Applied Micro CEO Discusses F2Q2011 Results - Earnings Call Transcript

| About: Applied Micro (AMCC)

Applied Micro Circuits Corporation (NASDAQ:AMCC)

F2Q2011 (Qtr End 09/30/2010) Earnings Call

October 28, 2010 05:00 pm ET


Paramesh Gopi - President and CEO

Robert Gargus - SVP and CFO


Rick Schafer - Oppenheimer

Sandy Harrison - Signal Hill

Jeff Osher - Harvest Capitals

Christian Schwab - Craig-Hallum Capital Group


Good day, ladies and gentlemen, and welcome to the second quarter 2011 Applied Micro Circuits Corporation earnings conference call. (Operator Instructions)

I would now like to turn the call over to your host, Mr. Robert Gargus, Senior Vice President and Chief Financial Officer.

Robert Gargus

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

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

That information is likely to change. There are numerous risks and uncertainties that affect our business and may affect these forward-looking statements, including product demand and mix, product development and introductions, design wins, manufacturing and supply availability, the impact of workforce reductions, employee relations and the integration of new or moved operations, risk relating from macroeconomic conditions and markets and other risks as set forth in our SEC filings, including our Form 10-K for the year ended March 31, 2010.

Our actual results may differ materially from these forward-looking statements. Applied Micro assumes no obligation to update forward-looking statements made on this call. I want to point out that Applied Micro has several analysts to cover the stock and this creates a range of variability relative to the Street financial model. 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'm going to turn the call over to Paramesh.

Paramesh Gopi

Thanks, Bob, and good afternoon everyone. During the September quarter we saw our total revenues increase sequentially by approximately 8.5%, and product revenues, excluding our licensing revenues increase sequentially by approximately 8%.

We are entering the December quarter with approximately 94% of the December quarter guidance already on the books. Since this is down from the greater than 100% we had last quarter, let me pause here and add some color to the September quarter.

To start, I will remind everyone that we entered the September quarter with a very strong backlog and our revenue forecast has been based primarily on our supply pipeline. At the start of the September quarter, we were expecting to catch up on delinquent processor shipments, but this did not occur and instead we were able to source and ship more transport products than anticipated.

Additionally, we did see orders slow particularly in the month of September, and we saw several orders pushed out off the December quarter and into the March quarter.

I would like to preface the rest of today's call with our business outlook that is based on first-hand discussion with our major customers and their major customers. We believe that the market is going through the classic communications-related ramp, pause, ramp pattern that is common with major technology inflection points.

Our conversations confirm that all of our end markets, telco, the enterprise and the SMB markets will show strong growth over the next six quarters. However, we do see the next one to two quarters being the pause part of the pattern we talked about. This pause is normal and covers a variety of inventory corrections, channel adjustments and end customer deployment issues.

Specifically, our research with our customers' indicate that the slowness in push-outs were caused by a combination of excess inventory and a variety of inventory imbalances. The imbalance issue is the result of having some parts but not all of the parts you would need to build and deploy end system solutions.

The imbalance issue appears to be the primary cause for the slowdown, and our customers have singled out next generation optical modules and various discrete components as the primary imbalance culprits. We also believe that some carriers, example, AT&T are delaying metro and LTE deployments unto the start of the next calendar year.

Lead times for transport products improved significantly during the quarter, while supply constraints for the processor side of our business continued with no improvement. Going back to the 94% visibility entering the December quarter, I will remind everyone that this "turns" number of 6% is the lowest number in at least the 12 quarters preceding FY '11.

Total book-to-bill was 0.96X and backlog visibility for the March quarter is greater than 50%, an increase in sheer dollars from the equivalent basis last quarter. All three of our product families recorded sequential growth in September over the June quarter. Processor revenue grew sequentially by 5%, transport revenues by 11% and our licensing revenues grew 15% sequentially.

For the September quarter, the TPACK revenues are reflected in the licensing revenues and with a modest $0.1 million for the quarter. I am extremely pleased to note that we have surpassed our guidance and have executed particularly well in growth and profitability. And Bob will cover the specifics of this in his section of the call.

Our long term success remains a function of our new product pipeline, and during the quarter, we announced our PacketPro line of processors. This represents our newest generation 40 nanometer power architecture multicore devices that scale in performance up to gigahertz. This product has received significant coverage in the press along with excellent customer attraction in both the data price and SMB volume platforms.

PacketPro, combined with the two processor products released last quarter, APM 8121xx Maui and APM 801xx LANai gives us three new processor products so far this year.

When you add in last quarter's 10G BASE-T Triveni product, the 10 gig copper PHY, it gives us four new products to date and equals the same number that we did for all of last year FY '10 and twice what we did for the year before that. Our execution of new products that are anchored with lead customers in our large vertical markets has been stellar. And I'm very heartened by our progress thus far.

Announcing new products does not mean a lot unless these products have a track record of being successful. I'd like to take this opportunity to elaborate on the success of the new products that we've introduced in the last three years. In fact, "new product", those introduced since FY08 contributed 15% of the June quarter revenues and this grew to 20% in September and is expected to be approximately 30% in the December quarter.

Let me now turn to some of the details of the business starting with transport. Please note, that our transport business encompasses two vertical markets, Telco and Datacom. Let's start with a brief review of our Telco business. Our transport telecom business is heavily influenced by Telco build-outs and I'd like to provide perspective on our end markets and drivers before getting into the details of our own business.

While the key drivers for the OTN transition worldwide are mobile, data and packet based video, we are seeing the advent of pad computing and it's specific on cloud infrastructure for storage as a rapidly emerging new vector that is adding further impetus to the plant upgrade of carrier networks worldwide.

Starting with the United States, we saw AT&T and Verizon announce major plan service upgrades on their packet optical networks. Both of these service providers have focused on scaling their RAN meaning Radio Access Network components and are now turning to their second wave of key upgrades, namely metro and core networks.

The announcement of capacity doubling by Verizon and a major packet optical IP MPLS core to metro upgrade by AT&T has largely benefited ALU, Ciena, Cisco and a variety of other smaller players.

It is important to note that network capacity and consequent protocol upgrade follow a ramp, digest ramp pattern. Please recall our commentary about a year ago on the evolution of OTN adoptions where we stated that almost 50% of the Pan American core network transition was complete and that the next step would be the metro portion, a portion of the network that is almost three times the size of the core.

The new mobile backhaul RAN and announced LTE deployments are proof that the metro transition is beginning and will soon become mainstream. The key beneficiaries of the North American upgrades were Alcatel-Lucent, Ciena and Cisco. A key example of the successful platform that incorporates a majority of our OTN technology is the Alcatel-Lucent 18xx platform. Turning to the EU, we observe major core network upgrades by BT, Telefonica and France Telecom.

I'd like to remind you of our comments in the past few quarters relative to the EU being more legacy oriented and slower to upgrade to new OTN based packet optical core technology. The drivers for both upgrades stem from capacity planning exercises to accommodate a unprecedented number of future mobile data plan users. The OEM beneficiaries and platforms associated with this EU upgrade are Alcatel-Lucent and Huawei. APM's Yahara and PEMAQUID platforms are pervasive across ALU and Huawei's core and metro platforms.

Turning to the Asia-Pacific region, we saw ALU, ZTE and Huawei score major wins with customers such as Softbank in Japan and China Telecom for the metro core ROADM, reconfigurable optical add-drop multiplexers and terabit packet optical platforms, proving beyond doubt that the cadence for major network transitions is consistent. With this as background, let me now turn to the specific of our business.

Our OTN business in the September quarter was up approximately 18% sequentially fueled by Cisco's ETE and ALU. Our Yahara platform line continued to win key transponder as well as multi port, multi service interface cards for various platforms. During the quarter, Yahara captured an additional 12 design wins across Alcatel-Lucent Tell Labs, Fujitsu and ZTE.

On the router and packet platform front, PEMAQUID, our second generation multi port OTN platform, continued its design ramp registering three additional designs across Fujitsu and Alcatel-Lucent

Finally, our breakthrough 40 nanometer PQX metro platform continues to secure leading edge designs at market leaders and the September quarter saw us get our third PQX design win at one of worlds leading packet optical router OEMs. As we have stated before, applied micro products enabled virtually every recently announced OTN platform. Our design win traction remains strong throughout the September quarter.

Finally, the addition of TPAC has been well received. The effects of IP consolidation and cross pollination are excellent and we are moving to use TPAC in conjunction with our enterprise businesses as well. The customer perception and reaction have been phenomenal. The combination of TPAC, our existing products and our PWX platform and making APM the early power and cost effective solution leader for 100 gig.

Turning now to our Datacom market. Overall, our Datacom product revenue declined approximately 40% sequentially, but was partially offset by an increase in our legacy switch business revenue. Please recognize that quarter-to-quarter revenue trends are currently masked by product availability, so one cannot read too much into this decline.

The best example of this is to point out that during the quarter we continued to get excellent attraction with our 10 gig E optical PHYs and we recorded an additional 13 major design wins across customers like Emulex, Alcatel-Lucent and Raytheon.

This quarter we saw bookings for these devices increase in excess of 60% sequentially. In summary, we had an excellent quarter in the OTN, Telecom and Datacom fronts. We remain extremely excited about the prospects of our new technologies and the value proposition they bring to our customers.

Now turning to the embedded processor market. Processor revenues grew more than 5% sequentially in the September quarter. Our business growth continues to be fuelled by strength in the Telco, Enterprise and small, medium business segments uniformly.

The energy-efficient 405 and 460 product families picked up 18 major design wins last quarter. Two of these products we announced just last quarter have already scored major Tier 1 design wins. We've continued to emphasize that every single one of our new product needs to anchored by a Tier 1 customer and give our customer base a differentiated product with the ability to set a new bar for performance.

Having an established lead customer committed to our new product shortens the time to revenue cycle versus our historical norms. Additionally, we had stated a goal of breaking into selective consumer cloud applications like NAS box and Smart Meters. We are very pleased to announce that one of the design wins with the APM 801xx, an small footprint and low power gigahertz processor relates to an award-winning NAS box that is already available now at Best Buy stores.

We are proud to announce that this processor has recently won its second major design win, and this one is for a major service provider gateway platform. Our new line of PacketPro products which incorporate the world's first TSMC-based 40 nanometer power architecture cores and our scalable interconnect fabric was announced this quarter and is already receiving significant attention in the enterprise wireless datacenter and wiring-closet-switch markets.

These markets are driven by a large amount of packet-based video-on-demand services that have pervaded through cable TV and IPTV head-ends as well as the emerging category of Apple TV like devices that utilize cloud-based broadband video delivery and processing services.

PacketPro is uniquely differentiated for this market, and we expect several major Tier 1 manufacturing and enterprise imaging customers to be in system qualifications before the end of this calendar year.

Our processor business is vectored correctly, and we are actively taking share from our competitors because of price, power and performance advantages.

Now let me turn the call over to Bob.

Robert Gargus

Backlog visibility at approximately 94% is still well above the norms we have experienced over the last three years. Book-to-bill at 0.96 was a bit disappointing, but coming off of book-to-bill in excess of 1.3 for the last two quarters and we've improving lead times out of TSMC, this was to be expected.

To push-off into the large quarter was not anticipated, and this combined with the order softness in the month of September are the primary cause for our cautious commentary.

On the positive side, we are expecting to make progress on catching up on delinquent processor shipments spread across the December and March quarters. This has been built into our forecast and guidance, and we have confirmed the ability to achieve this catch-up with our foundry partner, and this has taken us a while to accomplish.

Second quarter revenues were $66 million, up $5.2 million or 8.5% compared to the prior quarter, and up $16.8 million or 34% from the same quarter a year ago. Within the $66 million of revenues, we saw our product families, transport, process and licensing revenues all grow sequentially.

The product-only revenues were $62.2 million, and were up 8% sequentially from last quarter. The breakdown of our revenues by product family for the second quarter were; processor revenues at $31 million, a sequential increase of 5%; transport revenues were $31.2 million, a sequential increase of 11%; and licensing revenues were $3.8 million, a sequential increase of 15%.

Sales to North America accounted for approximately 35% of total revenues; sales to Europe contributed 20%, and sales to Asia contributed 45%. There were two sub-contractors that represented 10% or more of the September quarter revenues; Hon Hai at 14%, which was the same number they had in the June quarter, and Flextronics at 10% which is one point higher than the 9% they had in the June quarter.

Additionally, there was one distributor that was more than 10%, and that's Worldwide Avnet which accounted for 30% which is down from the 33% they were in the June quarter of total revenues for the September quarter.

Distributed revenues for the last quarter were approximately $30 million compared to $28 million for the prior quarter. Distributor inventory measured in days and based on the disties September quarter sell-through is at approximately 58 days. The 58 days is high, and requires additional explanation.

To start, remember that our distie revenues for the September quarter were only $2 million higher than the June quarter, where the disties had 38 days of inventory. What happened here was that in the month of September the contract manufacturers and end-customers shut off receipts and distributors' sell-through numbers dropped, and this resulted in distributors having about $4 million more in inventories as planned. If the disties would have shipped this $4 million, the inventory would have been approximately 43 days, which was in line with what we were seeking to accomplish. We expect this to correct itself over the next two quarters.

Turning to the P&L, our second quarter non-GAAP net income from continuing operations was $10.7 million or $0.16 per share compared to the non-GAAP net income from continuing operations of $8.3 million or $0.12 per share for the prior quarter.

The pretax leverage factor for the quarter was approximately 49%, meaning that we put approximately 49% of the top-line increase to the pretax profit line. Our non-GAAP operating margins continued to improve, and was 14.6% of revenue and improved 2.4 points from the 12.2% achieved in the last quarter.

Our non-GAAP EBITDA for the quarter from continuing operations was $11.8 million, almost 18% of revenues compared to $9.7 or 16% of revenues for the prior quarter. For the second quarter, non-GAAP gross margins, including licensing, was 68.9% compared to 67.6% for the June quarter.

This significantly exceeded our guidance of 65% plus or minus half a point. The improvement in margins relative to the guidance and prior quarter can be largely explained by the favorable product mix, higher licensing revenues, and improved manufacturing yields and efficiencies.

Looking forward to the December quarter, we are expecting overall gross margins to be approximately 67.5% plus or minus half a point, and this is down from last quarter due to the expected higher processor shipments and specific customer mix, as well as licensing revenue dropping back with the exception of adding TPACK.

For those building FY '11 models, we would guesstimate that gross margins as a percentage of revenue would be flat in the fourth quarter.

Non-GAAP operating expenses from continuing operations were $35.8 million compared to our guidance of approximately $33.8 million to $34.8 million. This increase of approximately $1 million in operating expenses compared to the high ends of our guidance is mainly related to two items; one, an increase in R&D expenses related to contractors bought in to facilitate product development schedules; and two, the timing of $0.5 million repayment that would be accounted for as an expense offset that was unfortunately delayed into the December quarter.

Going forward, we expect our operating expenses to be in the range of $36.5 million plus or minus $0.5 million. This increase is basically the net of a small reduction from last quarter's run rate, the NRE payment and the addition of TPACK operating expenses for the full quarter.

Our interest and other income was $1.4 million and is higher by approximately $0.3 million compared to the prior quarter due to a one-time gain generated from disposal of some equipment. Interest income is expected to be approximately $1 million for the December quarter and we expect our tax rate to continue as a 3% rate for the next several quarters.

The diluted share count for EPS purposes was 68.0 million shares. During the quarter, we bought back approximately 2.5 million shares. The full effect of the repurchase is not reflected in the diluted share count, as the repurchases were mostly executed towards the end of the second month of the quarter.

For the December quarter, we expect our share count to be approximately 67 million to 67.5 million shares, not counting any shares we repurchased during the December quarter.

Turning to the balance sheet, our cash and investments totaled $182.6 million or $2.68 per share at the end of the second quarter, a decrease of approximately $40 million from the June quarter. This decrease is primarily due to one, approximately $32 million that we paid for the acquisition of TPACK; two, approximately $23 million that we paid for our open market stock repurchases; and three, cash generated from operations of $11 million.

Capital expenditures for the quarter were approximately $4.5 million and our capital depreciation for the quarter was $1.8 million. You can refer to our cash flow statement in the earnings release for more information.

Our working capital was approximately $197 million. It was $238 million at the end of June and we have no long term debt. Our DSO is at 32 days, and we expect it to range from 30 to 42 days going forward.

Our overall inventories remain flat at approximately $17.6 million. Our inventory turns for the September quarter were 0.7. Inventory and lead times continue to be an issue that requires evaluating and monitoring.

We plan to build enough inventories to better serve our customers, and this means that we will in the short term be increasing inventory levels. We expect inventory turns to decline for the 3.5 to 4.0 levels over the next quarter or two.

Turning to GAAP. As you know, our non-GAAP financials excludes certain items required by GAAP such as amortization of impairment of purchased intangibles and goodwill, items related to other than temporary impairment charges on our investment portfolio, impairment of strategic investment, stock-based compensation expense, restructuring charges, acquisition-related charges and non-cash tax adjustments.

The timing, occurrence and magnitude of such items can be difficult or impossible to estimate for future periods.

Our net income on a GAAP basis was $3.6 million versus a net income of $1.4 million last quarter. The difference in our second quarter GAAP net income of $3.6 million and the second quarter non-GAAP net income from continuing operations of $10.7 million is a delta of $7.1 million.

This $7.1 million is primarily comprised of three items. One, $4 million of stock-based compensation and $3.8 million of amortization of purchase intangibles respectively for a total of $7.8 million; two, transaction-related costs associated with the TPACK acquisition of approximately $0.9 million. And three, these were offset by an adjustment of $1.7 million related to gains realized from the sale of investments in our cash and investment portfolio that had previously been written down.

Looking forward to the December quarter, we can expect certain known GAAP charges, such as the amortization of purchased intangibles and the stock based compensation to continue. We expect to see the amortization of intangibles increase to approximately $5.0 million as a result of the TPACK acquisition.

A complete reconciliation between the GAAP and non-GAAP financials can be found in our earnings release, which can be found in the Investor Relations section of our website. Please note that there is no reconciliation for forward-looking non-GAAP measures.

That concludes my remarks. Let me turn the call over to Paramesh.

Paramesh Gopi

Thanks, Bob. Bob already provided you with second quarter guidance for the OpEx and gross margins. As we look out over the next several quarters, we continue to believe we are well positioned to capitalize on our secular growth trajectories. None of our checks indicate a slowing of demand, although excess inventory and inventory imbalances are likely to have one to two quarters to correct before we return to the growth path we were previously on.

In short, we have a great fundamental secular growth story that unfortunately is being stalled by widespread macro conditions. As little as a week ago, we would have guided to be flat for the December quarter, but the increase in distie inventory has given us pause, and we feel that the level in excess of 42 days, which is approximately $4 million has to be worked up. As a result, we are guiding for the December revenues to be $62 million, plus or minus $2 million; that's plus or minus 3.2%.

We remain bullish about our business prospects and our outlook for next year. In fact, for our businesses we see several overall growth drivers. Number one, 3G and LTE deployment as growth drivers beginning early next calendar year, these deployments will be fueled by rapid APAC deployments such as the ones announced by BSNL and Airtel. We expect Europe to follow a quarter or so later.

Two, as the OTN deployments into the enterprise portion of the network begins, and in fact accelerates we will be the beneficiary as we have numerous design wins on many major platforms. Remember that the enterprise portion of that network is the largest and represent almost three times the OTN opportunity that existed last year for the data center.

Number three, our processors have registered several design wins in the enterprise and consumer segments that will either ramp more aggressively or begin shipping in the next few quarters. And number four, our Datacom physical layers continue to grow and will receive a boost in the second half of next year, as our 10GBASE-T PHYs begin to deploy.

I want to close by stressing that we are well positioned to capitalize on our secular growth markets that we have identified. Our long term prospects remain intact and we continue to execute to our plans. The models for FY '11 are, or should reflect us growing revenues 20% to 25% year-over-year, and our EPS expanding from $0.16 last year to a range of between $0.45 to $0.50 for this fiscal year. We still have a ways to go, but our progress has been excellent by almost any metric.

Looking in FY '12, we believe that we should be able to maintain our revenue trajectory of $0.15 to $0.20 growth as we have previously stated.

With that, let me turn the call over to Bob for Q&A.

Robert Gargus

Thank you, Paramesh. That concludes our formal remarks. Operator, please provide instructions to our listeners for the queuing process.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Rick Schafer of Oppenheimer.

Rick Schafer - Oppenheimer

I got a couple of questions. I guess the first one, just a little more color on the weakness, and would you say that it's more concentrated by any particular end market or by any particular customer? Anything stand out there, I guess and maybe could you describe the weakness, it sounds like its more push-outs than cancels, is that the right read?

Robert Gargus

We had a little bit of both, but there was more push-outs. And I'd say was little more in the transport area than in the processor area. In fact if you look at it secondly, I'd say the push-outs on the processor side were more the result of supply constraints than customers pushing out the orders, whereas on the transport side that definitely did slow down.

Rick Schafer - Oppenheimer

And any customer commentary you could provide, or color?

Robert Gargus

I think we saw it pretty much across the major guys. It wasn't identified or local to any geography or any single major customer; it was pretty widespread. For example, the $4 million increase in distie inventory above what we were planning, because we did want to increase them a couple of million, caught us by surprise a little bit. And when we got into it and gathered all the data, it looked like basically the disties had very little sell-through the last three weeks in the month of September.

That month, when you look at it, is the lowest sell-through month they've had in about nine or 10 months. So obviously the feedback we were getting from the customers about imbalances, meaning that they had lot of the parts, but not all of the parts.

It's kind of like the analogy I would use is, if you have a automobile assembly line and your building cars, but you're short with the steering wheels, you don't continue to buy engine parts until you get the steering wheels and clear the line. And I think that's what we're going through here.

Rick Schafer - Oppenheimer

And then kind of related to that, I think it was you Bob that mentioned it. Your wafer supply, it sounded like lead times probably have pulled in at least from one of your foundries. Is that a clear read, where we are at lead times now for you guys in terms of your ability to get supply?

Robert Gargus

We saw TSMC loosen up. And basically at this point, we're able to get pretty much whatever we want out of TSMC. Although they've told us that they don't expect that to last for more than a few months. They expect, based on their forecast that it's going to get tight again somewhere around three or four months from now. In the case of IBM, we didn't get any real relief from them and they're still in the 23 to 27 week lead time.

But we have had a real long conversation with them to work out some changes in business practices, which will go into effect and will help improve things for us. But we won't see that really until, some in December quarter and more in the March quarter. And when you're going to see it is, because we'll build inventories. But that's about the only way I could buffer this at this point in time.

Rick Schafer - Oppenheimer

And so your lead times to your customers then I would assume pulled in as well?

Robert Gargus

For TSMC-related products, yes; for IBM products, no.

Rick Schafer - Oppenheimer

Fair enough. And then another question, I guess the current pause or slowdown aside, what are you guys seeing from carriers in terms of their 2011 build plans. I mean, could the current pause actually cause 2011 carrier CapEx forecast to go up?

Robert Gargus

I'll let Paramesh jump into this, because we spent a lot of time talking to our customers and their end customers. And I'll let him give some specifics to this. But I think the thing that we're most encouraged about is, almost everyone of them had some fairly significant and sizable upgrades that they're planning to do somewhere in the next four to six quarters or over the next four to six quarters. And when I say four to six, I don't mean it starts in four.

I think there'll be one or two quarters of pause and then over the next four quarters you're going to see us getting back on the same kind of growth trajectory that we were on let's say one or two quarters ago.

Rick Schafer - Oppenheimer

So does that imply a catch-up I guess? I'm just curious.

Robert Gargus

I mean, again, Paramesh can go into the specifics. I don't think it's going to be a catch-up. I think what happens is you get back on to the same trend line that you were on, but you come from a lower starting point.

Paramesh Gopi

So I think, to kind of add to Bob's commentary there, we've had extensive conversations with a bunch of our customers and their customers over the last six weeks. Because as we see these things kind of happen, we want to make sure that we understand the ecosystem impact and what's going on. And clearly, I think there are two major trends that are in flight; one is basically the adoption of early 40 gig into the metro-type networks, and then obviously the acceleration towards the 100 gig platform. We're very well-positioned for both of those. But when you're actually going through and figuring out ways to start to really attach the new mobile backhaul-type devices to a new core, there is always going to be a digestion period, is the way our carrier friends put it.

And that digestion period has to do with transitioning equipment that has been 59, 69 reliable to a new packet optical flatter network. And if you really look at what happened last year and what has been announced over the next two years and trace that back to the phasing of all of these different build-outs, it has become very clear that there is no more question about the fact that the metro is in transition. The key question is, how is the digestive part of that cycle going to work itself out over the next two, three quarters.

Remember, in our business, optics dictates lead times. I can't emphasize to you how much optics and discretes that are on these line cards dictate lead times for these guys. And by the way, they are also perhaps the most expensive part of these types of equipment.


Your next question comes from the line of Sandy Harrison of Signal Hill.

Sandy Harrison - Signal Hill

A couple of quick questions on some of the prepared remarks. You talked a little bit about the success of the PacketPro and finding some opportunities out there. What's the typical gestation period with this product if you find it six months, 12 months versus the 18 to 24 months? Or when can you start to see or when will you expect to see some of the revenues from these opportunities coming through the P&L?

Robert Gargus

Yes. So a two-part answer to that, Sandy. Normal stuff is this, the customer having to get samples and then get the design in and then you ramp. You're probably still talking 18 to 24 months.

What we've talked about though is that we have a practice with the new products where we're trying to get lead customers that are kind of pre-signed up, and on those, we will probably be ramping in as little as six to 12 months.

Sandy Harrison - Signal Hill

Got you. And then your comments around the distie, and I think you'd said in your prepared remarks Bob or Paramesh is up to a week ago you guys were thinking sort of a flattish December quarter. And then I guess you got your POS from the distributors and saw the $4 million.

What was their explanation? What were their thoughts, the distributors? I mean, was that just, hey, too bad it happens, or do they think there's a catch-up or is this just the reduced demand concurrently?

Robert Gargus

So this is where I think actually the amount of intelligence we've covered may be better than theirs, because we went straight to customers, and customers', customers, and correlated it. And while that my sound like a lot of work, if you do it the right way with about the right dozen or so contacts, you can get your hands behind the major programs and then extrapolate from there.

So the disties told us that the customers had just shut off taking receipts and that they had no worries about digesting the inventory, but they were saying that the orders, because they had dried up in the last three weeks of September, they were seeing the orders still being slow in the first two weeks of October.

So I think we may in this case have a little more visibility than they do relative to that aspect of it. But again, the 58 days sounds high, but when you think about it, its $4 million of inventory and they had sold the $4 million, which made their sell-through more flat with what it was the prior quarter, then the days would have been 43.

We were trying to target to get them to about 42, so we'd been right on what we plan to. So by no means do I think this is going to be that difficult for them to clear up.

To put it in perspective, the month of June, the distie sell-through was almost $18 million. So this doesn't necessarily take a long time to clear up. But again, it's going to be a function with the holidays and how fast their customers pull.

Paramesh Gopi

I want to make one more comment on this, because it's a really important derivative that at least a lot of us miss when we look at these markets. The actual deployment of networks, and if you look at the lumpiness of this pattern that we're seeing, actually goes back to a lot of the way infrastructure contracts are built out relative to the actual deployers of the network.

Typically they involve unionized labor. And I was given a very rapid education in this by one of our key customers, very, very big customer who talked about how important it is for the entire network to be able to upgrade in a given period with a given labor force because that's the way things are done in major geographies like Europe and in India where unions are very, very commonly used to do this.

Therefore, a 16 to 18 week movement in inventory of parts may essentially lead to a three-month to a six-month movement in the way network deployments are scheduled because of the way union contracts are written to deal with everything from splicing of glass-based WDM-type assemblies, all the way up to actually deploying or lighting up dark fiber in a controlled fashion.

So it's actually very, very clearly a stepped and phased phenomenon that has to occur for a guy like an ALU or a ZTE to say, I'm going to ship 1500 ports of OTN into a network at China Unicom or into a network at BDD. I mean, that's a huge part of what you're going to see occurring over the next six to nine months.

Robert Gargus

It think we feel pretty comfortable about the research and the context we've done on this, such that I think more of what we're talking about will come to light, not just through us but through other sources over the next two or three months, let's say. And I think you guys will be able to look back and say that we had stirred you correctly from that standpoint.

So what we're kind of really implying here is that we had an upward-sloping trend line. That trend line is maybe, if you want a kind of flattening out or maybe stepping back a little bit for a quarter or two, and then it will start up again on the same kind of slope as the original trend line.

But it's an old adage; I don't think anything for the most part goes straight up in a straight line all the time. So we're just unfortunately going through that right now.

Sandy Harrison - Signal Hill

On TPACK, with that now closed and sort of under your wings, what have you seen now that you own it, it's yours, versus your due diligence. And as you look at sort of the rollout of them over time what's the best way to layer that in? Are there products sort of moving into the production phase at some of the OEMs you're talking about? What's the best way to sort of think about that in linear fashion?

Robert Gargus

I'll put that in two categories. I'll first just say that obviously for our December quarter, the revenues that TPACK is going to generate is going to be pretty much the stuff that they had previously. The impact of our sales force and stuff that we hope to integrate with them probably starts to show up more in the March quarter.

So I think you're going to see revenues in the 1.8 to 2.0 kind of range for the December for TPACK. And that'll put them roughly at a profit neutral kind of impact. And I'll let Paramesh talk a little bit about some of the interesting, say, customer and design kind of interactions that are going on right now. Because from that standpoint, I'd say we're more pleased and even happier than we were when we did the acquisition based on all the things and the TPACK they were getting from customers.

Paramesh Gopi

I really get so excited about something that is FPGA-like, but I got to tell you for our chosen spaces, especially the telecom market. When I walk into a major Tier 1 account or service provider and tell them that I had the tools to get them into a trial and take them from trail to actual deployment in under a year, that's a huge, huge, huge change to their cadence relative to the way they have experienced things before.

On that front, if you'd now take that and work it back to the portfolio that we have, I can walk into any Tier 1 OEM today and tell them I've got the best-in-class smallest footprint, most reconfigurable HP platform that has the ability to evolutionize into a complete system solution that all the mixed signal in a common DSMC process.

So if you really think about it, between the Altera parts that TPACK stuff rides on, or the Xilinx parts at 40 nm, our bleeding edge 40 nm stuff that is world-class, high performance mixed signal, all of our40 nm processors, I pretty much offer you a complete menu of system engineering solution that is not available anywhere else in the industry. I solved your time-to-market and time-to-money problem and I solved your long-term cost problem all in one fell swoop.

Robert Gargus

The biggest thing that resonates with the customers is the fact that we can start early with them and help them with their API and the fact is we can then show them how their API doesn't have to change. And it's a huge factor with them because they don't have to worry about to change software as they move from platform to platform. We can show how we can do it with them in a consistent way.

Paramesh Gopi

And it's basically a software investment and million of lines of code that they have no issue with protecting.


Your next question comes from the line of (Chris Zepf) of Kingdom Ridge Capital.

Unidentified Analyst

Paramesh, when you're doing checks with the carriers, so if I step back let's say two years ago, the carriers were openly talking about how they're going to migrate the network ahead from Sonet to OTMs, because Sonet just wasn't cost effectively managing all the data transportation they were seeing and the growth they were foreseeing for the next few years.

Now if you look back at the last one or two quarters with whether it's the iPad or Netflix, which I saw a week ago they said it's up to 20% of streaming video during usage time in terms of how much it's consuming the bandwidth. When you talk to the carriers, are they that much more fired up about making sure they have to change the network sooner rather than later? I mean, obviously we're going through an inventory correction now at the box level.

Paramesh Gopi

Are they talking about accelerating their deployment into OTM network, is that the right way to think about the question?

Unidentified Analyst

What they're seeing in their networks has changed relative to what they would have projected a year ago. There's even more video, whether it's the iPad or streaming video through Netflix. You're seeing more of that. They're still charging the customers the same amount, because they have to lower, obviously, the costs to deliver to the customer.

Paramesh Gopi

I'll answer that in two parts, one is, look at the number of RFQs that I've send in the last six months for 100 gig. I think the number RFQs from our vantage point has probably quadrupled, okay? So if I look at my TPACK acquisition and where it's aimed at squarely, it's aimed at two pieces, how do I get the carriers a 100 gig solution by the mid of 2012 that is actually deployable in the metro. It may not be the most effective from a power and cost standpoint, but how do we get there faster than ever, right?

And if you look at the number of 40 gig cancellations that have occurred in the same time, it's about 30% of all stuff that has originally being termed to be 40 gig has been essentially upgraded. So if you look at the 4X plus the 20%, that's a significant change in the landscape.

By definition now, every single port card that's been talked about in any reasonable piece of Rodem equipment or carrier metro router is nothing short of either 100 gig or 200 gig ports which means essentially, by 1210, by 340 or buy one coherent times two. So the fundamentals are essentially absolutely in line.

You mentioned Netflix and you mentioned the pad computing stuff. If you look at the forward demand that people are projecting now based on what we call video caching in the cloud, all our Apple TV and Netflix type stuff and just extrapolate that to being able to get the ARPU that is needed for 100 gig solutions, we actually did our own business tape analysis for 100 gig.

And it is our belief that the 100 gig business case over the next three years will eclipse all the 40 gig and the 10 gig business cases going forward. Which basically means that the rate shaping is going to be talked in terms of fraction of 100 gig. So that is in fraction of 40 gig or any tributary thereof. So fundamentals are absolutely in place for us to see that.

If you look at Yahara, I'm giving you very concrete example, and look at the Alcatel-Lucent 1800 platform, Yahara is not used in any 40 gig. They are used in 100 gig cards today. So absolutely clear and unequivocally evident that we'll have all the big demand queued up from a carrier perspective to move to 100 gig. What are the limiting factors so I can put some color on that as well? The biggest limiting factors right now are the manageability of a flat 100 gig network.

Believe it or not, software investments and OSS network management of big 100 gig pipes and fractional 40 gig pipes are non-trivial. So I think you'll start to see a lot more, the technology digestion period that I indicated in the two to three quarter period that Bob indicated has a lot to do with the way you're now going to rate provision your OTN pipe as part of your new service infrastructure.

Unidentified Analyst

I think it's pretty clear where the market is going? How do you view the competitive landscape in terms of when you're going out and weighing the designs for when you do those things? So how do you view the competitive landscape?

Paramesh Gopi

Relative to my OTN products?

Unidentified Analyst


Paramesh Gopi

First, I think on the edge, we're now actually a real competitor to guys who have essentially dominated that particular aspect of the network and we're a real competitor in the sense that we now have equivalent solution, albeit with FPGAs and all mixed signal devices to essentially go up and start to show equivalent mixed signals de-synchronizer plus channelize edge all the way down to ODU0 grooming and shaping solutions. So that's clear.

On the 100 gig front, we see two major competitors arriving. And this is very different than what we've seen in the past. And I want to be, in fact I didn't mention it in the call, but it's really important for you to realize that the notion of an internal 100 gig ESIC development is now resurfacing again with most of our customers.

And again, just like we did for PQX or Pemaquid, the 100 gig products that we are contemplating today are all joint developments or are all formed out of joint thinking between system guys and us.

Unidentified Analyst

So, are you getting NREs for this 100-gig development with your customers?

Paramesh Gopi

So on the TPACK side, there is already engagements on that front, absolutely. On the applied micro side for a 40 nanometer or 28 nanometer deployment, that is still in conversation. So I just want to be clear that at 100 gig, because there is such a plethora of features, because it's kind of the superset of 40 and 10 gig all rolled up into one giant big market, we believe that we need all the different features to come together. And there will be continuous evolution of features over the next four years as this network transitions.

Unidentified Analyst

100 gig, is that between more of 2012, 2013? Between now and then, given what's going on, whether it's Netflix, and you talked about the data traffic. The carriers themselves are talking about the need to upgrade next year. So I understand the need to get to 100 gig as fast as possible, but for next year, what are you seeing the carriers move to?

Paramesh Gopi

We're seeing a lot of carriers moving to the channelized notion of 100 gig. So when I say 100 gig, let me be very clear; there is going to be the need to at least have like a 12 x 10 card on most of these boxes. So today's cards are like with our Pemaquid, they are a by 4 or a by 2. So we're going to go from that to a by 12. So I look at it as, PQX essentially will start to become a very dominant part of most of these platforms.

So as the carriers need to upgrade, we have the density upgrade path over the next 12 to 18 months. So essentially, what we will end up doing is, from a short term perspective we're going to proceed with higher density 10 gig until they get to 100 gig. That's what I mean when I say there's this really, really important trend out there.

Robert Gargus

And the second part of your question, I think varied in prior to that, Chris, is competitive wise in terms of being positioned in the next 12 or 18 months to capitalize on that increased density until 100 gigs gets here, I don't think anything has changed. I think we're still pretty dominant there.

And when we find other competitors, and some people pop out of the woodwork so to speak, yes, we know about it, we know of some stuff that people are working on. But there's that old adage of, right now I think we've got to stock it and they've got to take it away from us.

Unidentified Analyst

But in truth, for the next 12 months, whatever is going to be deployed, the stock has already been won by somebody, and so if you haven't stocked it, you're going to ramp it up?

Paramesh Gopi

That's exactly correct, and the fact that we invested in 40 nanometers two and a half years before anybody else even got here, puts us at an interesting bull position going forward.


Your next question comes from the line of Jeff Osher of Harvest Capitals.

Jeff Osher - Harvest Capitals

Just a quick question along the cash flow statement. Looks like RSUs and SBC or FAS 123R was roughly a third of cash from ops. Is that the right ratio we should think about? A third of your cash flows coming from share creep or options or RSUs?

Robert Gargus

I think that's a more complicated calculation because it can also be a function of how the share price moves. And that particular number can go up even though it's based on shares and options that you gave out a long time ago.

The way I look at it, isn't really compared to the cash flow numbers as much as I compare it to the share count. And with ISS and some of the other services, we look at gross shares like the number of shares going out to the employee base or to management; we also look at it on a net basis. And I can tell you that over last three or four years, we have each year on a net basis been negative.

We've been anti-dilutive, meaning that, as we've transitioned workforce etcetera overseas, as we changed our management, we've actually had more shares being returned to the pool than we've had going out.

Jeff Osher - Harvest Capitals

That's also a function of your vesting schedule, though. But your stock over the last six months has been flattish. So typically you get a greater expense as your stocks' going up, not flat to down. So, all else being equal, if the stock is flat, and I don't know, maybe you're shrinking your vesting schedules, but all else being equal, should we assume, in other words $7 million, $7.8 million every six months of contribution, all else being equal to cash flow?

Robert Gargus

I think there could be a concept that the schedules are shortening from the standpoint of a lot of the share accounts that we put in place is a program we internally refer to as EBITDA shares. That was put in place based on established EBITDA parameters a couple of years ago. And basically, that pays out faster we get the EBITDA numbers over time. Then it can actually accelerate the investment that comes in. Or by that, I mean you can accelerate it in, but only if the numbers are achieved.

Jeff Osher - Harvest Capitals

So it becomes almost an unvirtuous cycle where the better you do in EBITDA, the more stock-based comp you'll see, which backs out a non-cash expense even further. Maybe we'll circle back offline. Let me look at this a little closer. But thanks for taking my question.

Robert Gargus

I wouldn't mind talking to you about it after the call too. Because many of the people have heard me talk about the fact that I'm not sure we can be backing out stock based compensation for very much longer because a lot more of it is in options, a lot more of it is RSUs. And I don't know of anybody that can argue that our RSUs aren't compensation.


(Operator Instructions) Your next question comes from the line of Christian Schwab of Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital Group

Bob, I just had a question on the guidance. We're looking for December to be $62 million plus or minus a couple and then, you know, March probably being flattish as we have a couple quarters inventory digestion or pause and spending, etcetera. Did I understand that correct?

Robert Gargus

That's probably the way I would guide you guys to do it for now. I probably may be a little more bullish than that, but right now, given how much things have changed from the last 30 days or so, I'd say, let's just be cautious. We can always increase numbers.

Christian Schwab - Craig-Hallum Capital Group

And then as we look to 2012, you guys suggested, I think I wrote down that you expect revenue growth, year-over-year of 15% to 20%. Did I hear that right?

Robert Gargus

We think the slope of that line which is kind of the line that we were on this year prior to the pause as I'll call for it for a second, we think we'll get back on a similar sort of line again, because all the basic fundamentals, in this case the metro has to upgrade to OTN. The design wins that we've gotten with the new processors that haven't even begun to shift; all those things we feel pretty strongly or pretty comfortable unless there is some weirdness in the macro kind of world should get us back into that kind of a growth trajectory.

Christian Schwab - Craig-Hallum Capital Group

Right, so the quick math then obviously, right, is we do $250 million next year and 15% to 20% growth next year, gets us to $287 to $300. If we just split that difference and call it $293, we get $73 and change a quarter. So, at some point, there's just a massive hockey stick recovery or acceleration, reacceleration, if you will, in your quarterly revenues. So would you expect that to start in June and continue on a very strong trajectory straight line through the year?

Robert Gargus

My concept is, I think really that 62 that we might be out for a quarter or two is an abnormalcy. So I think it could jump back to the 66, 67 range pretty easily and then go on to the growth pattern that we were on which is more on the 5% to 10% sequential growth. So I think you can give to that kind of a scenario for FY12 from that perspective.

Because if I look at it, if you could do as something as simple as even a low number like $65 million in the June quarter, and if you grew by about $4 million a quarter and maybe a little stronger like $5 million or something in the fourth quarter or so next year, I think you can be into the $285 million to $290 range with that kind of a number.

If you know me well enough to know I'm always going to be a little bit on the more conservative side, especially when I'm going out that far. And the proof has been in the historical numbers. Whenever we've guided you out that far, we usually expect low and then try to increase it as we go through the year. So it just depends on whether you're trying soft for the middle part or soft for the 15 and then inch it up afterwards.


As there are no further questions, I would now like to turn the call back over to Robert Gargus for closing remarks.

Robert Gargus

We'd like to thank all of you for your participation today. And there will be an audio replay of this call available on the Investor Relations section of our website. You can also access the audio replay of this conference call by calling 888-286-8010 and entering the reservation number 82420330. We will also file a copy of this script in an 8-K with the SEC in the next few days.

Please feel free to call me if you have any additional questions. Again, thank you for your participation on the call today and have a nice evening.


Ladies and gentlemen, thank you for your participation in today's call. This concludes the presentation and you may now disconnect. Have a great day.

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