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Applied Micro Circuits Corporation (NASDAQ:AMCC)

F4Q2014 Earnings Conference Call

April 24, 2014 5:00 PM ET

Executives

Traci Tsuchiguchi – VP, IR

Paramesh Gopi – President and CEO

Doug Ahrens – VP and CFO

Analysts

Krishna Shankar – ROTH Capital

Michael Lucarelli – Evercore

Vijay Rakesh – Sterne, Agee

Hans Mosesmann – Raymond James

Shawn Simmons – Raymonds

Christopher Rolland – FBR Capital Markets

Christopher Longiaru – Sidoti & Company

Operator

Ladies and gentlemen welcome to the Fiscal Fourth Quarter 2014 AppliedMicro Circuits Corporation Earnings Conference Call. My name is Sheena. I will be operator for today. At this time, all participants are in a 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.

And now I would like to turn the call to Traci Tsuchiguchi, Vice President for Investor Relations. Please proceed ma’am.

Traci Tsuchiguchi

Thank you, Sheena. 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 and Doug Ahrens, our Vice President and CFO.

Before we begin, I would like to remind you that various remarks that we make on this call including those about forward future financial results, including revenues, gross margins, operating expenses, design wins, product plans, our competitive situation, market trends, statements about future developments production and adoption of X-Gene, X-Weave and other products and our anticipated growth and profitability all constitute forward-looking statements for the purpose of the Safe Harbor Provisions under the Private Securities Litigation Reform Act.

These forward-looking statements and all other statements that may be made on this call, that are not historical facts, are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our most recent Form 10-Q and Form 10-K filed with the SEC, in particular to the section entitled Risk Factors and to other reports that we may file from time to time with the SEC. For additional information on factors that could cause actual results to differ materially from our current expectations. These forward-looking statements speak only as of the date hereof and we disclaim any obligations to update them.

I want to point out that AppliedMicro has several analysts that 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 will turn the call over to Paramesh.

Paramesh Gopi

Thanks Traci. As you’ve seen in the earnings release, we had a solid March quarter that is unexpected on the bottom-line. For the full fiscal year, our base business grew 10.5% over fiscal year 2013 and continues to support investment in our X-Gene and X-Weave growth initiatives. Most importantly I’m pleased to announce that both X-Gene and X-Gene 2 are on track with our stated milestones as of last quarter. Customer interest is strong and design win momentum continues to build. We have received our first purchase orders for production volumes. Initial production wafers of X-Gene are currently in the fab and we expect to ship our first production units of the world’s first ARM 64-bit Enterprise Class Server on a Chip Solution this summer.

I’m also very happy to report that we have 28-nanometer X-Gene 2 silicon back in our lab. We are very pleased with what we are seeing so far. We are on track to sample X-Gene 2 to customers and partner later this spring. Contribution from X-Gene has been growing every quarter and we continue to expect meaningful revenues from X-Gene in the second half of our fiscal year, the December 2014 and March 2015 quarter.

Meanwhile, the ecosystem around X-Gene continues to develop both inside and outside of the cloud. Red Hat demonstrated enterprise deployment technologies used to provision a full rack of X-Gene based servers running an internal engineering build of a Red Hat enterprise Linux operating system had its summit in San Francisco last week. This is an important step towards the future production release of the fully supported Red Hat enterprises and systems running on X-Gene.

Canonical introduction of its Ubuntu 14.04 Long Term Support of LTS on X-Gene marks yet another important milestone for ecosystem maturity. We are pleased to report that X-Gene is the first ARM 64-bit Server Silicon to be satisfied for Ubuntu 14.04 LTS. As you know Ubuntu LTS is a supported Linux operating system that is important in hyperscale cloud and scientific computing environments.

In January 2014, Microsoft announced its involvement with ARM server-based system architecture or SBSA 64-bit v8 platform standards body. This is meaningful for AppliedMicro and that it demonstrates Microsoft’s growing support of ARM. This for shadow is the potential expansion of X-Gene stem as it begins to open the enterprise market in addition to the cloud for on v8. We are excited to be the first silicon provider to enable Windows and the rest of the software ecosystem on ARM v8 for servers.

I would like to take a moment to explain why this is so important for AppliedMicro X-Gene has been used as a defacto ARM v8 development platform for critical ecosystem components and workload optimizations for the last two years by both software companies and server vendors.

The 90 formal evaluation agreements that we have executed to-date are evidence of the sizeable software and platform investments by our ecosystem partners and end customers. There ARM v8 ecosystem maturity is directly tied to X-Gene and any other competitive solutions will lack the maturity needed for enterprise deployment for the foreseeable future.

It is inevitable that any non-X-Gene ARM v8 server processor alternative would have to go through the same extensive testing and validation by ecosystem partners and early customers. This involves substantial investments in terms man hours and dollars by these ecosystem partners and customers. As we build on our first generation X-Gene success by delivering X-Gene 2, the time to market advantage enjoyed by our customers will continue to be preserved.

Let’s look at X-Gene’s architectural advantages relative to others targeting the ARM server market and some of the reasons why we are gaining traction in the cloud and beyond. Number one, X-Gene features brawny v8 custom cores designed to run at very high speeds and support large memories of systems. There is ample market evidence in the competitive landscape that of the shelf cores or cores original designed for mobile applications are ill-suited to run made similar clouds in the cloud or in the enterprise.

Number two, X-Gene supports machine critical server class features including reliability, availability and serviceability or RAS and ECC. RAS is a must have for any meaningful enterprise deployment. It is the only way that enterprises and cloud service providers can guarantee five nines reliability. To-date, we believe that X-Gene is the only on v8 implementation with RAS support. Mobile ARM cores do not support these enterprise class features.

Number three, X-Gene has an unprecedented level of deep connectivity integration. AppliedMicro’s proven low power connectivity IP has been integrated along with our brawny on v8 custom cores on a single piece of silicon. X-Gene has four integrated 10 gigabit Ethernet network interfaces inclusive of all the analog I/O eliminating the need for extensive bulky and power consuming external network interface cards.

Continuing our legacy of breakthrough technology leadership in the server space X-Gene 2 integrates the industry’s first Rocky Network Interface including the requisite analog I/O along with our brawny 28-nanometer ARM v8 custom cores on a monolithic piece of silicon. Rocky or RDMA over converged Ethernet was derived from InfiniBand and is intended to provide low latency, high connectivity, massive scale-out architectures for hyperscale clusters.

In summary X-Gene is clearly the most mature and lowest risk solution for ARM-based servers today and in the foreseeable future. Now let’s commentary on our base business, I would like to highlight the following trends. Number one, in connectivity, AppliedMicro is the undisputed meter in the 100 gig OTN Ethernet space with over 50% market share and products that enable converged Ethernet in the data center.

Our devices deliver the lowest power and highest density per rack unit had 10, 40 and 100 gig, because of our differentiated heritage in service provider and transport IP. The migration of converged OTN Ethernet into and between data centers drives growth in our 10, 40, and 100 gig devices. In fact last quarter, we announced and we shipped our 4 million 10 gig OTN Ethernet port.

Number two, X-Weave represents the next step in the evolution of our base connectivity business into data centers and service providers central offices intended to deliver the highest density lowest CTO platform. At the open compute summit in January, we discussed the bearing of X-Weave with X-Gene 2 which will allow customers to connect multiple services together to build massive scale-out systems significantly improving density and performance relative to today’s predominant architectures.

And building upon our converged OTN Ethernet leadership last month, we announced the world’s first 240 gigabit per second of smart 5 devices for carrier Ethernet and data center connectivity applications. We also introduced our Multi-Link Gearbox II which integrates and aggregates 10 gigabit Ethernet to 100 gigabit Ethernet for the next generation cloud computing and data center environments. We have tier 1 design wins and are on track to ship production 28-nanometer X-Weave products in the December 2014 and March 2015 quarters.

Number three, however we expect our base computing business to be impacted by the secular market decline in the use of our PC based products until our ARM based embedded products begin to meaningfully contribute to embedded computing revenues.

Number four, we see an opportunity to leverage our ARM based technology into high-end embedded networking applications from a design and perspective, we are already seeing significant traction to the number of design wins including a high volume flagship socket that is expected to begin to contribute in calendar year 2016.

Number five, profits from our base business will continue to support X-Gene and X-Weave development and production efforts.

With that, let me turn the call over to Doug.

Doug Ahrens

Thanks Paramesh. Last quarter consolidated net revenues were $51.8 million in line with our guidance. Computing revenues were $27.6 million and connectivity revenues were $24.2 million. In terms of geographical splits sales to North America accounted for approximately 42% of total revenues. Sales to Europe contributed 10%, and sales to Asia contributed 48%.

In the quarter, four customers accounted for more than 10% of our business. Global logistics support vendor, Wintec and distributors Avnet, Arrow and PowerPac. Distributor revenues for the March quarter were approximately $26.8 million. Our fourth quarter non-GAAP net income was $730,000 the quarter or $0.01 per share.

Our non-GAAP financial exclude certain items required by GAAP, our net income on a GAAP basis was $23.1 million or $0.30 per diluted share versus a net loss of $7.3 million or $0.10 per share for the prior quarter. A complete reconciliation between GAAP and non-GAAP financials is available on our fourth quarter earnings release, which can be found in the Investor Relation section of our web site.

Please note there is no reconciliation relating to forward-looking statements. Our backlog covers as of the date of this call is greater than 70% for the June quarter. The book-to-bill ratio in the March quarter was slightly above one. As projected last quarter, we managed channel inventory excluding non-cancelable, non-recoverable orders down to 47 days from 70 days the prior quarter.

Turing to the balance sheet, our cash and short-term investments totaled $106.6 million from $74.3 million in the prior quarter. This includes the $40.2 million received from the sale of our corporate headquarters building and land in Sunnyvale, California which closed in mid March.

Inventory levels were $18.9 million from $10.5 million in the prior quarter, due to planned increases from very low levels in the previous quarter. We intentionally built inventory to meet expected demand for specific products.

Now turning to the Veloce payments, during the March quarter we paid out a total of $46.3 million, ion combined cash and stock primarily as a result of achieving the milestone associated with 28-nanometer X-Gene 2. The payment was comprised of $18.2 million in cash and $28.1 million in stock. To-date we paid a total of $154.1 million out of the Veloce maximum merger consideration of $178.5 million.

Importantly cash flow from operations was a positive $8.2 million during the March quarter excluding the merger consideration paid to Veloce. One of the many transformational impacts of our ARM server strategy in the Veloce spin-in has been in the significant efficiencies, gains in R&D.

By blending our R&D resources from our base business and our growth initiatives, we are beginning to see the economies of a converged strategy at AppliedMicro become more apparent. Therefore we expect to incur a lower expenses going forward. With regard to guidance for the June quarter, we expect revenues to remain in the range of $50 million to $54 million.

We expect gross margins in the range of 57% plus or minus one percentage point. Our gross margins in the June quarter will be impacted by the forecasted mix within the computing business. However, as connectivity grows as a percentage of our revenue beyond the June quarter, we expect a more favorable effect on gross margins.

Non-GAAP operating expenses are expected to be in the range of $29 million to $30 million and the interest in other income is expected to be approximately $300,000. We expect to be breakeven in the June quarter on a non-GAAP basis. Furthermore, we expect the share count to be in the range of 79 million to 81 million shares.

For reference excluding the R&D expense for X-Gene development, our core business generated a profit of $0.22 per share during the March quarter on a non-GAAP basis. Importantly, the cash flow from our core business has and should continue to enable us to invest in X-Gene and X-Weave development through commercialization.

Now I’ll turn it back over to Paramesh for some closing remarks.

Paramesh Gopi

Thanks Doug. In conclusion, we’d like to leave you with the following; number one, our base business is solid and continues to provide incredibly valuable IP and technology leverage to create differentiated and the compelling products targeting the data center. Number two, X-Gene is on track, in the March quarter we started production wafers in order to fulfill our POs and X-Gene 2 is in our lab and is on track to begin sampling this spring. The ecosystem which is begin developed on X-Gene silicon is robust and is driving commercial adoption. We believe as X-Gene ramps to production other ARM solution will still be in the early stages of prolonged further typing and ecosystem development process.

With that, we’d like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions]. First question comes from [indiscernible].

Unidentified Analyst

Hello.

Operator

You’re live in the call.

Unidentified Analyst

Yes. Do you hear me all right?

Operator

Yes, sir. Please proceed.

Unidentified Analyst

All right, very good. Thank you. So with X-Gene on track and the production orders in hand now we are a quarter closer to material revenue, are you getting a better sense or maybe what’s X-Gene revenue might look like in 2015?

Paramesh Gopi

I think the simple, we kind of want to go back to what we said, which is if you look at it we have three big sets of customers large scale folks OEM selling to them and networking folks. I hope you got the -you got the message that they are all fully engaged on the POs, different spheres, all three spheres. And I think we’re on track to make sure that there is going to a fairly important and I’ll call it notable deployment at the end customers and with the OEMs towards the second half of our fiscal year.

So, one thing I want to leave you with is that, we’re more confident than ever that the category is real, we’re also extremely confident now that we have POs in hand, what we are going to be looking for is in terms of timing of what amounts get built out in terms of how many clusters of 1000s of servers get built out in what timeframe is the biggest variable right now. But we have POs in hands, so the market is fully engaged.

Unidentified Analyst

And Paramesh something that you said you had POs from all three large customer tranches?

Paramesh Gopi

Yes. So, yes we have POs from all three spheres of customers, Web-scale operators, OEM selling to web-scale operators and networking folks.

Unidentified Analyst

And your estimate to which one of those is likely to be the largest material contributor first?

Paramesh Gopi

I have the feeling that they all contributed, the question is relative to contribution in terms networking.

Unidentified Analyst

Announced you – we looked at few other earnings reports earlier, it looks like infrastructure spending is feeling little bit better globally maybe on a carrier basis, can you just characterize the health of infrastructure activity carrier and OTN for data center?

Doug Ahrens

Sure. And this is Doug. What we’re seeing is some recovery in the bookings on the connectivity side. So if you go back to the quarter, we talked about slowdown that was visible and we factored that into our guidance for the March quarter. And at this point, we’re starting to see bookings pick up on the connectivity side driven by service provider demand.

Unidentified Analyst

And then lastly, Paramesh on the last conference call you talked about X-Weave and having three significant design wins, you said you wanted to be able to discuss those design wins in more detail on this conference call that discussion was a bit absence, can you give us any more detail there?

Paramesh Gopi

Yes. I think I said that we had design wins and that we were actually had sampled X-Weave, in fact at this point in time I can tell you for a fact that our customers have already built the with X-Weave and they are in various service provider installations being tested.

Unidentified Analyst

And just Paramesh, first -in the first expected material revenue for X-Weave is when?

Paramesh Gopi

We basically said that it is going to be in the December and March quarters.

Unidentified Analyst

Okay in line with X-Gene, okay.

Paramesh Gopi

Absolutely.

Operator

Our next question is from Krishna Shankar, ROTH Capital. Please proceed.

Krishna Shankar – ROTH Capital

Yes congratulations on the X-Gene platform progress and your base business. Couple of questions, Paramesh if you could refresh first again, you had sort of laid out a longer term objective for X-Gene being the catalyst for AppliedMicro revenues to potentially double over the next, I guess couple of fiscal years. So are you still sort of confident with that sort of longer term market for revenues based on X-Gene?

Paramesh Gopi

Well absolutely, I think the – if you look at it from where we stand today. We are probably 18 months ahead of any ARM competitor in this space. We are on the cost of essentially getting key customers to adopt this brand new technology in the data center. And I want to remind you that if you look at the cloud market it’s a $4 million market and for us to get basically one customer to turn in that market is a very, very I’ll call it tractable objective, given our technology leadership and the need for an alternative architectural source for hyperscale and cloud environments.

So one of the things that you should consider as proved positive is that we would not be gardenering the design win momentum that we are if there was no cognizance of the fact that this market and this category really now has teeth.

Krishna Shankar – ROTH Capital

Great. And then you said that you will be sampling X-Gene 2 the spring, can you talk about the cadence for the X-Gene 2 adoption will that be a little more quicker than X-Gene 1 is it socket compatible and in what applications will your customers use X-Gene 2 versus X-Gene 1?

Paramesh Gopi

So, first of all right on track to sampling in the spring we have it in our labs, we’ve been very pleased that what we see, please recognize that we are doing what the server market is used to, we have basically a volume generation that is going to production and a technology generation that will go to production between nine months in the year hence follow. The biggest differentiation between these two is the addition of integrated RDMA which has never ever been done so far in the server space to-date. So what we’ve done is change the effective bar for building scale-out systems by taking our custom v8 cores and integrating complete RDMA hardware accelerated network interfaces on X-Gene 2. So we get all of the best of breed of X-Gene 1 at a much lower power plus we are raising the bar from a competitive point of view to be able to build out essentially 100s of nodes in a cluster within a rack.

So fundamentally you should expect to see the same survey market cadence, it’s basically 18 months between two generations, in our case it’s pretty much the same. And you should see a revenue concordance of roughly two big years to two and half years were revenues overlap between the two. So just to be clear we expect X-Gene 2 to be sampling in the spring and be production in the first quarter of next year.

Krishna Shankar – ROTH Capital

Okay. And then your guidance for the June quarter is that based on growth in the – in the connectivity business and is that assuming for the June and September quarter continuing a meaningful decline from the legacy business. Can you sort of frame for us how much the legacy business decline is impacting your guidance?

Doug Ahrens

Sure. We don’t break out the exact split between the two, but I can’t tell you directionally connectivity we will be growing in the June quarter and that trajectory is expected to continue where the embedded our PowerPC business as a structural decline built into it, let’s you tend to net each other out next quarter which is why we end up with the guidance of $50 million to $54 million revenue.

Krishna Shankar – ROTH Capital

Great, thank you. Thank you.

Operator

Next is Michael Lucarelli, Evercore. Please proceed.

Michael Lucarelli – Evercore

Hi guys thanks for taking the question. Good job on depending on that quarter there, just quick question on the base business, I know you talked about it and you don’t really want to break it out, but I guess as we think about for the year should we consider connectivity growing then the process declining and will connectivity grow faster in the back-half of the year in the process declines?

Doug Ahrens

No we haven’t projected the mix out that hard to provide externally. We do expect as I said, the connectivity will continue to be the growth part of the business and the PowerPC business will be in decline until we start to see ARM make its way into the embedded space as Paramesh mentioned in his comments. But, you can see the trajectories of both sides of the business as I just mentioned.

Michael Lucarelli – Evercore

Fair enough. And then the gross margin guidance was obviously at the lower end of your – kind of range recently, how should we think about that going forward with connectivity growing more?

Doug Ahrens

So, the gross margins for the June quarter are really driven by the mix within the computing space, you got some products falling off, some coming in. It’s purely mix within that portion. But, as we go forward connectivity becomes a larger portion of our overall revenue. And that has a favorable effect on our gross margins if you look past the June quarter.

Michael Lucarelli – Evercore

Sounds good. The inventory, you touched on it about, that it grew about $9 million, is that some stuff for X-Gene and X-Weave in there or is it also legacy stuff?

Paramesh Gopi

It’s broad-based. So it’s -we thought that we were lean in several areas, so we are getting our inventory model back to where we -think it should be to prepared for specific orders that we see coming?

Michael Lucarelli – Evercore

And on X-Gene, what of the mechanics will win the X-Gene counter expense will turn into revenues, what flips that switch for you guys?

Paramesh Gopi

So it really comes down to materiality. So as X-Gene grows -becomes a larger contributor, it moves from becoming a counter expense to revenue.

Michael Lucarelli – Evercore

So its materiality?

Paramesh Gopi

Yes.

Michael Lucarelli – Evercore

Got you. And then looking for -what are the milestones we should look for whether it’s X-Gene on the ecosystem as we move forward through this year?

Paramesh Gopi

I think, you should look for, let me actually take this back because something we need to conceptualize what happened over the last six months, okay? Number one, before any of this, before we had Red Hat talk about through production platform in San Francisco last two weeks ago. We actually had them say exactly what they were going to do six months ago.

We also had Oracle say that they would have Java already for enterprise deployment beta in the fall. You also had at OpenCompute Microsoft essentially throw their hat into the arm SBSA space. If you really look at the arc of things that have happened thus far, you can see the coincidence of the people in the broad customer base placing POs, people in the broad customer base getting ready to start to build out silver clusters based on arm and go so far -I will go so far as to say that arm in the data center today is primarily all due to X-Gene, all right?

So if you look forward, continue the same track, you will see the Red Hat maturity occurring in line with the clusters getting built out. You will see Java maturity occurring on the ecosystems. You will also start to see meaningful clusters or servers being built out by various web scale properties.

Michael Lucarelli – Evercore

Sounds good guys. Thank you.

Operator

Next is [indiscernible].

Unidentified Analyst

Hi, Paramesh, hi Doug. Good job in the quarters guys. In terms of the OpEx, can you talk about where the OpEx now includes or even build outs for future exchange like three and four products, or will there be a spike up. Can you just clarify the clusters by the synergies, you mentioned on the prepared remarks for OpEx?

Paramesh Gopi

Sure. So after we spun in Velochi, we found efficiencies in our engineering efforts and we are able to complete current projects with less spending because of our execution being very effective. And so you are seeing some savings just in the -on the execution and driving less expense in R&D as well as some reductions in headcount that came with those efficiencies.

If you look forward, this is more along the lines of what we will during this year and then we get into X-Gene 3, and you start thinking about things like FinFET that would be the time you would see OpEx start to increase because of mask expenses. But, keep in mind that the revenue from X-Gene will be contributing in that time and that will far outweigh the increase in the OpEx.

Unidentified Analyst

Great. That helps. And then also, I mean POs you have in hand Paramesh, I mean the nature of the orders, are these kind of proportion of a data center built out, are they something of a prototype of effort by these large customers, I want to understand nature of the projects that these POs placed for? Thanks.

Paramesh Gopi

Please note that the -we have been shipping X-Gene for the last two and a half quarters roughly and those all have been pilot production units; we have clarified that on previous calls. These POs are for production units that are all production wafers in the fab and fully equipped for production servers. So these are production orders. There is pilot here. We have moved from the pilot phase to the production phase for all of these platforms.

And I also want to clarify that the span all of the workloads, so you got storage, we have got web scale, hyper scale, then servers and high performance computing, all three are spanned in those POs.

Unidentified Analyst

Great. Thanks guys.

Operator

Our next question is from Vijay Rakesh of Sterne, Agee. Please proceed.

Vijay Rakesh – Sterne, Agee

Hi, guys. Just going over the X-Gene, the POs obviously good job with getting POs from web scale and OEM and networking guys. But, I know you said you are not adding it because it’s not material, so is the application that the POs are not materially at this point in terms of the revenues when you ship in and some of its I’m assuming it’s probably June or September quarters?

Paramesh Gopi

So I will add to my earlier comment by saying it’s a combination of production readiness on the product as well as materiality. So we will start to see moving the revenue during the summer months here. So it’s a combination of those two factors. But I’m just trying to put it in perspective relative to the meaningful revenues we talked about in the second half. It’s just not to that scale yet. So that’s why it’s categorized over this.

Vijay Rakesh – Sterne, Agee

Got it. And based on what you are seeing now, do you expect this to get material more like in 4Q, the calendar fourth quarter of 2014 and same with X-Weave -you said X-Weave shipping fourth quarter of 2014 and first quarter of 2015, if I heard that right. Is that how materials will that be if you can quantify that a little for us?

Paramesh Gopi

So I think it’s consistent with what we have been saying for the last two months, which is first of all, I want to be also clear about one more thing, X-Weave samples have shipped, people have good equipment and production quantity with X-Weave will ship in the March 2014 and December 2015 quarters. The exact same thing goes for X-Gene.

Vijay Rakesh – Sterne, Agee

Got it. Great. Thanks a lot.

Operator

Next question is from Hans Mosesmann, Raymond James. Please proceed.

Hans Mosesmann – Raymond James

Thanks. Congratulations on the progress of X-Gene. Just an update on X-Weave in the December and March quarters, the orders that you have there or the shipments that you have there, are they always going to be in combination of X-Gene or are you seeing the uses -uses case where they used independently?

Paramesh Gopi

Hans, really good question. I would say that the December and March quarters would be essentially mostly non-X-Gene bundled. We expect these products to be existing in a -in the same framework towards the middle of next year.

Hans Mosesmann – Raymond James

Okay. That’s helpful. And then hey, Paramesh, if you can give us an update on the competitive dynamic, I think you did a good run down on those bigger picture dynamics, but from what you have seen over the past two or three months, what is your observation on the competitive field in the ARM and X-86, what have you learned or are there, is there a change?

Paramesh Gopi

Let me start by saying that I think we are more comfortable today talking about our lead both on a unique value proposition as well as in our core technology which includes the brawny cores that we built, the large memory subsytems that we support, the integrated networking functions that we support. That’s become very clear to us that the amount of ruggedization, robustness and the amount of work that customers have done on ARM directly has been done on us. So it would not be a farfetched statement to say that ARM maturity in the server space is directly correlated to X-Gene today, all right?

I would also tell you that anybody who enters this market since it’s a brand new category with a whole new instruction set its going to have to go through the same amount of arduous testing, rigorous regression and performance benchmarking that we have gone through.

I’m also really pleased to report that for the first time in the last six months, I have seen customers and end customers validate the TCO proposition that we set out to deliver three years ago. So, I think have made a series of decisions that have been very deliberate on the on-front. We have made huge investments in terms of time and in terms of technology, and we have a large portfolio of connectivity IP that we are able to leverage going forward.

So, one thing, I can tell you is that the comparisons that are being drawn today are extremely telling for the workloads that we are seeing. And I can tell you that the 50% TCO number has come through with all the three different workloads that we talked about across the X-Gene family. We will see even more compelling truth points as we bring up RDMA over the next year and start to look at the benefits of rebuilding really dense scale-out systems. So, we’re not talking anymore about 8 and 16 cores but we’re talking about a men cash density that could include hundreds of cores and potentially terabytes of memory in a rack, right. So, that’s – that one piece. As far as versus the incumbent, I think I can tell you that all of these benchmarks and these TCO exercises have been done versus the incumbent and all of the context that I’m giving you is in context of the incumbents last generation and this generation product.

Hans Mosesmann – Raymond James

Great. Thank you very much.

Operator

Next is Rick Schafer, Raymonds. Please proceed.

Shawn Simmons – Raymonds

Hey, guys. This is Shawn Simmons calling in for Rick. I have just a couple of quick questions. I hopped a little late, so I apologize if you covered this in the prepared remarks. But, Intel in the quarter announced a sizeable investment in Cloudera. I was just wondering how you sort of view that I mean is that a validation of the ecosystem? Would that potentially inhibit your ability to pour at software over on Hadoop, I mean any sort of elaboration on that would be great.

Paramesh Gopi

So, I think if you were to look at it, Cloudera has not stopped working on other non-X-Gene architectures, number one. Number two, from our perspective, Cloudera is one of many Hadoop distributions used and from the cloud perspective, no large Web-scale tier property essentially relies on one Hadoop distribution, they essentially either use modified versions of things like Cloudera or their own, right. So, from our perspective, one of the things that we want to make sure is that, I believe Intel had their own distribution of Hadoop probably about two years in the making and from our understanding that distribution never made it out of their bond. So, that’s kind of the color I’d like to place on that essentially it’s a non-event for the ecosystem.

Shawn Simmons – Raymonds

Okay, great. And then just one quick question on the remaining Veloce payments, when do you expect those to occur, it looks like you guys have still I guess little under $24 million or $25 million pick out. When would you expect those to occur and what milestones are they based off of?

Doug Ahrens

So, we have $24 million to go, that’s correct and it’s the combination of cash and stock which is in our discussion. Next quarter, we would expect to see a payment of about $6 million to $7 million and then the remainder spread over 12 to 18 months after that. And it can be tied to a variety of things, relate to milestones, retention and time based, it’s a variety of things that are disposal.

Shawn Simmons – Raymonds

Okay, great. And then, I guess one last question. It looks like accounts payable doubled quarter-on-quarter I mean is there any sort of clarity into that?

Doug Ahrens

It’s just timing, we had some inventory increases during the quarter and it’s directly related to that. So, that would be temporary, you would expect that to settling back down in the next quarter.

Shawn Simmons – Raymonds

Okay, great. Thanks, guys.

Operator

Next is Christopher Rolland, FBR Capital Markets. Please proceed.

Christopher Rolland – FBR Capital Markets

Hey guys. Congrats on the POs, excited to hear more next time. So, in discussions with the channel, they described lead times on your comp products has being pretty long sometimes two or three times that of other firms out there. So, I was wondering, first of all is that’s correct and then why are those lead times so long? What sort of strategically behind that? Thanks.

Doug Ahrens

So, Chris, we are able to meet our customer requests and have very low delinquencies. They do tend to order 14 to 15 weeks out on us and we build accordingly. So, it’s not as if there are some large delinquency situation there and unable – being unable to meet orders. So, we are keeping up with the orders.

Christopher Rolland – FBR Capital Markets

Yes. No, I was just wondering if there is anything strategically behind that or not. Okay, that’s fine.

Doug Ahrens

No, we build to forecast and then finish out to end products based on backlog as they come.

Christopher Rolland – FBR Capital Markets

Okay. So, you guys have talked about the amount that you allocate for R&D to X-Gene in the past and I think remarkably 45% of revenue is R&D we’d call it $10 million to the core business and $15 million to X-Gene. So, moving forward, how do you sort of view the minimum that you need to sustain each of those? And if you had to say one or the other, which would you do? What sort of levers would you pull there?

Paramesh Gopi

So, Chris, X-Gene would not be successful, if it were not for our connectivity business. I said that for the last three years, I’ll continue to maintain that. I will also continue to say that the biggest differentiation that X-Gene brings to the market and the reason we’re able to extract the TCO savings for these types of systems, is because of the integrated SoC components that stem directly from leveraging the IP that is developed for the communications business.

Therefore, we will continue to make the appropriate investments in the communications business based on the same model that we have used for the last three years, mainly selective cooperation with large customers. I will point out to you that most of our 100 gig technology was developed in conjunction with two or three very large customers. These customers board the blunt of initial R&D payments to us via various financial means like NRE’s and make sure that their technology is leveraged across to their product portfolio, that is why we are able to get things like RDMA, things like high performance I/O, integrated with the level of ease that we have today and with the level of proof positive that we have today that it will work with existing interfaces. So, as far as the investment is concerned, I view those two as being extremely important. I want to also tell you that X-Weave will not stop at 240 gigabit per second at all. We are right on our way to get until we are not resting it at 240 gigabits. We’re now looking at how do we move to scale that up by with appropriate order of magnitude to intercept in 2016 and 2017 data center demand.

Christopher Rolland – FBR Capital Markets

Okay. So, I guess talking about X-Weave for a second there, I see a lot of similarities with X-Weave and X-Gene and what Intel is doing with Rackscale. However, Intel did announce a date and partners for silicon photonics this quarter, that’s – is up part of Rackscale that you guys may not have, you have optical but silicon photonics may have cost advantages on the connector side versus traditional optical. How do you sort of view that? Do you view it as a threat? Is there a way for you to play in that ecosystem at all? And is there a way to stay competitive with Rackscale is for example silicon photonic offers pretty good economics?

Paramesh Gopi

Silicon photonics has been talked about for the last half a decade. It was first talked about by Intel relative to USB 3 and USB 4. The volume that would have been driven by USB 3 and USB 4 would have barely made the technology cost points be profitable for any company. And if silicon photonics were to be truly profitable, to be truly useful in the data center, you would have major optical component vendor such as Avago and Finisar and JDSU fully participant in it.

It is our belief that for Rackscale computing, the first step today is going to be low cost short range non-integrated optics and very, very dense high performance 100 gigabit per second copper. Both those are being used and are being talked about as we speak today to be incorporated into Rackscale deployments later this year.

Christopher Rolland – FBR Capital Markets

Interesting, you keep my interest. Thanks.

Operator

Thank you. Our next question comes from Christopher Longiaru, Sidoti & Company.

Christopher Longiaru – Sidoti & Company

Hello guys can you hear me.

Paramesh Gopi

Yes.

Christopher Longiaru – Sidoti & Company

All right, congratulations on the results as well and on the POS, so I basically have, just a couple of questions that, you talked about that having orders from all three tiers is there a different the way each is integrating there, so can you give us a little more color on how you see that progression continuing with respect to each of the tiers?

Paramesh Gopi

Sure, so let me start with the hyperscale and Web-scale tier, both vertically integrated data center operators as well as the OEM selling to them. And I’ll give you an example, we’ve always maintained that X-Gene design for three key workloads in the cloud and these three key workloads made up for $4 million down to a large extent. One of front-end large Web-scale service, dynamic Web-scale, the other was distributed large scale storage both one and both, and the third was men cash which has the ability to do really fast, really cash amount, right.

So I can tell you that, those are the three key applications, so you would have systems that satisfy high memory configurations with large memory surrounding X-Gene, the big thing, just want to pay men cash or a high performance computing application, you would have a whole set of discs on the other side which would be one megabyte for storage for instance being controlled by a couple of X-Gene for a large distributed filer.

And the third would be a very dense web server that you would have essentially 48 blades in a 4RU kind of form factor which would essentially serve out 100s of 1000s web sessions.

Christopher Longiaru – Sidoti & Company

Sure, excellent, thanks.

Paramesh Gopi

Sorry I didn’t meet in proper there is one more thing.

Christopher Longiaru – Sidoti & Company

Yes, absolutely.

Paramesh Gopi

A few years ago we talked about essentially in the high-end embedded space where you would have PowerPC essentially being going away and PowerPC being replaced eventually by ARM. A lot of what we said in that space is coming true, so the transition from a pure PowerPC plus a tiny ARM on some of our chips is going to move to a big ARM and no PowerPC in the future.

Christopher Longiaru – Sidoti & Company

All right. And then just I guess a couple of quarters lag between the time that PowerPC goes away and that kind of ramps up?

Paramesh Gopi

Yes, the timing of which I think it’s going to be, I think it’s hard to predict the timing but I can tell you for a fact that we had received in the last six months zero RF use for PowerPC based anything.

Christopher Longiaru – Sidoti & Company

Okay, so…

Paramesh Gopi

What I can tell you it’s supreme confidence.

Christopher Longiaru – Sidoti & Company

Sooner or than later, I mean your customers are telling here, okay that’s all I have. I’ll jump out thank you guys.

Doug Ahrens

Thank you.

Operator

Thank you for your questions ladies and gentlemen. I would now like to turn the call over to Traci for closing remarks.

Traci Tsuchiguchi

Thank you all for joining in the call this quarter. A replay of this will be available on our, the investor relation section of our website at www.apm.com. Thanks.

Operator

Thank you for joining in today’s conference. This concludes the presentation. You may now disconnect. Have a very good day.

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