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EZchip Semiconductor Limited (NASDAQ:EZCH)

Q2 2013 Results - Earnings Call Transcript

August 7, 2013 2:00 PM ET

Executives

Ehud Helft - CCG Investor Relations

Eli Fruchter - President and Chief Executive Officer

Dror Israel - Chief Financial Officer

Analysts

Gary Mobley - The Benchmark Company

Joseph Wolf - Barclays Capital

Jeff Schreiner - Feltl & Company

Jay Srivatsa - Chardan Capital Markets

Dov Rozenberg – Clal Finance

Paul McWilliams - Next Inning Technology Research

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the EZchip’s second quarter 2013 results conference call. All participants are present in listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded, August 7, 2013.

I would like to remind everyone that forward-looking statements for the respected company’s business, financial condition and the results of its operation are subject to risks and uncertainties, which could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development and the effect of the company’s accounting policies as well as certain other risk factors, which are detailed from time-to-time in the company’s filings with the various securities authorities.

I would now like to hand the call over to Mr. Ehud Helft of CCG Investor Relations. Mr. Helft, you may go ahead.

Ehud Helft

Thank you, operator, and good day everybody. I am glad to welcome all of you to EZchip’s second quarter 2013 conference call and thank EZchip’s management for hosting this call. With us on the line today are Mr. Eli Fruchter, CEO, and Mr. Dror Israel, CFO.

Before we begin, I would like to point out that during this call certain non-GAAP financial measures will be discussed. These non-GAAP measures are used by management to make strategic decisions and forecast future results, and the company believes that these figures provide a better method of evaluating the company’s current performance. A full reconciliation of the company’s non-GAAP financial measures to GAAP financial measures is included in the earnings release released earlier today.

I would now like to hand over the call to EZchip’s CEO, Eli Fruchter. Eli?

Eli Fruchter

Thank you, Ehud. Good day everyone and welcome to our second quarter 2013 conference call. Revenue for the quarter totaled $16.7 million, up 9% sequentially and up 5% compared to second quarter last year. Gross margin on a non-GAAP basis for the quarter reached 85.6% with non-GAAP net income of $8.7 million for the quarter, representing a 52% non-GAAP net income margin.

We increased our cash balance by $7.6 million to $181.9 million with zero debt at the end of the quarter, further solidifying our already very strong financial position.

Looking at our quarterly revenues in further detail, second quarter revenues from Cisco reached a record $7.7 million or 46% of our revenues in the second quarter, up 55% sequentially and up 33% from the second quarter of last year. We continue to feel very comfortable with Cisco and expect our revenues from Cisco to grow significantly year-over-year in 2013.

Second quarter revenues from ZTE reached $1.7 million or 10% of revenues, down 21% sequentially and down 54% from the second quarter last year. The lumpiness in quarterly revenues from ZTE can continue as we believe revenues quantity should be monitored on an annual basis and we expect our revenues from ZTE to grow significant year-over-year in 2013. We continue to see a lot of activity at ZTE that is expanding the yields of our products.

Second quarter revenues from Juniper totaled $3.2 million or 19% of the quarter’s revenues, down 21% sequentially and up 41% from the second quarter last year. The recently increase in Juniper’s orders and forecasts will likely result in an increase in sales Juniper in 2013 or the 2012. We started to ship NP-2 to Juniper in 2005 and expect that we will continue to see some level of NP-2 revenues from Juniper beyond 2013 as well. These are strong indications to the long life cycle of design wins in strategic platforms.

All other customers as a group excluding Cisco, Juniper and ZTE totaled $4.1 million or 25% of the second quarter revenues, down 2% sequentially and down 1% from the second quarter of last year.

I am pleased to say that we are [shaped] to our third NP-4 production order and now all our NP-4 customers are in production with at least one NP-4 platform. We believe that substantially all NP-4 based platforms at all our customers will be in production at the end of the year.

Turning now to our next generation products. During the quarter we sampled NP-5 which is now being tested in our lab. We are pleased with this major milestone and continue to believe the substantially all NP-4 customers will select the NP-5 for their next generation platform. We now expect that to sell for approximately eight years. NP-5 was the NP-4 performance and total entity reduces the price for both for our customers and we expected to sell at approximately 50% higher ASP compared to the NP-4.

With respect to the growth in (inaudible), there is an improvement in carriers CapEx and the significant platform with the NP-4 and NP-5. We are spending with our customers. We sell their platform successfully grow their market share and continue to drive growth for us. The NPS, our new Network Processor for Smart networks, continues to receive very positive feedback from both carrier and data center equipment vendor.

During the quarter we started to provide customers with the [slow pull] that allow them to stimulate the silicon and right growth for them NPS. As communicated last quarter, we intend to sell the NPS directly to all customers, thereby shifting from the business model we applied for the NP-3, NP-4 and NP-5 where we used a royalty-based model for Cisco.

We feel that the company reached a point in which we are more comfortable being independent and believe that all our key customers will be comfortable buying the NPS directly from EZchip.

We believe the market with this transition in coming years to new architecture based on concepts and technologies, both about by network utilization, software define networks, SDN and network function virtualization, NFV. While some low performance network applications may use general purpose CPUs to run both the control plane and the data plane, this approach is not viable for high performance applications in large carrier and data center networks.

Our NPS will enable the networks to harm data plane functions of high performance, flexibility, flexibly placed in the network when needed in the variety of hardware platforms to enable efficient and scalable networks.

10 years ago, the market slowed start of a great conviction from ATM and solid network to carrier Ethernet. Our NP product was the right product to enable that condition with a tight performance, fuller mobility and integrated traffic management. We believe that also with NPS we're coming out with the right product mix condition to virtualization in carrier as well as in datacenter network.

When we launched NPS last year, we highlighted the importance of a new class of NPU that provide a clear operation between control payment data plane function that will be easily programmed for maximum flexibility and (inaudible). This unique properties enable live branch of network services at extremely high performance that can be involved with simple software updates and make NPS an excellent which facilitate the next transition in the networking market.

These days we're exposing NPS to customers with (inaudible) distinct market segment. First, a result of additional customers, the carrier Ethernet routers that are looking at NPS as a follow on for the NP product line and NPS provides them with a very compelling global mix for many years to come.

Second, the datacenter network appliance and (inaudible), most of which are new potential customers for us and represents a growth opportunity. And finally, with the large carrier and datacenter operators that are innovating self solutions for internal views and are looking ahead to NPS as an nine layer cellular (inaudible) new network innovation.

NPS is going significant into from all of these type of transformers. There is still much work to be done to complete it into design wins, but we are very encouraged from the level of interest on the brave of customer, we are seeing for the NPS so far.

In 2013, is shaping out to be a grow field for EZchip with NP-4 in production with all customers and we substantially all NP-4 based platforms expected to be rolled out by year-end.

The growth rate now depends on our customers’ success with their NP-4 based platforms and on carrier spending. With regards to guidance for the upcoming quarter, we expect revenues to be at the $18.5 million range with a product and customer mix that will result in approximately 83% non-GAAP gross margin.

I would now like to turn over the call to our CFO, Dror Israel for a more detailed financial review, Dror?

Dror Israel

Thank you, Eli. In order to better understand our business, we are providing both GAAP and non- GAAP results. While we discuss the non-GAAP results on this call, the GAAP results and the reconciliation between the figures are included in our earnings release. The non-GAAP financial measures exclude the effects of stock-based compensation and amortization of intangible assets. Now to the results. Revenue for the second quarter of 2013 totaled $16.7 million up 5% from the $16.8 million in the second quarter of 2012 and up 9% from the $15.3 million in the prior quarter. Cisco was well accounted for $7.7 million or 46% of revenue; ZTE accounted for $1.7 million or 10% of revenue. Juniper accounted for $3.2 million or 19% of revenue and the other customers are revoke accounted for $4.1 million or 25% of revenue for the quarter.

The non-GAAP gross margin for the quarter is total 85.6% up from the 82.2% in the second quarter of 2012 and up 81.3% last quarter. The increased in gross margin this quarter resulted mainly from a higher portion of revenues from Cisco, coming through Marvell as royalties. Non-GAAP R&D expenses net for the quarter totaled $4.2 million. This amount included $1.1 million in R&D grants received from the Israeli Office of the Chief Scientist. On a gross basis, our R&D expenses for the quarter totaled $5.3 million.

Non-GAAP operating expenses for the quarter totaled $6.1 million compared to $5.2 million in the second quarter last year and compared to $6.2 million in the prior quarter. We expect that our annual OpEx level in 2013 will be in the range of $26 million. Non-GAAP operating income for the quarter was $8.2 million, up 5% from the $7.8 million operating income in the second quarter last year and up 31% from the $6.2 million in the prior quarter

Non-GAAP net income for the quarter totaled $8.7 million up 3% from the $8.4 million net income last year and up 29% from the $6.7 million net income in the previous quarter. Fully diluted EPS on non-GAAP basis was $0.29, similar to the second quarter last year and up from $0.23 in the previous quarter.

Moving over to the balance sheet, cash, cash equivalents and marketable securities totaled $181.9 million as of June 30, 2013, compared to $174.3 million at the end of the previous quarter. Cash generated from operations during the quarter was $7.5 million, cash used in investing activities was $0.3 million, cash provided by financing activities was $0.8 resulting from the exercise of stock options and an additional $0.4 million decrease resulted from marketable securities cash adjustment.

With that I would like to open the call for the Q&A session. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen at this time, we will begin the question and answer session. (Operator Instructions) Our first question is from Gary Mobley of Benchmark. Please go ahead.

Gary Mobley - The Benchmark Company

Hi guys. Looking at your the gross margin relating to revenue other than Cisco it looks like it came in about 200 basis points to 300 basis points above the historical trend. Could you explain what cause for that? Was that a function of heavy amount of revenue to Juniper and then as well implied in your third quarter gross margin outlook, should we assume that revenue to Cisco takes flat sequentially or even decreases?

Eli Fruchter

This is also, gross margin other than Cisco which is 100% because its royalties. I would say it generally can move between 68% to 72%. This is the kind of the range that we should expect and then it's a matter of a customer mix, product mix. So I can’t really point out to any special situation, Hill, and same for the next quarter. So we guided for over 83% and we assume Cisco is going to be a bit maybe lower than say percentage wise compared to this quarter and in general of course, we expect it to grow and over the year from Cisco and from the other customers.

Gary Mobley - The Benchmark Company

A follow-up question relating to Huawei. You mentioned that they are now taking shipment of NP-4 product. Could you give us an update on that relationship and has there any change to your long-term outlook as it relates to Huawei as a customer and that’s my final question and congrats on a good quarter. Thanks.

Eli Fruchter

I will answer that, Gary. We don’t see a change to Huawei from what we said in the previous quarter. They used NP-4. As we said that now using it in the higher-end product while the (inaudible) are lower in the field second we believe that will continue.

Operator

Okay. The next question is from Joseph Wolf of Barclays Capital. Please go ahead.

Joseph Wolf - Barclays Capital

Thanks. I have two questions, the first is if we look at the Cisco revenues and for the expenses you can, is there any way to toss how many platforms you think are producing significant revenues right now and can you tell us what we are seeing right now as filling out box of that were still last year with more line cards or we still seeing new installations or is that kind of is that too granular for you guys a bit feeling right now? That’s my first question.

Eli Fruchter

Hi Joseph, so we really don’t want to focus out the basic platforms that at Cisco and but there is one platform that generate most of the revenues and in general I would say not just for fiscal we are now seeing a lot of cards that the Juniper is probably shifting for fill up exact fees that they felt many years ago. And this is the typical I would say thing that you would see with the new platforms that initially have a lot of boxes are being shift and then (inaudible) in those boxes could be smaller and then once those boxes will filled with line cards then our portion of the revenue gets bigger and I think that is the trend that we will see with all customers including Cisco.

Joseph Wolf - Barclays Capital

Thank you, and then my second question is you just are sampling or you are sending over software stimulation for the NPS to customers and you mentioned a ray of customers you expect to look at that. Can you combine those two comments, are you sending a software to a wide group of customers, are you sending it to more select group within the potential customer base, could you give us any more flavor on first step of that is really wide spread launch to see where the interest and kind of develop facility?

Eli Fruchter

So we are seeing a wide range of customer in the different segments that I described before but we are not shipping our software to too many and we like to collect information and inputs and we are trying to shift the software only to few selected customers in each of the different segments, and as we move on we will obviously shift it to more customers.

Joseph Wolf - Barclays Capital

And are these new customers in the layer spot 4 to 7 or new projects with existing core customers?

Eli Fruchter

It’s both, we are seeing customer that are between looking NPS in the upper layers and the customers that will only use it in the lower layers, remember that NPS is also targeting our current customers for the new generation of [healthcare] and some of them are looking just for basic line cards out would let 2, 3 only and others are looking to give smart line cards, where they would be using go up in layers. For all the appliances in the data center than obviously the upper layer is a basic request that come from those customers, so it’s a mix.

Operator

Your next question is from Jeff Schreiner of Feltl & Company. Please go ahead.

Jeff Schreiner - Feltl & Company

Yeah, thank you gentlemen. I was wondering Eli, could you perhaps maybe rank the opportunities or the platform opportunities within the other customer group in terms of what you think maybe the largest, the smallest in terms of overall EZchip opportunity (inaudible) and Huawei?

Eli Fruchter

It's really harmful, I have been, I think those are different situations while Huawei is using us in transaction on an interim basis, we believe that the others are using us exclusively. And believe that the success with those customers will depend on the success of their platforms in the market. So we do observe, we get a design win, we ask them to build the product and then we move on now it seems to they are tend to be successful and generate revenue for us. This is how it was. And we are already busy designing with the NP-5 and so long. So that's how we put it.

Jeff Schreiner - Feltl & Company

Okay. Well just rolling on to that, I guess you continue to use the word substantially all NP-4 customers move to NP-5 in the last few press releases if you are talking about the product. Has there has been a customer who has already indicated that they are going to move away from NP-5 or why is the word substantially not all I guess? How should investors interpret that?

Eli Fruchter

I think that we will be able to say all in once, all of them actually have done enough work in the development and cannot turn back I would say. We feel that right now since NP-5 is above just sampled and about a year from production, I think that we're just trying to be conservative and we will be able to say all when we feel 100% sure that it is all.

Jeff Schreiner - Feltl & Company

And then last question for me. Juniper has obviously been a source of strength this year that probably was middle of a surprise. How far can the Juniper contribution remain? How long can it remain at current levels in your mind and when should we start to think about this maybe starting to fall off from seeing year-over-year decline versus year-over-year contribution? Thank you.

Eli Fruchter

I thought it would fall off two years ago. So it's a good surprise and I think that now that carriers start to spend more, they are feeling their empty [chassis] and I really don’t know how many chassis are out there and as a longer not full, we will continue to ship bulk to Juniper I think, but I really don’t know for how long.

Right now, the level is pretty high and the revenues from Juniper this year could be very, very significantly higher than last year and the range could be in the range of 40% to 50%. So this is supplies. I don’t think that it can like stop immediately, it would probably take long time, that’s my feeling

Jeff Schreiner - Feltl & Company

Thank you.

Operator

The next question is from Jay Srivatsa of Chardan Capital Markets.

Jay Srivatsa - Chardan Capital Markets

Yeah. Thanks for taking my question and congratulations on good quarter and guidance. Eli at a higher level, it is clear that CapEx spending appears to be improving in the U.S., what's your view on Europe and China which have tended to be weak in the past, are you sensing that there is some improvement in the spending over there as well?

Eli Fruchter

We are cautiously optimistic so we hear some good inputs from our Chinese customers, but we are not seeing it in the numbers yet, so we do expect ZTE to go significantly this year over last year, and Huawei of course, Huawei was deal last year. So any goals will be significant, so we will do a lot more in China this year, but I cannot tell you for sure that we are, that there is a big change in the carrier spending, we need more time for to see that.

Jay Srivatsa - Chardan Capital Markets

And then in Europe?

Eli Fruchter

I think that Europe is a slower based on what we are hearing from our European customers and also from the results that we see from them right now. We obviously expect to another base onto impact that.

Jay Srivatsa - Chardan Capital Markets

Okay, and in terms of the NPS you mentioned targeting couple of different customer base is a carry Ethernet customers and data center customers. What do you need to do to affectively address those markets, do you expect having to that separate or different types of ASICs for each of those markets or is it software that is changing, can you give us some inside there?

Eli Fruchter

So we don’t expect that will be different to achieve, we have build the NPS for client target all the different in markets and the really the difference would be in the software. So each market will develop entirely different software for the NPS.

Operator

Your next question is from Dov Rozenberg of Clal Finance. Please go ahead.

Dov Rozenberg – Clal Finance

First of all just to be clear, I heard you mentioned before the Juniper could be 40% and 50% of revenue this year is that correct?

Eli Fruchter

No, I said that Juniper could be 40% or 50% higher this year and last year.

Dov Rozenberg – Clal Finance

Can you give us any color to what percentage of revenue this year would be NP-4?

Eli Fruchter

Those in general I mean we don’t breakout revenue by quarter lines. In generally it’s clear that NP-4 is taking the lead, right now its above 50% of revenue still less than that in terms of volumes, because the ASPs are much higher. So this is the general plan and I think it will go a more towards NP-4 as we move on quarter to quarter. So essentially, we feel I think NP-4 will the highest contributor to revenues and of course next year it will be greater than that. So, NP-4 is by far the number one revenue goal in the coming years.

Dov Rozenberg – Clal Finance

Now just on customers, first of all do you expect to could it be higher than 40% this year or 40% exactly or under. And second of all as far as EPE, do you see them stabilizing going into next year once they start shipping the NP-4 little bit more heavily.

Eli Fruchter

So, Cisco is going to be above the 40% and how much exactly we don't really know. I think the right model to use is 40% if you look at the six months, then you feel this is the number actually. Q1 was below that, Q2 was above that number. I think for modeling purpose we should use the 40% in some cases it can be above. ZTE is more let's say 10% customer, it looks like it's going to remain like that in the coming years and of course that would result in growth. So revenue are growing and if ZTE remain 10% customer, it means that they will grow proportionally.

Dov Rozenberg – Clal Finance

Okay, great. Last question, even though I think I know the answer, but just putting out there. Cash is obviously growing very nicely, are there any attention and intentions any new prospects?

Eli Fruchter

That's the usual answer for high cash levels are very important for customers to be a stable company, and we're designing to be a more strategic platform and the platforms that are running for many, many years. So this is one important issue. The other of course is to be flexible to go up strategic opportunities that may go up and we want to be able to use (inaudible) and for strategic move. We believe that at this point of the company and we expect very high growth in the coming years. This is the right use of cash. And not to mention the fact that spreading out the cash in terms of dividend or buybacks may harm our privilege to emphasize and tax benefit (inaudible).

Dov Rozenberg – Clal Finance

Do you see targets out there for acquisitions or expansion whatever?

Eli Fruchter

What was the question?

Dov Rozenberg – Clal Finance

If you see targets, in other words, you are saying to use these opportunities as one of the purposes, I am asking is there sort of target banker or anything of this sort?

Eli Fruchter

We're monitoring opportunities all the time. This is something that we do on an ongoing basis.

Operator

The next question is from Paul McWilliams of Next Inning Technology Research. Please go ahead.

Paul McWilliams - Next Inning Technology Research

I may have missed it earlier but did you give a revenue number for the combination of Huawei, Telabs and Ericsson?

Dror Israel

No. Huawei, Ericsson and Telabs are not a significant peers and until they will be getting closer to a 10%, their potential each, we will regard them and start with the other group.

Paul McWilliams - Next Inning Technology Research

I thought that in past calls you’d given a combine number for the three.

Dror Israel

Yes. We did I mean we last year, we monitor them, if you remember in Q4 2011, also we booked a substantial amount of NP-4 samples and the expectation will if they will move to production in 2012 and become significant customers obviously did not happened. So the potential still exist we believe that they went to some difficult time, the last year, and so we definitely expect them to go, it may be volatile, it may take time, but eventually we believe they will go together with many other customers, but until they are significant, we decided to start enforcing them as part of the (inaudible) and we started doing that last quarter.

Paul McWilliams - Next Inning Technology Research

Okay. Do you have any value with classify as design wins for the NPS?

Eli Fruchter

We don’t get of design wins for the NPS. We do have customers they said that using our software tool and are developing some software, but we don’t regard it as design wins yet. And but I believe that we will have excellent design wins for the NPS and (inaudible)

Paul McWilliams - Next Inning Technology Research

Okay. And if that (inaudible)

Eli Fruchter

Right now we are looking at mid next year.

Paul McWilliams - Next Inning Technology Research

Okay. Last question here regard to [NFB] and [STN], it was seemed to me that the NPS in particular and your NP products can help customers in able deployment of those technologies is that right way to look at it?

Eli Fruchter

Yes, absolutely the NP and (inaudible) are concepts that look at visualizing the network and we believe that product fast is NPS, can help increase performance very significantly. And we are speaking to quite a few such companies and get extremely good feedback.

Paul McWilliams - Next Inning Technology Research

Excellent, little follow-on to that. Would you see as the primary competitors of the NPS at the performance levels you are targeting?

Eli Fruchter

I think that we are not really seeing significant competition, I think that since we are focusing on data plan I think that we are actually the only one that are doing it and hazards of doing both or doing control and data plan and when you do the both you cannot really be optimized either. So I think that the concept of using NPU which is fee based, run that can use software tools that are based on standard development environment. This is something that is unique to us.

Operator

We have a follow-up question from Jeff Schreiner. Please go ahead.

Jeff Schreiner - Feltl & Company

Eli, I was hoping that you could maybe comment on a more macro level in terms of the fact that some of your customers have commented to the point that we are in the midst of the louder CapEx cycle that possibly and just the beginning through the best cycle.

How long do these types of cycles last and what's EZchip's experience historically in terms of selling into these cycles and what impact it may have on your ability to generate higher levels of revenue?

Eli Fruchter

As you pointed out, we do hear our customers saying that this is the beginning of a cycle. Obviously, the last two years were pretty disappointing in spending levels, it seems that it's increasing now and hopefully it will continue to increase in the next couple of years. We were starting to see it and which I mean if it really at times, I think that we will obviously see the result of that in a significant growth in revenue.

Jeff Schreiner - Feltl & Company

And what’s your experience Eli in terms of maybe how long these lasts, I mean, two quarters, four quarters, two years, given your experience when these cycles come about and I'm not sure when maybe the last one might have been. What's the typical duration of these cycles?

Eli Fruchter

I don't, I cannot tell you that I can’t give precise number for that. I think that the cycle moves with the bottleneck. You invest in one portion of the network then the other one compensates that and you will start investing there. I think that lot of investments well in the wireless side needs subscribers and this created some bottlenecks in the call. So now more investments of them in the router. I cannot tell you how long it will continue.

Jeff Schreiner - Feltl & Company

Okay, and then just following up on that, when you talked about the Huawei situation in the fourth quarter 2012 earnings conference call, you also referenced maybe that you thought your end market estimates for growth in general, where perhaps maybe over heated and to my recollections, brought those down in terms of your long-term growth rate and what we've implied there from end market growth. Has this increased in carrier CapEx, the forecasted growth in revenue you referenced? You know, caused any revisions to your long-term growth expectations?

Eli Fruchter

The long-term growth expectations are based on a few numbers and the main numbers that changed this is our market share assuming that Huawei will be smaller than we previously anticipated and also some reduction in the [Merck] and edge routing globe based on the numbers that we get from Infonetics Research. So we monitor those numbers on an ongoing basis and if we have new numbers that show differently from what we are showing today, then obviously we will update our focus. Based on what we are learning from customers, I think that we should see better numbers for edge router; we would like to wait for the report and make change based on that.

Operator

(Operator Instructions) There are no further questions at this time. Before I turn the call over to Mr. Fruchter for the concluding statements, I would like to remind participants that a replay of this call will available on the company website at www.ezchip.com. Mr. Fruchter, would you like to make your concluding statement?

Eli Fruchter

Yeah. I would like to thank everyone who have joined the call today and looking forward to talk to you all in the next call. Thank you.

Operator

Thank you. This concludes the EZchip second quarter 2013 results conference call. Thank you for your participation. You may go ahead and disconnect.

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