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Ikanos Communications (NASDAQ:IKAN)

Q3 2013 Earnings Call

October 29, 2013 4:30 pm ET

Executives

Keith Kummerfeld

Omid Tahernia - Chief Executive Officer, President and Director

Dennis A. Bencala - Chief Financial Officer, Principal Accounting Officer, Vice President of Finance and Secretary

Analysts

N. Quinn Bolton - Needham & Company, LLC, Research Division

Operator

Welcome to the Ikanos Communications Fiscal Third Quarter 2013 Results Conference Call. I would like to remind, everyone, that today's call is being recorded. [Operator Instructions] At this time, I'll turn the call over to Keith Kummerfeld, Corporate Controller of Ikanos. You may begin, sir.

Keith Kummerfeld

Thank you for joining us today. Our CFO and Vice President of Finance, Dennis Bencala; and our President and CEO, Omid Tahernia, are on the call today. The information discussed on this call speaks only as of today, October 29, 2013. Statements made during this call that are not historical facts, including statements accompanied by the words such as will, believe, anticipate, expect, estimate or similar words are foreward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's estimates and assumptions as of the date of this call and are not guarantees of future performance. Actual results may differ from those expressed or implied by these statements as the result of uncertainties and other factors, including the factors described in the company's registration statement on Form S-1 filed on August 23, 2013. The company cautions you not to place undue reliance on these forward-looking statements.

In addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, Ikanos reports non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in the press release available on our website at ikanos.com. Now I will turn the call over to Ikanos President and CEO, Omid Tahernia.

Omid Tahernia

Thank you, Keith, and thank you, all, for joining us today. Let me start with a quick overview of Q3, which I consider to be a solid quarter for us. I'm pleased with our results, achieving revenues near the midrange of our guidance while exceeding our targets, both on margins and operating expenses. We added 2 more design wins to our pipeline and closed in on multiple new opportunities, which we expect to convert to design wins in the next few months.

Before I discuss the detailed results, I'd like to discuss our progress and a few important areas. To start with, we're excited about our activities and progress with our Velocity product family. Velocity-3 is being recognized within the industry through our successful lab trials with various OEMs and carriers, as well as our participation in key industry events. In fact, as you are probably aware, Velocity-3 was recently declared the winner of the Best Broadband Enabler award at this year's Broadband World Forum. This distinction was awarded by a panel of judges, consisting of distinguished industry experts from Deutsche Telekom, British Telecom, Korea Telecom and Telstra, among others. This is a great recognition of the innovation realized in this product family and its unique contributions to advancing the industry.

Our lead customer for Velocity-3 continues to make progress with their development and their upcoming lab trials. In addition, we're making very good progress in our engagements with other major OEMs and expect to close on additional Velocity-3 design wins in the next few months.

Another key event this past quarter related to our VDSL access business was the introduction of our single-port FTTdp Velocity-Uni. When combined with our Fusiv Vx185 CPE chipset, Velocity-Uni, enables an aggregate data rates of up to 300 megabits per second on a single copper pair at a distance of 200 meters. Our introduction of Velocity-Uni is in response to the market demand for cost-optimized and low-power VDSL solution for the hybrid fiber copper network to cover the last few hundred meters to individual residences. Velocity-Uni represents another important milestone for us, further highlighting Ikanos' commitment to maintaining a rate-reach technology leadership.

We're now well-positioned within the rate-reach continuum with our Velocity product family addressing the full range of distance from CO to FTTx to FTTdp and port count configurations from 1 to 384. Alpha customers will be receiving samples this quarter, with production units available in the first quarter of 2014. While the introduction of the Velocity-Uni is a great enabler for the carriers in the near term, the industry is also preparing for the next big performance leap in DSL, which is G.fast and the promise of gigabit performance.

Ikanos has made significant contributions to the standardization efforts. We're excited to see this standard body reaching the home stretch. With ratification of G.fast standard on the horizon, once again, we demonstrated our technology leadership by introducing our next generation, newest architecture for G.fast at this year's Broadband World Forum.

Alpha engagements on this new architecture have already begun.

And finally, I'd like to provide you a quick update on our progress with inSIGHT. We've had very positive carrier feedback in response to our launch earlier this year. And our engagements have resulted in several lab trials at Tier 1 carriers in North America, Europe and Asia. We expect to complete these trials over the next 2 quarters and are targeting to close on key design wins by early next year. We were quite excited to see inSIGHT feature -- inSIGHT features already appearing in top-tier carrier RFPs as a requirement for OEM product proposals.

Now let me turn to our third quarter results. As we reported in today's press release, highlights of Ikanos' third quarter results are as follows: Revenue for the third quarter of 2013 was $16.9 million, which was within our Q3 guidance of $16 million to $18 million. GAAP gross profit was 51%, which exceeded our guidance of $47 million to $49 million. GAAP operating expenses were $17 million, which was below our OpEx guidance of $17.5 million to $18.5 million. GAAP EPS was a net loss of $0.12 per share on 71.7 million weighted average shares outstanding. Quarter ending cash, cash equivalents and short-term investments were $25.6 million, which included a $10.8 million drawn under our revolving line of credit.

Revenue for the third quarter of 2013 of $16.9 million compared to revenue of $31.4 million for the third quarter of 2012 and revenue of $19.1 million for the second quarter of 2013. On a percentage basis, our shipment revenue for Q3 is as follows: Europe represented 56% of the revenue; Americas represented 9% of revenue; Japan and Korea combined, represented 30% of revenue; rest of the world represented 5% of revenue. The Vx18X, Vx17X Fusiv communications processor family maintained a sizable portion of our business at 46% of total revenue in Q3.

As a percentage of shipment revenue, Europe continues to be a growth area for our products with 56% of our business. Utilizing our historical product family categories, broadband DSL represented 48% of total revenue in Q3 2013 as compared to 50% in Q2 2013. Communications processors represented 46% of our total revenue in Q3 2013 as compared to 41% in Q2 2013, with the remaining percentages comprising the other products' categories. When grouping the product family's base as either the central office, broadband access or CPE gateway processor business, our central office broadband access business represented 22% of total revenue in Q3 2013 as compared to 27% of total revenue in Q2 2013. Our CPE gateway processor business represented 78% of total revenue in Q3 2013 as compared to 73% total revenue in Q2 of 2013.

While the overall revenue picture trended lower as anticipated, we're pleased with our Q3 financial performance relative to the guidance. As stated before, our business is in transition, both geographically and in product mix. As we navigate through some of the uncertainties typical of such transition periods, we remain committed to our key principles, including continued investment in the business, accelerating our roadmap and diversification of geography, products and customer base. It is encouraging to see several of our customers turning the corner under inventory and contributing to reversing the revenue trends we have seen in the past few quarters. In the meantime, we successfully managed our own inventory of finished goods to $1.6 million at the end of Q3.

We're encouraged by the continued expansion of our design win pipeline, which is a direct result of our decision earlier this year to strengthen our sales and marketing organizations. Both our DSL central office and CPE business are showing positive design win momentum as the industry transitions to VDSL and vectoring accelerates. We secured 2 additional Gateway design wins in Q3. Revenue ramp is expected in late 2014 to early 2015.

Now I will turn the call over to Ikanos' CFO and Vice President of Finance, Dennis Bencala, who will cover the third quarter financial results in more detail.

Dennis A. Bencala

Thank you, Omid. Now turning to the details of our financial result. Our GAAP gross profit for the third quarter 2013 was approximately 51% compared to GAAP gross profit of 47% for the third quarter of 2012 and GAAP gross profit of 49% for the second quarter of 2013. We continue to effectively manage operating expenses as GAAP operating expenses decreased sequentially for the fourth consecutive quarter to $17 million in the third quarter of 2013, compared to $21.1 million in the third quarter of 2012 and $17.5 million in the second quarter of 2013.

Our GAAP net loss for the third quarter of 2013 was $8.7 million or a loss of $0.12 per share. This compares to a net loss of $6.4 million or a loss of $0.09 per share for the third quarter of 2012, and a net loss of $8.7 million or a loss of $0.12 per share for the second quarter of 2013.

Moving on to our non-GAAP results.

Non-GAAP gross profit for the third quarter of 2013 was 52%, compared to 48% non-GAAP gross profit for the third quarter of 2012 and non-GAAP gross profit of 49% for the second quarter of 2013.

Non-GAAP operating expenses for the third quarter of 2013 were $16 million, compared to $20.2 million for the third quarter of 2012 and $16.5 million for the second quarter of 2013. Operating expenses in the third quarter were managed below our third quarter guidance of $16.5 million to $17.5 million. Our non-GAAP net loss for the third quarter of 2017 (sic) [2013] was $7.5 million or a loss of $0.11 per share, compared to a non-GAAP net loss of $5.1 million or a loss of $0.07 per share for the third quarter of 2012 and a net loss of $7.5 million or $0.11 per share for the second quarter of 2013.

Now turning to our balance sheet. As a result of the close management of our inventory levels, operating expenses and capital expenditures, we ended the third quarter of 2013 with total cash, cash equivalents and short-term investments of $25.6 million. This compares to $27.3 million at the end of the second quarter of 2013 and $31.2 million at the end of the fourth quarter of 2012. Our third quarter 2013 cash, cash equivalents and short-term investments included cash of $10.8 million from our accounts receivable, secured line of credit.

Inventory was $1.6 million at the end of the third quarter of 2013, compared to $4 million at the end of the second quarter of 2013, and $8.1 million at the end of the fourth quarter of 2012. To close the balance sheet, accounts receivables at the end of the third quarter of 2013 was $13.8 million as compared to $12.1 million at the end of the second quarter of 2013 and $15.7 million at the end of the fourth quarter of 2012.

Finally, current liabilities at the end of the third quarter of 2013 were $25.8 million, compared to $21.1 million at the end of the second quarter of 2013 and $24.4 million at the end of the fourth quarter of 2012. The $25.8 million current liabilities at the end of the third quarter of 2013 included an additional $3.3 million takedown during the quarter under our line of credit, which brought our total advances under the line of credit to $10.8 million.

Additionally, on August 23, we filed a registration statement on Form S-1, under which we may offer and sell up to $30 million worth of our common stock.

Now moving on to guidance. As we look ahead, we anticipate to see the effects of new customer ramps in Q4, particularly for our Fusiv line of CPE processors. However, the positive impact of this new business will be somewhat offset by the softening of our legacy business in certain maturing markets, particularly in Japan.

As a result, the overall revenue ramp will be moderate. We anticipate revenues to be in the range of $17 million to $19 million for the fourth quarter of 2013. For the fourth quarter of 2013, we expect GAAP gross profits to be between 49% and 51%. Non-GAAP gross profits are expected to improve, to be between 50% and 52% for the fourth quarter of 2013.

GAAP operating expenses for the fourth quarter of 2013 are expected to be in the range of $17 million to $18 million. We expect non-GAAP operating expenses to be in the range of $16 million to $17 million for the fourth quarter of 2013. GAAP net loss for the fourth quarter of 2013 is expected to be in the range of approximately $7.5 million to $9.9 million, or a GAAP loss per share of $0.10 to a loss of $0.14. Non-GAAP net loss for the fourth quarter of 2013 is expected to be in the range of approximately $6.5 million to $8.6 million or a non-GAAP loss per share of $0.09 to a loss of $0.12.

Now, I will turn the call back to Ikanos' President and CEO, Omid Tahernia.

Omid Tahernia

Thank you, Dennis. The VDSL2 and vectoring carrier adoption and deployments are accelerating at a global level, with Europe and North America leading the way. We are seeing very positive signs in the market, with the carriers detailing their vectoring plans and already inquiring about next-generation G.fast products. To a large degree, this is helped by the competitive landscape and the gigabit bandwidth wars. The availability of FTTdp products with short loop placements and the transition to G.fast is making DSL, for the last mile, a very viable and attractive alternative to costly FTTH deployments, making hybrid fiber copper networks and FTTx solutions the fastest-growing segment of the broadband access market, as highlighted in a recent report from Point Topic, outpacing FTTH by more than 2x. These are all very positive signs for Ikanos in our markets. Our product focus is well-aligned with these macro trends. Our strategy for fully addressing the rate-reach continuum through our existing Velocity CO, central office processor family, and Fusiv gateway solutions, as well as the next-generation G.fast architecture, positions us well as the telcos prepare for the gigabit over copper era.

While we navigate through short-term challenges as we diversify our products and customer base, we will continue to invest in our future as demonstrated by the recent introduction of our next-generation Neos architecture. Ikanos was the first to introduce VDSL products and the first to create the notion of NodeScale Vectoring and bonding. With the G.fast Neos architecture, Ikanos continues this tradition of innovation in technology leadership.

Now let me open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first today to Quinn Bolton with Needham & Company.

N. Quinn Bolton - Needham & Company, LLC, Research Division

I wanted to just start with some of the new products. Obviously a big quarter, you just got out of Broadband World Forum and a big show for the industry. Omid, can you talk about just any broad themes you saw? Does it feel like RFPs or queues for vectoring are accelerating or industry momentum around vectoring is accelerating?

Omid Tahernia

Yes, definitely Quinn. I think that's one of the messages I wanted to get out in the early part of the call, is that there's a significant acceleration in service provider plans for deploying vectoring and certainly the latest being the Australia region coming into play. So one of the things that, obviously, we saw at Broadband World Forum is the momentum around that, as well as interoperability is a big -- was a big topic, which Ikanos participated obviously as an end-to-end. And really, the longevity of our market segment around bandwidth delivery, quality of experience and quality of service, all the way to Fiber to the Distribution Point and then the next step, G.fast, is quite clear and quite pervasive as seen at the show.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Great. And you mentioned that your first OEM customer for Velocity-3 continues to make progress towards field trials. Is that still on track to happen by the end of 2013?

Omid Tahernia

Correct.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Got you, okay. And it sounds like beyond the first customer, you continue to make progress with additional OEMs for Velocity-3 that you'll hopefully be able to announce over the next few months.

Omid Tahernia

Yes, absolutely. I think one of the things that we've consistently sort of been talking, certainly to all of you guys, is to -- the steps as we've gone through since the last Broadband World Forum, which we actually unveiled the availability of the chips to the carrier trials to lot of momentum that now we have in a variety of opportunities that we're pursuing. So we feel very good about that momentum. We feel very good about that opportunity pipeline as it's maturing through the process as we go through. And we're very specific about sockets that we ultimately proclaim as a win. So I think a number of those are expected in the next few months.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Great, okay. I just wanted to ask quickly on the Velocity-Uni. It sounds like, if I heard your comments on the script that, that's sampling in the first quarter of 2014. Is -- did I catch that right?

Omid Tahernia

Sampling now, production in Q1.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Okay. Production -- okay. And that's production for lab and field trials or is it -- can you bypass some of that and go fairly quickly to actual deployments in carrier networks?

Omid Tahernia

Well, let me answer it in couple of ways. So my reference to the production was really our products. However -- obviously, this deployment is not to make it too simple. It's a bit simpler than a 384-port FTTx deployment. So having said that, we will be ready with our silicon and software products and we consider that production ready in Q1. We anticipate end customers to begin sort of first trials toward the second half of next year.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Great. And then just -- lastly I wanted to ask on the gateway business. You added 2 design wins, so I think you're up now to 19 wins. On the last call you said about half of those wins, I think, were expected to ship over the next 1 to 2 quarters. Is -- that feels like that's on track, given Dennis' comments about the CPE business being stronger in the December quarter, but just wanted to check that.

Omid Tahernia

Yes, we've had a few more that have begun the process of ramping, early ramp. So I think we're starting to see more of those design wins finding their way to the end market. So, yes, that seems to be going along pretty well.

N. Quinn Bolton - Needham & Company, LLC, Research Division

Okay. And then the last question for me. Just -- you had mentioned some sort of slowdown in legacy business, I think, in particular in Japan. If I did my numbers right, it looks like Japan and Korea was just a little more than $5 million of revenue in the September quarter. How much of that roughly $5 million is what you would call more legacy, say, Velocity-1 type solutions that could continue to trend down? Is that the majority of that Japan, Korea business or is legacy only a small portion of the overall geographical revenue in that region?

Omid Tahernia

Well, I think a couple of things. One is, Velocity-1 is actually not that old, so I'm not sure I would categorize that in the -- necessarily in the legacy product, because we actually have older platforms that we're shipping in those markets, pre-Velocity-1. I think what -- really the dynamic in Japan is more of a maturity that, that market has reached, having been the first and the early adopter on VDSL. Frankly, we've been shipping 100-megabits-per-second symmetrical service there since 2007. So I think that market has kind of been plugging away. So I think we have other opportunities, obviously, as we look to -- not reestablish, I mean, we're basically the 100% share player there, but to really refresh our business strategy there. And I think the opportunity there are going to be things like inSIGHT for quality of service and quality of experience, as well as technologies like G.fast as we go forward. So I think the softening that we're -- Dennis alluded to in the call, is in reference to some short-term dynamic that we see there. We expect that to sort of get back to more of a stable point in the next couple of quarters. But it really is more than the Ikanos legacy issue, it's really more of a mature market that really is finding its way to the next generation of broadband services. And I tell you, Japan is driving 8K television, just when you thought 4K was coming. Well, they are pushing 8K. So certainly, I think they are going to be one of the early adopters when it comes to next-generation broadband technologies.

Operator

[Operator Instructions] We'll move next to Ruben Goose [ph] with Opus Fund.

Unknown Analyst

First question about inSIGHT monitoring solution. If I heard it correctly, some service providers actually require RFPs. I wanted just to understand how they become aware of this product that they put in an RFP.

Omid Tahernia

Your question is what kind of products those RFPs are for?

Unknown Analyst

Yes, my question is when service providers are putting RFPs, they're dealing with probably equipment manufacturers or with Alcatels or ZTE with vendors. So what makes them aware of the products from Ikanos to put it in the RFP. I just want to understand the mechanism of their awareness.

Omid Tahernia

Yes, I understand. So couple of things. One is, as you might know, we have a very close relationship, partnership and engagement with carriers, that's one. Service providers, by and large, want to know the underlying technology that goes into their -- not only their infrastructure access business, but also on the gateway side of the business. So when an RFP or a tender comes out, sometimes this actually references the underlying technology, sometimes it does not. But our presence with the various OEMs and ODMs in the marketplace, really kind of connect the dots for us there. So we're always aware of tenders that are coming and the objectives for those tenders. And I think that's just a function of our relationship with the carriers, as well as our global customer base, both OEM and ODMs.

Unknown Analyst

If I may, another question. A recent press release of [indiscernible] boxes gateway being retrofitted for vectoring, so is it a -- couple of questions regarding that. Is it a soft retrofit?

And another one, did you start recognizing the revenues from this win? And lastly, is there any parallel opportunity for central office vectoring because these boxes, obviously, had to work with central office of Deutsche Telekom or some other European carriers, so 3 questions, there.

Omid Tahernia

Yes, good question. I think the recent announcement we made on vectoring is really a software upgrade. We obviously see ourselves in the business of making sure that vectoring as an end-to-end takes place. And we've always talked about there is an element of, call it, legacy CPEs or older CPEs that are out there that are going to be capable of -- have to be upgraded to be vectoring-capable. And since Ikanos has been in this business for a number of years, clearly it's one that we've been paying attention to. It's actually, frankly, one of the leading indicators that vectoring is on its way, so I think that's one. In terms of the financial aspect of it, I'd rather not comment because ultimately they're very customer-specific and customer-centric. But nevertheless, I think it's important to highlight the fact that this is meaningful in a lot of respects, one of which is continuing to sell more gateway products to our customers, as well as the pull that, that then creates on the central office side. To the latter part of your question, which is about the carrier side of it and vectoring, and I think absolutely, because interoperability and deployability of vectoring systems by carriers is very important. So as we enable the gateway side of it in various geographies, that's certainly part of a key element of the strategy, both from a carrier perspective, as well as our relationship with them.

Operator

[Operator Instructions] And at this time, Omid, I would like to turn things back to you for closing remarks.

Omid Tahernia

Thank you. I want to thank all of you for joining us today. This concludes today's call. I look forward to reporting on our progress next quarter. Thank you.

Operator

Again, that will conclude today's conference. We thank you all for joining us.

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