarter, we expect the share count to be approximately 67.5 million to 68 million shares. The increase is primarily due to additional quarterly grants related to the Veloce acquisition and our additional shares related to our employee share purchase program likely to be issued in January.

Turning to the balance sheet, our cash and investments totaled $84.2 million or approximately $1.30 per share at the end of the third quarter a decrease of approximately $5.4 million from the September quarter. Our DSO at the end of December was at 31 days. We expect this measure to be in the range of 30 to 42 days going forward. And our inventory turns for the December quarter were 6.4 up sharply from the 4.3 for the September quarter.

Let me now address the Veloce expenses previously mentioned by Paramesh. First, let me repeat that we are very pleased with the progress that we have made with our X-Gene ARM 64-bit product development. Although, we were not expecting the core to be at this level of performance we are related. We believe this gives us the ability to actively drive ARM into the enterprise cloud server market. Furthermore, we also taped out the 28-nanometer test chip for ARM 64-bit product in early January.

For accounting purposes, the consideration payable for the acquisition of Veloce is considered compensatory and is recognized as research and development expenses. Accrual of this expense occurs when certain development and performance milestones become probable of achievement, and therefore associated payments become probable of being earned. As a result of what now appears to be probable achievement of higher than expected performance benchmarks, we have updated the estimated range of potential payments for Veloce under the merger agreement.

During the three months ended December 31st, 2012, the company accrued $52 million of research and development expenses in connection with progress and performance achieved on the 40-nanometer and 28-nanometer test chip efforts, in addition to the approximately $65 million that we have previously accrued through the September quarter for a total of approximately $117 million through the December quarter. The company currently projects aggregate payments with respect to the Veloce acquisition to range from $117 million to $178.5 million. The low end of the range is what we have accrued to date. At the high end of this range, we may accrue up to an additional $61.5 million of expense over time.

Accruing expenses is not the same as incurring a legal obligation to make such payments or actually making such payments. We have already paid out approximately $32 million in cash and stock. For planning purposes, we are forecasting that $77 million in additional Veloce-related payments will be made by September of 2013. The timing and amounts of payments in periods after that will depend in large part on future events, such as development and performance milestones achieved in the 28-nanometer chip, and thus is not presently being forecasted. Of the $77 million we expect to pay by September, we are committed to pay approximately $7 million in cash, approximately $7 million in stock, and the remaining $63 million can be in cash or stock or any combination.

Our decision as to what mix of cash and stock to use in making these payments will depend on several factors, including our stock price and cash requirements at the time the payments become due. Although we are mindful that this creates uncertainties as to our future cash balance, we expect that our resources will be sufficient to make such payments while maintaining adequate cash to run our operations. We will keep you updated each quarter as we continue making these Veloce related payments.

Returning to the third quarter of fiscal 2013 operational results, the bottom line is that this is the second consecutive quarter where we have seen our revenues expand and we are guiding up for the March 2013 quarter. So, we’ve also been able to rein in expenses and we are approaching cash breakeven for operations for the March quarter. Our gross margins have also been very stable and in fact we see this expanding in the March quarter. In the meantime we have been to share with you the stellar progress that we have made on our X-Gene product development efforts.

Turning to GAAP as you know our non-GAAP financials excludes certain items required by GAAP our net loss on a GAAP basis was $71.6 million versus a net loss of $21.6 million last quarter. The difference in our third quarter GAAP net loss was $71.6 million and our third quarter GAAP net loss of $6.9 million is a delta of $64.7 million. The $64.7 million is primarily comprised of the following. $51.9 million for the acquisition of Veloce, $6.2 million of stock-based compensation, $6.2 million of restructuring charges, $1 million of amortization of purchased intangibles and $1.3 million gain from the sale of certain non-strategic assets. A complete reconciliation between GAAP and non-GAAP financials can be found in our earnings release which can be found in the Investor Relations section of our website.

Please note that there is no reconciliation for forward-looking non-GAAP measures. That concludes my remarks. Let me turn the call back over to Paramesh. Paramesh?

Dr. Paramesh Gopi - President and Chief Executive Officer

Thanks Bob. In summary we had a very good quarter where we delivered and beat the numbers and remain on track to achieve breakeven in the March quarter. We are guiding our March quarter revenues to be up 6% to 10%. Our book to bill is very strong and our expanded guidance includes approximately 24% in turns business. With some of our end-of-life business and the remainder of the product mix geared in a favorable direction for next quarter, we expect our margins to be in the 59.5% range. With the expense reductions we implemented in the December quarter, we are very well poised to breakeven in the March quarter.

Finally, three years ago we envisioned the market for low TCO cloud servers. Since then we have created a category, had that category validated and have established a time-to-market advantage. Having our first generation X-Gene silicon in-house marks a significant accomplishment in this journey and makes the market opportunity for this category a reality. With that let me turn the call over Bob.

Bob Gargus - Senior Vice President and Chief Financial Officer

Thank you, Paramesh. Before going to Q&A let me specifically recap our guidance for the March quarter, total revenues to be up 6% to 10% sequentially with a midpoint of $55.8 million, total gross margins to be 59.5% plus or minus half a point, OpEx roughly $34 million to $35 million, interest income of $0.5 million and a tax rate of 3%. This concludes our formal remarks operator please provide instructions to our listeners for the queuing process.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ambrish Srivastava with MBL. Please proceed.

Ambrish Srivastava - BMO

Hi, this is Ambrish with BMO. Just on Veloce, I am just following upon the details Bob. Is there a – so it’s gone up versus the initial range that you have given us, is there anything in the original agreement that would point to additional upside from here for the team?

Bob Gargus

No, the $178.5 is the max.

Ambrish Srivastava - BMO

Okay. And then on breakeven, when you say free cash flow on a non-GAAP basis does that also means I am assuming you are breakeven also in the free cash flow basis?

Bob Gargus

Don’t know about free cash flow, I guess that I didn’t do that calculation Ambrish. But what I know is that for the March quarter we have about $1 million going out the door related to the Veloce payments. And I am profitable or breakeven then I usually am $1 million to $2 million favorable on the cash flow form operations which would wash with $1 million going out for Veloce. So, that’s why it’s kind of breakeven both cash flow from operation as well as profit on a non-GAAP basis.

Ambrish Srivastava - BMO

Okay. And then how should be we thinking about from year on in terms of top line expenses, so if the top line stays around this level, we should assume no increase in the OpEx sho you should be in the $34 million, $35 million range?

Bob Gargus

Correct.

Ambrish Srivastava - BMO

Okay, and then one last one and I will cede the floor, Paramesh?

Dr. Paramesh Gopi

And actually Ambrish let me I may go ahead and expand on that. It’s our intent to keep the OpEx in that range basically flat until such time as our profitability gets at least into the double-digits.

Ambrish Srivastava - BMO

Okay. And then the follow up is kind a related Paramesh now that you have 28-nanometer also. Is there a change in how much you would be spending on the ARM development? So, either $34 million, $35 million is that a shift more to the ARM side and why I am asking that is that you laid out a pretty good metric quarterly on the new products. So, that gives us confidence that the core business is not being neglected. So, what happens now you have two concurrent processes nodes being develop for ARM? Thank you.

Dr. Paramesh Gopi

So, let me start by saying that it always talked about two generations of processors. Let me talk about the server market that was the inceptual agreement and we will continue to basically develop two generations at a time to make sure that is the tables stakes to participate in the server market. Also I want to tell you that the base business is robust and the base business allows us at this current spending level to maintain that investment. So, there is absolutely no change from a metrics perspective.

Ambrish Srivastava - BMO

Thank you.

Operator

Your next question comes from the line of Rick Schafer with Oppenheimer. Please proceed.

Rick Schafer - Oppenheimer

Yeah, thanks. Thanks guys and congrats and getting 40 and 28 taped out. I have a couple questions I guess the first one is just you talked about having the chip taped out everything, your samples, can you talk about I guess samples are they going to go out this quarter. Can you quantify the number of trials that you expect for X-Gene either this quarter or for the year and maybe how that ramp looks?

Bob Gargus

I’ll let Paramesh comment on this but the chip only came in-house 36 hours ago.

Rick Schafer - Oppenheimer

Right.

Bob Gargus

So, the fact that we’ve got it up in the quarters running, but we have long ways to go to finish testing it before we sample, but we are very pleased with the progress so far and that’s in-house.

Dr. Paramesh Gopi

So, let me take you back to some of the earlier comments we made. I think we took a giant step by seeing silicon in terms of making this product reality. Also recall that at Open Compute the VP of Facebook essentially showed off a card that card because Open Compute has the ability to spread to multiple OEM-type engagements, right. So, just to layout kind of the flow of what’s going to happen between now and the end of year, we have always said this as samples in Q1. We have also said that people will bring up systems between the June and September quarter in their labs. And I think our calculations have been revenue in calendar year ’14. That is the plan of record. Also let me tell you that our FPGA platforms have been invaluable because all of the customers that we have engaged with are fully leveraging the software even as they are in the early bring up processes with us in our labs. So, it’s a very, very neat thing that we did by feeding the ecosystem and we are very proud what we’ve done.

Rick Schafer - Oppenheimer

And so when you talk about revenues and I know you have said that in the past about really first revs in 2014 are those really going to be primarily trial revs, do you expect to have any production revs before 2015 if we are talking calendar years. And how should be kind of think about that?

Dr. Paramesh Gopi

I think if you look at any silicon development, any company of our size good news here is we’ve done at least three test strips for 40, which is why it’s so important to take things out and make sure that we have confidence in what we do.

Rick Schafer - Oppenheimer

Right.

Dr. Paramesh Gopi

Given the unprecedented level of mix signal integration whether it’s 10 gig, 100 gig fabric as well as the just raw codes, our plan of record has always been silicon-backed one rev to production and that timeframe is usually from the first silicon to productions about a year.

Rick Schafer - Oppenheimer

Okay. I didn’t know if things would move faster since you guys are engaged in some of the yield the web 2.0 companies and obviously their timetable seems to be a little faster than maybe some of the more legacy kind of oriented guys? I did have one follow-up.

Bob Gargus

If that happens that will be good news, but right now we’ll just stay on the conservative side.

Rick Schafer - Oppenheimer

Okay. And then Bob or Paramesh just I wanted to understand a little better the Veloce payment, just I am some crystal clear, your total potential payment of Veloce just increased from $117 million to $179 million correct. And is it, I know you said management’s discretion on that $77 million due in September in terms of how much is cash and how much is stock. If you end up paying that extra $62 million, I guess that’s the delta between the $117 million and $179 million, will you have that same discretion on the stock and cash?

Bob Gargus

Yes.

Rick Schafer - Oppenheimer

And what will the timing be Bob like when would you have to start paying if you get to a point where you know you are going to have to go above the $117 million?

Bob Gargus

That I don’t believe will become apparent to us until at least the second half of the calendar year. And then the timing will still be subject to a projection of when deliverables will be met.

Rick Schafer - Oppenheimer

Okay. So, is it more tied to the trials I assume that will be going on?

Bob Gargus

It’s going to be tied to hard deliverables. Now, the accounts will make us accrue for it in the advance of that.

Rick Schafer - Oppenheimer

Okay.

Bob Gargus

Okay. So, you’ve got to always separate what’s accrued versus what’s paid. The payment again will not occur even other than the $60 million that was the initial spending nothing is really locked in to be paid until at least certain other milestones are completed.

Rick Schafer - Oppenheimer

Okay. Okay, great. Thanks.

Operator

Your next question comes from the line of Sandy Harrison with Wunderlich. Please proceed.

Sandy Harrison - Wunderlich

Thanks guys. Quick question, you talked a little in your prepared remarks about the 10GBASE-T products, I think during the quarter when your competitors either exited or teamed with a privately held company. Has that helped you on that front, have you seen any difference in the market just sort of a quick view on some of those products?

Dr. Paramesh Gopi

Well, I’ll have you know that 10GBASE-T has been talked about for the last seven years and we thought things have supposed to have materialized over the last five years and that’s the consolidation just to set context. We are extremely pleased because absolutely we have had a nice tailwind because of that. And the other thing is that finally the robustness of 10GBASE-T relative to noise canceling in real data centers has become a critical success factor for the technology. And since we hold the patents and the implementations relative to that at our company and we were the first to implement such mechanisms. We have had a very, very nice traction run on that.

Sandy Harrison - Wunderlich

Got it. And then a follow-up on the new products you talked about 15% to 20%, the 21% in the last three quarters and that you are looking at something like 25% for the March quarter, so that nice increase on top of the 10% suggest growth. How should we or how could we breakdown that incremental growth you are expecting in new products, is that further sales of existing new products or is it new products that are going to be hitting the market for sale for the first time or relative first time?

Bob Gargus

So, we’ll have some additional new products that will hit towards the second half of next year. I think it’s too soon to project or it’s outside of the guidance range that I would give for that. So, all we would say is if you remember Sandy, I think it was about a year ago we said that we had 12 new products and then we expected those to ramp by $150 million to $200 million and then the base business from a legacy point of view to go down a $100 million. So, if you use $200 million as the starting point that we would get to $250 million to $300 within 30 months. So, well we are only 12 months into that. And I think if you project out into next year, we are well on pace to do what we said we are going to do.

Sandy Harrison - Wunderlich

Got you. And then just my last one seeing the nice pop in gross margins of almost two percentage points from the 57.5% to 59.5%, and then commenting that it’s going to drop down again in June back to 57.5%, do you think you will have the revenues from March to June to be able to support sustained breakeven or even profitability?

Bob Gargus

Yes. And the mix isn’t hard to understand because if you look at the – we have always said the processor business has lower margins than connectivity. Connectivity was flat in December quarter and the processor business was up like 20% something sequentially. So, now this quarter connectivity will grow, processors will be flat. That’s going to drive the couple of points, but part of that growth in the connectivity will be end-of-life products, which won’t be reoccurring in June, but we expect to have other growth happening in the June quarter.

Sandy Harrison - Wunderlich

Got it. And had those end-of-life products been written down before?

Bob Gargus

There is no inventory write-off associated with them.

Sandy Harrison - Wunderlich

Got it. Okay, great. Thanks for answering the questions guys.

Operator

Your next question comes from the line of Hans Mosesmann with Raymond James. Please proceed.

Hans Mosesmann - Raymond James

Thank you very much. Hey, Paramesh, congrats you Bob as well, what is driving the better than expected performance, is there something specific that you have been able to see so far on the X-Gene?

Dr. Paramesh Gopi

Let me comment a little bit, the 40-nanometer is a bulk CMOS process. It’s a very vanilla process. When we envisioned this product three years ago and when we envisioned this two generations of product, if you look at the view of the process and its capabilities, it requires extraordinary circuit design and really some world-class CPU design to get a core to run a 64-bit core nevertheless with all of the features that we have in it to run at these speeds. So, I think it speaks to a very large engineering achievement and a huge leap forward for us from a technology perspective. So, just to be clear, we were the first ARM 64-bit licensing and we expect to be first to market. We created this category and I think the key here is that we accomplished the types of performance with vanilla CMOS. Three years ago, the process wasn’t even mature, right. So, we had to do a lot of things in terms of pioneering techniques to do this stuff in vanilla CMOS for both 40 and 28. So, I think engineering wise, there is no more question on execution.

Hans Mosesmann - Raymond James

Great. And the follow-on the better than expected performance and assuming that the test 28-nanometer is good and meets your expectations, could OEMs potentially come to market more quickly. I know you are not changing your timelines at this point, but given what we have learned today, could that be in the cards early next year?

Dr. Paramesh Gopi

I want to emphasize two things. One is the way we view this is that we have now actually created a material notion of a real category right. So, the answer to your question is if we didn’t have this level of performance we wouldn’t be able to drive the category forward. Number two, the ability for us to do two generations and show OEMs who depend on two, if you look at the server market today, you are struggling always between what I call a volume generation and a technology generation, right. So, no OEM makes a decision on the technology generation without solid proof on the volume generation. So, if you look at 40, we have now established and taken away any execution or technology issues relative to running processors at that speed with this level of performance in that process. So, what it does is fortifies the category on both the technology generation and the volume generation.

Hans Mosesmann - Raymond James

Very helpful. Congratulations.

Dr. Paramesh Gopi

Thanks.

Operator

Your next question comes from the line of Christopher Longiaru with Sidoti & Company. Please proceed.

Christopher Longiaru - Sidoti & Company

Hey, guys. I’ll add my congratulations.

Dr. Paramesh Gopi

Thanks.

Christopher Longiaru - Sidoti & Company

So, just in terms of the cost reductions first, are we seeing the majority of those in the March quarter or we are going to see a little bit spillover into June?

Bob Gargus

We’ll see a little bit spillover into June.

Christopher Longiaru - Sidoti & Company

And then just in terms of you guys had said that there is some end-of-life revenue, how much of that is in your guidance?

Bob Gargus

It’s in our guidance.

Christopher Longiaru - Sidoti & Company

I know, but how much end-of-life revenue were we talking about?

Bob Gargus

Don’t know if I want to get into that level of detail, what I will do is if you go back to the earlier statement about the book-to-bill being 1.3, and this is not for the end-of-life this quarter, but if you use that and then back into the 1.1, you would calculate that the end-of-life orders that came in that are scheduled for delivery in the second half of next year is above $11 million.

Christopher Longiaru - Sidoti & Company

Got it. That’s helpful.

Bob Gargus

Okay. And that’s not abnormal, every company have those and you usually give your customers a couple of years advance notice and then at some point in time, they have to place the orders non-cancellable and non-returnable and then they got a year to take delivery of them, okay. So, this is not abnormal, okay, but we didn’t want you guys to take the 1.3 book to bill and while it’s good news we didn’t want you to blow it up into an expectation from next quarter, so the book to bill with out that is 1.11.

Christopher Longiaru - Sidoti & Company

Great, that’s helpful. Alright, that’s all I have for now. Thanks guys.

Operator

Your next question comes from the line Patrick Wang with Evercore. Please proceed.

Patrick Wang - Evercore

Yes, thanks. Hey, I want to just kind of follow-up on that question. Bob you are not going to break that number out for us it sounds like it’s a portion of that $10 million to $11 million. But as we kind of look forward to the June quarter or maybe something beyond that, is it fair to assume that whatever end-of-life revenues that you are going to see in the March quarter is not going to be big enough, so that it negatively impacts kind of the sequential going forward?

Bob Gargus

Correct.

Patrick Wang - Evercore

Okay, great and presumably that’s just other new products, that these other programs that you guys have that are going to start ramping?

Bob Gargus

Yeah, if we have a cliff we would hint to it.

Patrick Wang - Evercore

Got you, okay, great. And then also Paramesh I want to ask you quickly one of the things that you said in the press release I found really interesting the networking performance of chips suggests that you maybe able to further penetrate enterprise class, could you elaborate on that for us please?

Dr. Paramesh Gopi

Sure, the new developed and industry leading ISA and you were the first one out of the chute to build a custom core. You make a lot of assumptions in terms of performance relative to the existing market, the only other cores in the market, which is the x86 architecture. What we have problem that over the last few weeks as we look at the measurements is that we can with this particular product and running at these frequencies really drives on into enterprise server market, enterprise private cloud server market. If you look at what is in the enterprise market versus the, I will call it, public cloud market which is more of the Linux based market, you have proprietary applications that take and use the cores to do things like mathematics and analytics. So, things like the ability to run at these speeds and run floating point units at these speeds gives us a phenomenal advantage relative to conventional ARM cores. So, what I meant by that is that now with this level of performance we have the ability now to really drive adoption of ARM into the larger enterprise base.

Patrick Wang - Evercore

Got you, that’s helpful. Two more quick ones, one is the when you take a look at some of the initial silicon you’ve got back on 40 nanometer. You said that your expectation is about 2.4 gigahertz clock rate. Is there any other color you can maybe kind of give us to help frame how excited or how good or anything there please?

Dr. Paramesh Gopi

I think 2.4 gigahertz at 40 and 36 hours is quite phenomenal on its own. I will just stop there because we are excited in a huge way but we were able to get these speeds on X-Gene again this is right out of a chute. So, I think I will stop there, but expect things to unfold here over the next six month.

Bob Gargus

So, Patrick we did mention in the script here, thought that there is no other 64-bit ARM core to compare it to right now. But the 32 bits inside the 40 nanometer, the fastest one we can find out there is around 1.6, the 1.8 x32 without enterprise server type features, okay. So, I mean going from there to 2.4 is huge.

Patrick Wang - Evercore

Got you. That’s definitely, that’s pretty much answers it for me and also I guess.

Dr. Paramesh Gopi

I hope one more thing just to take you back on Bob said. We didn’t rest on the current laurels in terms of the product. We are already pulled well into 28, so that should send a signal that we are taking this very seriously from the market leadership point of view and from a roadmap commitment point of view.

Patrick Wang - Evercore

Got you. And also just to clarify the 28-nanometer stuff you talk about earlier is it test chip tape out, so we are still expecting the final product tape out to have in latter this year right?

Dr. Paramesh Gopi

Yeah, we have not announced when it is, but yes. But this is the test chip tape out very similar to what happened last year with the first X-Gene test chips.

Patrick Wang - Evercore

Got you. Hey good job guys. Thanks.

Dr. Paramesh Gopi

Thanks.

Operator

Your next question comes from the line of Vijay Rakesh with Sterne Agee. Please proceed.

Vijay Rakesh - Sterne Agee

Hi guys. Nice job on getting to these milestones here. I am just wondering when do you start to get, not to beat a dead horse, but when do you start to get feedback from your customers on the first silicon that you got here like 36 hours back?

Bob Gargus

Well, we haven’t sampled yet. We hope to sample this quarter, and then obviously it will take customers couple of months or more of playing with before we’ll get feedback. So, that’s, I mean, part of this is the timeline that Paramesh talked about the fact that they will build up samples and play with it. And then it usually takes six months to a year get to production and 6 to 12 months from now is when we are saying we’ll have revenue.

Vijay Rakesh - Sterne Agee

Alright. And the 28-nanometer that you have said, the second revision of the 64-bit, do you said that, when do you expect the first silicon in that to come out or when do you expect that to finish tape out with the first silicon coming out?

Bob Gargus

We haven’t said exactly when, but we said we expected later this year.

Vijay Rakesh - Sterne Agee

So, is it exactly same chip but just shrunk right?

Bob Gargus

No, not.

Vijay Rakesh - Sterne Agee

Okay. And last question on the core business as you look at your PQX connectivity and the router products that you are ramping, how is the visibility on that as you look out?

Bob Gargus

Well, we are like most semis, we have visibility for the March quarter, which is why we said we have 76% or so in backlog entering the quarter, okay, but we don’t have much visibility into the June quarter.

Vijay Rakesh - Sterne Agee

Got it, great. Thanks a lot guys. Good job.

Operator

Your next question comes from the line of Krishna Shankar with ROTH Capital. Please proceed.

Krishna Shankar - ROTH Capital

Yes, congratulations on the milestones achieved. A couple of questions, can you talk about the size of the market that you will address now with both the 40-nanometer platform and the 28-nanometer platform? And what sort of market segments will you go after with these two platforms?

Dr. Paramesh Gopi

Well, let me take you back to some of the public statements we have made in the past relative to the size of the market. If you look at the cloud datacenter market, today it’s roughly about $2.5 billion to $3 billion for what I called the public cloud market. The rest of the sever market is all enterprise. And the biggest differentiation between the public cloud and the enterprise or private cloud is the open source software versus more captive software such as Windows and Oracle and Legacy, right. As you know with captive software and captive applications, the hurdle rate for CPUs to participate in that market directly stems into performance requirements, right. So, I think that at this point in time, we did not expect our performance to be at the class that we are seeing today. And that is the largest part of the server market, bar none. That is the significant portion, the enterprise part. So, it’s more about – I think the question should be how can we penetrate that and how fast can we penetrate that. I can confidently tell you that the performance levels we are seeing and the resulting implications of that, the barrier to enter that market and to participate, which is into the 70% of that whole server market is significantly lower for ARM right. So, it’s great news for the ARM architecture in general, because of the customizations we have developed. And I think we have just opened up a whole new gate into this new market.

Vijay Rakesh – Sterne Agee

And what kind – do you have any announced partnership with people like Microsoft or VMware, what kind of folks do you have for things like virtualization, ECC, security and other types of hardware acceleration blocks on the processor?

Dr. Paramesh Gopi

We have if you go back to our earlier public filings and if you look at our presentations of the ARM Technology Conference and other folks, I can tell you that Oracle and Java folks like Cloudera, folks like KVM, folks like Citrix, all of the complier folks like - the BIOS folks, Phoenix, AMI complier guys are all fully ready for us. In fact, they have been using X-Gene for the last nine months and Red Hat more importantly. We have not announced any of the other the vendors that you talked about.

Vijay Rakesh - Sterne Agee

Great, thank you very much and all the best.

Operator

Your next question comes from the line of Brian Thonn with Kingdom Ridge Capital. Please proceed.

Brian Thonn - Kingdom Ridge Capital

Hi guys. Thanks for taking me in. A quick question for you, obviously as you said you’ve only had the chip for 36 hours, this being X-Gene, but can you kind of help us understand is the performance you are seeing kind of inherent to 64-bit ARM or is it more do you think because of your proprietary core versus the other cores, that may follow you?

Dr. Paramesh Gopi

Yeah. So, let me set some context here. It’s a really good question. Most conventional 32-bit ARM cores that are bought from ARM today, if you look at what we believe the going frequency is it’s between 1.5 and 1.8 gigahertz and that’s at the really high end of the spectrum. This is 32-bit ARM cores today right, that you can get from ARM and that too that require some level of customization on the semiconductor process. Unless if you want to break, we call 2 gigahertz the real value, right, if you want to break that and get to the tune of 2.4 or more towards, half towards 3 gigahertz, you need custom implementations. That’s the key. That’s the absolute key. So, the revolutionary core that we have developed is the absolute key to render the performance that we need and that we see to really drive our leadership in this segment. So, absolutely, you can’t do that with an ARM core off-the-shelf. And I wanted to just before I finish, this frequency that we are talking about is with a complete set of enterprise management. So, all of the RAS and ECC what you would find today on a conventional server class x86 chip is what we are talking about in a vanilla bulk CMOS at these speeds, so security, management, all of the features that you would find in the current server processor running on the world’s first 64-bit architecture at these speeds.

Brian Thonn - Kingdom Ridge Capital

So, if you didn’t have those features, your chip would even run faster? Is that how I should think about it?

Dr. Paramesh Gopi

Absolutely. I mean, mobile chips don’t have any of those features today.

Brian Thonn - Kingdom Ridge Capital

So, what kind of overhead penalty is there for all those features, if I am just trying to kind of benchmark what you are doing and compare it to others?

Dr. Paramesh Gopi

I think the key, the way to think about it is this, if you buy a core and if you add features to that, you can’t even get up to the features, the 1.5 gigahertz range that we talked about. You would have to start from scratch and think through how those features, because they are such an integral part of the machine, how those features need to be implemented in advance, so that you can scale up the frequency. Did I answer the question?

Brian Thonn - Kingdom Ridge Capital

Yeah, that gets me where I want to go. Thanks a lot.

Dr. Paramesh Gopi

Thanks.

Operator

There are no further questions in the queue at this time. I would now like to turn the call over to Bob Gargus for closing remarks.

Bob Gargus - Senior Vice President and Chief Financial Officer

Thank you everyone. We’d like to thank all of you for your participation today. There will be an audio replay of this call available on the Investor Relations section of our website. You can also access the audio replay of this conference call by calling 888-286-8010 and entering the reservation number 98851945. We will also file a copy of this script in an 8-K with the SEC in the next few days. Please feel free to call me if you have any additional questions. Again, thank you for your participation on the call today and have a nice evening.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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