Centillium Communications Q4 2007Earnings Call Transcript

Centillium Communications, Inc. (CTLM) Q4 2007 Earnings Call February 20, 2008 5:00 PM ET

Executives

Faraj Aalaei – Chief Executive Officer & Director

Linda C. Reddick – Interim Chief Executive Officer

Analysts

Michael Coady – B. Riley& Co.

Joel Achramowicz – MBD Capital Group

Anton Wahlman – ThinkEquity Partners, LLC

Al Shams – Mid South Capital

David Wright – Henry Investment Trust

Presentation

Operator

Good afternoon and welcome to the Centillium Communications fourth quarter and 2007 financial results conference call On the call today will be Mr. Faraj Aalaei, Co-founder and CEO and Mrs. Linda Reddick Vice President and CFO. This conference call is being recorded also all participants are in a listen only mode. Later we will open up the call for your questions. I will now turn the call over to your conference host Mrs. Linda Reddick. Ma’am you may begin.

Linda Reddick

Before we begin I would like to remind you that except for the statements of historical fact the matters presented in this conference call contain statements that are forward-looking statements within the meaning of the US Federal Securities law. Actual results may differ materially from those indicated by the forward-looking statements based on a variety of risks and uncertainty, a partial list of which is listed in today’s financial results release. Information about potential factors that could affect our financial results is included in our most recent annual report on form 10Q and our other documents on file with the Securities & Exchange Commission. We undertake no obligation to update forward-looking statements for any reason.

Also during this conference call we will discuss non-GAAP financial measures in addition to GAAP financial measures. Our non-GAAP financial measures for Q4 exclude the effect of the benefit from the reversal of accrued royalties, impairment of assets charge, restructuring related to surplus base charges and stock-based compensation. Our non-GAAP financial measures for the prior quarter exclude the effective stock-based compensation. Please refer to today’s financial results press release which provides additional information and a reconciliation of GAAP to non-GAAP results. These can be found on our website at www.Centillium.com.

Today we reported fourth quarter 2007 net revenues of $8.6 million compared with $10 million in the third quarter of 2007 and in line with the revised guidance that we provided on our January 15th conference call. Our GAAP net income for the fourth quarter was $2.4 million or a net income of $0.06 per share compared with a GAAP net loss of $5.2 million or a net loss of $0.13 per share for the prior quarter. Our GAAP net income for the fourth quarter included a $8.9 million benefit from the reversal of approved royalties. Restructuring expense related to surplus base charges of $518,000 and a $1.4 million impairment of assets related to the divestiture of our DSL business. Our non-GAAP net loss for the fourth quarter was $4.2 million or a net loss of $0.10 per share compared with a non-GAAP net loss of $4.7 million or net loss of $0.11 per share for the prior quarter. Our non-GAAP net loss for the fourth quarter excluded an $8.9 million benefit from the reversal of approved royalties, restructuring expense related to the surplus base charges and $518,000 and a $1.4 million of assets related to the divestiture of our DSL business.

Stock-based compensation expense was $336,000 or $0.01 per share for the fourth quarter compared with $496,000 or $0.02 per share for the prior quarter. During Q4 four customers: SCI, Erickson, [inaudible] Lucent and OP each exceed 10% of our net revenue. I will provide additional Q4 financial details and our Q1 guidance later in the call. Faraj will now provide an overview of our business and a product update by market.

Faraj Aalaei

On February 13th we completed the sale of our DSL business to the Ikanos Communications for $12 million. This transaction included the $2.5 million transfer of net assets comprised of inventory equipment and release of other liabilities. Expenses and contingency payments related to the transaction were approximately $1.5 million. As a result we expect to recognize total estimated net gains of approximately $8.1 million. We have taken significant steps to restructure our business as a result of the DSL sale. These steps are intended to generate substantial savings by reducing employee related expenses, reducing the reliance on consultants, reducing facility costs by exiting certain facilities worldwide and reducing our design and development tool expenses. We are also evaluating potential cost savings associated with being a public company. We have reduced our headcount by approximately 95 employees including 30 employees who moved to Ikanos. We also reduced the size of our executive management team as part of this restructuring plan. The new Centillium employees approximately 150 people. We are a smaller but a more nimble company moving forward.

Upon completion of our restructuring initiative we expect to reduce our operating expenses by approximately $21 million per year beginning in the third quarter of 2008. Our target quarterly operating model at the completion of the restructuring includes a gross margin of approximately 55%, total operating expenses of $5.5 million and breakeven revenue of $9.5 million. As a result of the restructuring initiatives we wrote off approximately $1.9 million in Q4 which included an impairment of assets charge related to the development contract and a restructuring expense related to surplus space. We anticipate additional write-offs of approximately $6.5 million during Q1 and Q2 as we continue with our restructuring efforts which will include service charges, additional surplus space and software tools.

In addition, as many of you are aware through our SEC filings, we have been engaged in litigation in Japan with Fujitsu. We are pleased to announce that the court has ruled in our favor and the time to appeal has now passed therefore, this matter is now closed. As a result of recent evaluations of our royalty contingency we have determined that it is now reasonable to reverse certain accruals related to our DSL business. The impact of this evaluation was a reversal of $8.9 million in accrued royalties during Q4. The remaining royalty accrual will continue to be evaluated and we believe it is likely that we will reverse more reserves in the coming quarters. The combination of the restructuring initiatives, the legal victory and our ongoing balance sheet improvements is putting Centillium on a more solid financial footing. The new Centillium is a leading provider of SoC solutions for the VoIP and optical markets. According to industry data both of these markets will continue to grow substantially over the next several years. Centillium has compelling product offering and competitive position in these markets. We believe that the new Centillium has the talent, resources and focus necessary to deliver substantial year-over-year revenue growth and improve market share.

The Gigabit Ethernet PON, GEPON is fast becoming the dominant FTTP standard being deployed in the Asia, Pacific region. There were approximately 10 million subscribers on GEPON fiber to the home in Japan by the end of 2007. This number is expected to double to 20 million subscribers by 2010 with 3 million new subscribers expected to be added in 2008. Korea is expected to add approximately 700,000 subscribers in 2008 substantially driven by IPTV deployments and China is expected to add approximately 350,000 subscribers driven by the Olympics. Taiwan is starting targeted trial deployment. In addition, to our traditional media gateway voice market we are targeting the fast growing multi-service access or MCAN applications and next generation digital loop carry environment such as posture placement and business communications. iSuppli forecasts a steady growth in low density acquisition media gateways with a compound annual growth rate of 62% through 2011. Our recently introduced Entropia access gateway product is targeted specifically to this high growth segment of the web market.

In 2007 our Voice and optical business accounted for $15.9 million in revenue. Based on Q1 projections the current run rates for 2008 is approximately $22 million which represents a year-over-year growth rate of 38%. We expect to exceed this growth trajectory as we move through 2008.

During 2008 there are several initiatives and imperatives necessary to continue the growth momentum. We must increase our market share in the EPON market. To this end we’re working very closely with other customers to get our product deployed by service providers. In the growing sector of Voice access our newly introduced Entropia III-C must succeed in winning designs with major telephone access equipment providers. We must get our Entropia Gateway and CP Gateway customers into production and shipping to their respective telephone customers. We are optimistic because we believe that we have the design wins today necessary to get us to profitability. We must accomplish this while at the same time building a stronger growth potential for 2009.

Now let’s turn our attention to Q4 2007 results for the VoIP and optical markets. Our net revenue for 2007 were $39.2 million compared with net revenue of $64.6 million for the prior year. Our VoIP revenues were $2.3 million in the fourth compared to $2.5 million in the prior quarter. We expect VoIP revenues to increase during Q1. We continue to garner positive response to our Entropia C3 products. In deed we recently received one of internet [inaudible] magazines product of the year awards. We developed the Entropia III-C as a smaller sized highly integrated version of our flagship VoIP system on a chip with cost structures in channeled in to these that squarely target the requirement of business communication and subscriber loop infrastructures. We have successfully secured three desginments for our new Entropia III-C Gateway product with one in Asia and two in Europe. Many of our existing media gateway customers have shown interest in designing in and using our Entropia III-C product. We expect to add more design wins for each we’ve seen in 2008 and to work closely with our customers to complete these designs and to move a number of them through qualification and to deployment by the end of 2008. In our traditional media gateway market, a design win we announced last year for our Entropia product with a tier one system entering in the US has completed its development qualification phases and has started service provided deployment and generated revenue in Q4 2007. We expect this customer to ramp substantially during 2008. Our Entropia design win with NEC also announced last year has been qualified as major service provider in Japan and is expected to start field deployment in 2008. In the residential gateway market our Atlanta processer design win with the tier one vendor in China for WiMAX gateway has moved into trial deployment with a US service provider. It is expected that this product will proceed to volume shipment at the successful conclusion of this trail.

Now turning to our optical business. Our optical revenues during the fourth quarter more than doubled to $3.8 million compared with $1.5 million in the third quarter. As we previously discussed we had a significant ramp in our optical revenue during Q3 and Q4 as a customer began to ramp in order to meet its initial employment. We expect optical revenues in Q1 to be lower as our customer digest the initial bill. We expect our customers market share to increase during 2008. We are on track with our customer qualification process with the ME300. Due to the sensitive competitive nature of this business, we are unable to provide additional details at this time. We are optimistic however about our chances for success and the resulting increase in market share. Linda will now give you more details on or Q4 financial performance and guidance for Q1. Linda?

Linda Reddick

As I said at the beginning of the call net revenues in the fourth quarter of 2007 were $8.6 million compared with net revenues of $10 million in the third quarter of 2007. The decrease in net revenues was due to our DSL customer’s inventory and push out. Our GAAP gross margin for the fourth quarter was severely impacted by the benefits from the reversal of the accrued royalties. The GAAP gross margin for the fourth quarter was 168% which includes a benefit of 103% from the above mentioned reversal. This compared with the GAAP gross margin of 62.4% in the third quarter. Our non-GAAP gross margin was 64.4% in the fourth quarter compared with 62.5% in the prior quarter. The Q4 07 non-GAAP gross margin included the benefit of $612,000 or 7% due to the unexpected sale of previously written down inventory, $570,000 or 7% of credits received from our fabrication facilities for prior yield losses partially offset by $186,000 or a 2% write down of excess obsolete inventory.

GAAP operating expenses for Q4 increased to $12.4 million from $12 million in the prior quarter primarily due to a $1.4 million impairment charge partially offset by lower tape out related costs. Non-GAAP operating expenses decreased to $10.1 million in the fourth quarter compared with $11.5 million in the third quarter. The non-GAAP operating expenses exclude the effect of stock-based compensation for all periods and surplus base charges and impairment of asset charges during Q4. GAAP R&D expenses decreased $6.6 million in the fourth quarter compared with $8.1 million in the prior quarter. Non-GAAP R&D expenses were $6.5 million in the fourth quarter compared with $7.9 million in the previous quarter. Stock-based compensation was $101,000 in the fourth quarter compared to $196,000 in the third quarter. GAAP SG&A expenses were $3.8 million in the fourth quarter compared with $3.9 million in the prior quarter. Non-GAAP SG&A expenses remained relatively flat at $3.6 million for the fourth quarter compared with the prior quarter. Stock-based compensation was $239,000 for the fourth quarter compared with $290,000 in the third quarter.

Our GAAP net income for the fourth quarter which includes the effective stock-based compensation was $2.4 million for a net income of $0.06 per share compared with a GAAP net loss of $5.2 million or a net loss of $0.13 per share in the prior quarter. Our GAAP net income for the fourth quarter included an $8.9 million benefit from the reversal of accrued royalties, restructuring expense related to surplus base of $518,000, stock-based compensation of $336,000 and a $1.4 million impairment of assets related to the divestiture of our DSL business. Our Non-GAAP net loss for the fourth quarter was $4.2 million or a net loss of $0.10 per share compared with a non-GAAP net loss of $4.7 million or a net loss of $0.11 per share in the prior quarter. Stock-based compensation expense was $336,000 or $0.01 per share for the fourth quarter compared with $496,000 or $0.02 per share for the prior quarter. Our non-GAAP net loss for the quarter excluded an $8.9 million benefit from the reversal of accrued royalties, restructuring expense related to surplus base of $518,000 and a $1.4 million impairment of assets related charge related to the divestiture of our DSO business.

Now for some balance sheet comments. Cash and short term investments were $36.8 million at the end of the fourth quarter compared with $41.7 million at the end of the third quarter. During 2007 we entered into an agreement for up to $10 million of a revolving line of credit. As of the end of the fourth quarter we had drawn down $1.5 million against the line and committed an additional $1.5 million in letters of credit for the line. Days sale outstanding were 39 days in the fourth quarter compared with 40 days in the previous quarter. Inventories decreased to $2.8 million in the fourth quarter compared with $3.4 million in the third quarter. Capital expenditures were $82,000 in the fourth quarter compared with $458,000 in the third quarter. Depreciation and amortization expense was $410,000 in the fourth quarter compared with $395,000 in the third quarter.

I will now provide our financial guidance on a non-GAAP basis for the first quarter of 2008. We expect net revenues to be approximately $6 million. We anticipate that the non-GAAP growth margin will be approximately 53 to 55% and non-GAAP operating expenses will be approximately $8.5 million. The non-GAAP operating expenses include approximately $1.3 million of expenses related to the DSL business in the first half of the quarter. As a result we expect non-GAAP per share results for the first quarter of 2008 to be a net los of $0.12. Although we normally do not provide cash guidance, we believe we need to make an exception this time given the significant changes in our business during the quarter. We estimate the cash level during Q1 to be approximately $35 million and $37 million. I will now turn the call back to Faraj for some closing remarks followed by Q&A.

Faraj Aalaei

With our recent and ongoing restructuring initiatives we have taken significant steps and are in the process of fully aligning our operating costs with a robust business model going forward. With the talent, resources and necessary focus we are well positioned to be successful in the compelling VoIP and optical market. We have identified and are focused on key initiatives and imperatives for the business of the new Centillium. We have an exceptional product portfolio and a solid tier one customer base with a strong pipeline of new design wins which will provide the necessary foundation for the growth of our business and to reach profitability. We would now like to open up the call to questions. Operator you may open up the line to our first caller please.

Question –and-Answer Session

Operator

We will now start the formal Q&A session. (Operator Instructions) We do have our first question coming from Michael Coady of B. Riley.

Michael Coady – B. Riley& Co.

Regarding the guidance for the March quarter of $6 million, could you provide a little bit more detail? You mentioned the VoIP revenue would be up and optical down, is there any DSL included in the guidance?

Faraj Aalaei

Yes there is a small amount. I think the amount is in like $400,000 or something like that.

Michael Coady – B. Riley& Co.

Okay and your comment regarding the growth rate of 38% based on the run rate of?

Faraj Aalaei

It’s an example if you look at Q1 with out guidance being about 5.5% or 5.6%. What you’re looking at is, if you just multiple that by four it gives you $22 million and then compared to 2007 that’s about a 38% growth year-over-year but our goal obviously is to beat that.

Michael Coady – B. Riley& Co.

I see. And given the current changes you’ve made $21 million annually to the op ex or to the cost structure beginning in the third quarter. Do you expect that to be fully realized on July 1st?

Faraj Aalaei

Yes we expect that you know all the restructuring work that we have is done with and in Q3 we can get our fist clean quarter with the new model.

Michael Cody – B. Riley

Okay. Regarding the accrued liabilities and the reversal there of, what of that was based on the DSL sale? And what on that is based on the fact that it’s somewhat old and you haven’t heard from?

Faraj Aalaei

Its you know we do this thing from time-to-time, it’s to evaluate kind of what we’re doing with royalties obviously selling the DSL business prompted us to have a deep look at that and looking at the standings, basically the patent law of the land and the fact that you know we’re no longer in this business, we decided to do this reversal.

Michael Cody – B. Riley

Okay makes sense. And then I missed a comment that you made earlier on about the VoIP business, you mentioned your design win with [inaudible] qualified as a service rider in Japan, prior to that you mentioned a customer with whom you have a design win and work with in the service providers that has been done there, did you say that that was Alcatel-Lucent or did you mention a name there?

Faraj Aalaei

No we did not mention a name but it’s other than Alcatel-Lucent. Alcatel-Lucent has been the announced customer but this one has not been.

Michael Cody – B. Riley

This is an unannounced customer and the design win is going into deployment?

Faraj Aalaei

It has into deployment starting in Q4.

Operator

Our next question is coming from Joel Achramowicz with MDB Capital Group.

Joel Achramowicz – MBD Capital Group

I had a question a couple of technical questions to start off here Faraj. Regarding your focus in the gateway business and certainly the premises side the CPE side, do you retain certain libraries, transceiver libraries to provide transceiver operation from central office, you know DSL lines in order to have a complete SSE for a gateway chip?

Faraj Aalaei

So Joel the gateways that we are actually designing, this is our Atlanta product line by the way which does not have an integrated DSL obviously. This is a clean sort of like processor product, broadband processor product but it does include a voice over IP it does include bridging, routing and security functionality. So it can be used frankly in conjunction with wireless networks and particular design win that we talked about that is in field trials right now is actually a WiMAX network it has nothing to do with DSL. So this device could be used in wireless access networks it could be used in the wireless land type of boxes where you know certain bridging, routing or processing functionality is required plus the voice over IP capability. So it’s actually distinct from any one particular access technology.

Joel Achramowicz – MBD Capital Group

Okay and you continue to go down that, your plans are to continue down that line to be independent of [inaudible]?

Faraj Aalaei

Absolutely yes.

Joel Achramowicz – MBD Capital Group

Okay very interesting. Could you also Faraj, since now you’re clarifying your operating model and I recognize that you may not want to give us ASAPs but maybe qualify the market sizes in your mind from a chip perspective you know in terms of total certain markets?

Faraj Aalaei

I think we’ve talked about you know some of these markets before and their size. You know we think for example the media gateway market is about a $200 million TAM. We think that the access portion which is the new and the fast growing part of that market you know within the next year or two let’s say can be anywhere from you know it will be around lets say $70 to $100 million TAM. And then of course on the CPE side which is where Atlanta plays at, that market is quite large but it’s quite diversified across many different networks and applications so the TAM for that is huge and you have to go and really look at compatibility of your product with particular deployment models. And as you know when we’re talking about the opticals, the biggest current optical market is Japan with Korea and China coming up, we think that this market you know obviously is going to grow tremendously once the China networks start after the Olympics start doing the deployments in earnest. I mean that can be quite a large market.

Joel Achramowicz – MBD Capital Group

Very interesting. Just an accounting issue Linda on the charge for excess space that was, could you just maybe describe that charge, it sounds like it was non-cash right or was it?

Linda Reddick

Well it’s not instant cash but its cash to spend over time in accordance with the remaining leads but we took a non-cash charge this quarter for abandoned space surplus space in the building that sits next door to us.

Joel Achramowicz – MBD Capital Group

Okay and then you’ll accrue against that or advertise against that?

Linda Reddick

Yes as time goes on. The lease expires in February 2011.

Joel Achramowicz – MBD Capital Group

Great. And then so we’ll have some restructuring cost probably in the second quarter of 08 some just residual restructuring?

Linda Reddick

Yes. Most of the restructuring will be done in Q1 but there will be some residual in Q2.

Joel Achramowicz – MBD Capital Group

Okay and then finally regarding your projection for cash which I appreciate, does that allow for paying off the $3 million in the credit line?

Linda Reddick

No it does not. It allows for $1.5 million of being paid off. That $1.5 million is against letters of credit which is against our normal operating business.

Joel Achramowicz – MBD Capital Group

Okay so there going to be obviously some charges for restructuring and severance and that kind of thing.

Linda Reddick

Correct.

Joel Achramowicz – MBD Capital Group

Okay well the company certainly seems cleaner now. Faraj now you just have to grow the top line in these chosen sectors but the cost model seems like its coming into line so good luck getting that revenue line to ramp this year.

Faraj Aalaei

Thank you very much. I think you know that the key points of the new company are you know we’re now into the markets that are growing by themselves and hopefully we can grow and increase our market share. We have really compelling products that the competitive landscape is favorable here because we have unique positions in these marketplaces and there’s high barrier to entry in at least some sectors of this market. You know our operation cost being low gives us leverage and you know hopefully we think we have by the way the design wins today in hand to get us to reach profitability so at this point it’s just executing on this plan and these initiatives.

Joel Achramowicz – MBD Capital Group

Would you say that you could achieve at least on a quarterly basis breakeven or profitability by the fourth quarter of 08?

Faraj Aalaei

We’re not giving any time because its really you know like I said the design wins have been won and now it is when these guys will start to turn up and how much they turn up. But, it’s certainly a possibility its not one that we’re promising but it’s a possibility.

Operator

Our next question comes from Anton Wahlman, ThinkEquity.

Anton Wahlman – ThinkEquity Partners, LLC

One thing, you went over kind of the center of the demand for GEPON here as it is in Japan and Korea and China and obviously this is all centered around certain portions of Asia but you know as you sort of dig deeper into the shells are there any at all sort of pockets of maybe the second tier carriers or you know whatever it may be build outs either in Eastern Europe or somewhere in among sort of second or third tier carriers in North America that are doing this or are they all going with the GEPON in those areas without any expectations at all?

Faraj Aalaei

My personal view just being out there and talking to people is that tide is actually starting to turn in favor of EPON and the reason for that is I think the volume deployment in EPON and Asians countries and their obsessive drive for lowering the cost of equipment is getting it to a point that its making it hard for GEPON to frankly be at anywhere near the same price point. And then at the same time if you look at what’s happening for example in Korea and what’s beginning to happen now in this next quarter in Japan. These service providers are starting to offer a full array of IPTV and you know video type services, broadband services over these EPON network infrastructure and as other service providers look at the reality of being able to offer all of the consumer businesses over EPON then there is no really need to go pay the higher expenses for a different kind of PON. And so I think the tide is turning and I think if you know we’re more focused looking frankly at the big telecos, I think the big telecos if they have any plans to do PON down the road there going to be looking at EPON with a lot more serious look than they have in the past.

Anton Wahlman – ThinkEquity Partners, LLC

Well I mean that’s very interesting and extremely interesting I mean I just had not seen a lot of sort of examples yet of that turning so you are actually in - I mean how would you characterize, are theses in discussion stages? Are they in trial stages or moving to?

Faraj Aalaei

I think that we’ve got to be careful with is that when we talk about GPON Anton as you know there aren’t really any GPON deployments to speak of any ways so those telecos that are seriously looking at PON as a you know investment strategy in their network are looking at both. They you know they we know of examples, I know of examples of telecos that have brought EPON equipment into their lab and looking at them at the same time as they’ve looked at GPON. Where as you know a year and a half ago for example they were you know they were basically GPON guys. So I think the tide is shifting, I don’t know of any deployments that were going to.

Anton Wahlman – ThinkEquity Partners, LLC

I understand their special in the context of GPON itself not having been really come out there. I’d be curious to see if you could maybe maybe if you could point to some articles or speeches, presentations or anything of the kind whether at conferences, [inaudible] conference that and obviously OFC is coming up here for that matter but by the sort of the almost CTOish types of reasonably major teleco say in Europe or North America where they’d refer to this path as something that they would hold out to be on par with or you know being discussed. I mean if you listen to the official proclamations as they arise and for example I just hadn’t recently heard that this was in the mix.

Faraj Aalaei

Right so as I come across that I’ll be sure to forward to you. But I think the key thing to remember is that frankly from a semiconductor perspective if you project forward let’s say you know into 2009, 2010 time frame I think you’ll find that there won’t be a lot of difference - that there is no advantage to be gained by doing something other than EPON and that EPON can give you all the services that GEPON was invented to do and EPON can give it to you perhaps even at higher speeds than what GEPON is standardized to be. So I think that’s all part of that trend moving in that direction. But you know we as a company frankly aren’t going to take one versus the other. We are in EPON today because that’s where the volume is and if we see volume generate in GEPON we have the know how to get into that market.

Operator

(Operator instructions). Our next question is coming from Al Shams with Mid South Capital.

Al Shams – Mid South Capital

Just a couple of brief questions. Number one you made a statement that you’re studying the feasibility of remaining a public corporation. I’m not sure I really understand what you mean by that. Secondly, why do we have so much stock-based compensation? Thirdly, with our cash balance why are we borrowing money against a line of credit?

Faraj Aalaei

Let me write your question down as I remember them. The last one was what?

Al Shams – Mid South Capital

Okay why are we borrowing money against the line of credit? Due to the fact we’ve got a strong cash position.

Faraj Aalaei

Okay so let me answer the first one and then I’ll answer the second one. The comment that we made about public company talked bout the cost reduction related to the services that we need as a public company. Those include for example you know accounting firm charges and things of that [inaudible] as we are now a smaller company, smaller revenue based, smaller number of sets of customers and transactions, you know we’re going to be relooking at those costs to see if we can drive those further down. That’s what that comment was. I’ll turn the stock-based compensation and the borrowing against the line of credit to Linda.

Linda Reddick

Regarding the line of credit we have borrowed $3 million against the line of credit, $1.5 million of it is actual cash but the real reason the $1.5 million is recording our letters of credit and it prevents us from having to put up individual CDs is what we’re using that for. The other $1.5 is that we at times borrow against our line depending on when - keep that commitment and provide us with some operational flexibility.

Al Shams – Mid South Capital

So you’re saying it’s more effective to utilize the line of credit then utilize your own cash resources?

Linda Reddick

At times it is, yes.

Al Shams – Mid South Capital

Stock-based compensation, is that in lieu of traditional cash compensation?

Faraj Aalaei

Well I mean you know we as a technology company providing you know stock options to employees is frankly a must here in Silicone Valley and to attract the talent you have to provide stock options to these employees across the board and so associated with that obviously is a stock-based expense. And relative to our run rate in the past which has been you know in terms of salaries and fringe benefits being I think in the $6 million range about $300,000 I think with stock-based compensation is actually a small number relatively speaking.

Al Shams – Mid South Capital

Well that’s per quarter so we’re talking about $1.2 million per year which sounds like roughly 25% of your cash expense. Is that correct?

Faraj Aalaei

Our cash expense, what do you mean?

Al Shams – Mid South Capital

Well I thought you just said you had a cash expense, total expense employee compensation expense around $6 million a year.

Linda Reddick

It’s approximately $336,000 of stock comp based this quarter. But additionally we accelerate our stock compensation. We’re using the multiple approaches which accelerate it. You’ve seen a high percentage of stock in the beginning years.

Al Shams – Mid South Capital

Well I’ll look at the option plan and that a little closer but in general I see stock option compensation as a reward for progress and improvement in profitability, it’s not really an entitlement, it’s a bonus for performance. That’s the way I see it and clearly we haven’t had that in this situation. Any comment?

Faraj Aalaei

Nope.

Al Shams – Mid South Capital

No comment?

Faraj Aalaei

No comment on that. You know as I said in order for you to attract and retain the talent you know, at least in the technology company’s in Silicone Valley if you don’t provide stock options to those employees you’re not going to get talent necessary to create the success that were looking for. We agree that success has been alluding us but I don’t think to solve that you can go and tell employees that you’re not going to give them stock options and have them all leave and then what do you have? It’s a balancing act.

Al Shams – Mid South Capital

That’s right. There is a balance but you know I think my point though is well taken that shareholders shouldn’t be paying for something until they receive it and you know this is expectation of receipt. We’ll see how it works out but you know certainly in the last couple of years it hasn’t paid off. Okay so those are the questions that I’ve got so we’ll see what transpires.

Operator

Our next question is from Michael Coady from B. Riley

Michael Coady – B. Riley& Co.

Just a quick follow up on a couple of things first of all you spend obviously a lot of your focus the large majority on Japan and the optical business and talk about China, Korea, Taiwan how quickly can you get into this markets and what are your expectations for Q4?

Faraj Aalaei

Okay Michael as I’ve said in the past is the Korean market is the market that’s open to us. We can go and compete in that market today. The China market requires a unique encryption engine that the Chinese have adopted that makes them different from others and our expectation is that in the next generation of products which I’m not ready to announce right now is that we are including those capabilities and we will be addressing that market. And I don’t think by the way, I think our timing for China market is actually very good because what China has done primarily been focused on EPON deployment prior to the 2008 Olympics and that’s kind of what they’re busy with now and we think once that’s done which is this summer they will start looking at the next phase of deployment and they will be looking at more competitive and more performance capable products and we think we can meet that head on.

Michael Coady – B. Riley& Co.

Okay thanks. And then, regarding the Q1 optical revenue going done as OFM [inaudible], OFM/NDT, given the you’re providing ONU, I would expect a little bit steadier ramps in OLT and how long do you expect that suggestion period to be? And then, just on top of that will you stick with ONU or will you ever go into OLT at least in this [inaudible]?

Faraj Aalaei

Okay, let me answer the last one first we actually have an OLT product that has been deployed in Japan market with the alternative you know access providers, including NTT communications. But in the NTT operating companies we are selling into the ONU market. If you just kind of look at what happened last year the first half of the year we had no revenues from PON business on the ONU side and then towards the end of Q3 was the first initial sort of like deployment, purchases from us which then got deployed in Q4, then we had a very nice large Q4. So this is the initial ramp for our customer who for the first time was starting to shift into the NTP network and then the new fiscal year which starts April 1st you know obviously there going to get basically at this point they qualified, they’re in the network so we expect that they will be getting additional orders coming in that will be significantly more than what we did in 2007. So the digestion period is more of an initial ramp shifting in Q4 and part of Q1 and then kind of going through a phase where they need to kind of wait and then gear up for Q2 and beyond. So I think it’s probably you know at two or three months where the shipments are going to be lower not a lot lower but lower than what we experienced in Q4. I don’t expect it to be long. To make a long story short. And the business by the way there is very healthy and the expectation is that this customer will do very well in the new fiscal year in Japan.

Operator

Our next question is coming from David Wright – Henry Investment Trust.

David Wright – Henry Investment Trust

Can you talk about the instruments that comprise your cash, cash equivalents and short term investments?

Linda Reddick

It’s basically these instruments are money market funds and cash. On the cash equivalent side, mutual funds and our investments are very liquid mutual funds and some corporate bonds. We have had a full look at our investments to see if there’s any risk given the current state of the economy and the subprime.

David Wright – Henry Investment Trust

And?

Linda Reddick

And our results have been fine and we’re going to look at it again before we file the 10K. We have no risks.

David Wright – Henry Investment Trust

Okay so you don’t have any option rate securities?

Linda Reddick

No not at all.

David Wright – Henry Investment Trust

Okay and I want to ask a question about cash and the lease termination charge which you may have answer because the operator came in to talk to me and I missed part of that particular question and answer. But you’re guiding Q1 end of quarter cash at about the same as end of Q4 cash and you’ve got $12 million coming in from the sale so where does the $12 million go?

Linda Reddick

Well the $12 million coming in is first off reduced by approximately $1.5 million of transaction cost and contingency payments. $1.8 million is in an escrow account so it’s not included in this right now, it’s a restricted cash amount for one year and additionally we are having some restructuring charges in Q4 of approximately $3.5 to $4 million and then we have our normal operating loss.

David Wright – Henry Investment Trust

Okay so is the $1.8 million in escrow included in your quarter end cash balance?

Linda Reddick

No it’s not.

David Wright – Henry Investment Trust

Okay and on this lease termination I heard a number $6 point something million dollars is that right?

Faraj Aalaei

No. The $6 point something million dollars were.

Linda Reddick

I think you’re referring to the restructuring charge of $6.5 million which we are giving as guidance for Q1. Most of it happened in Q1 and some of it trickled into Q2 and a portion of that is severance, buildings for surplus space and then software design tools.

David Wright – Henry Investment Trust

So you don’t have a lease termination charge?

Linda Reddick

No.

David Wright – Henry Investment Trust

My misunderstanding I apologize. Thanks for taking my questions.

Operator

(Operator Instructions) No further questions at this time. I will now turn the call back to Mr. Faraj Aalaei.

Faraj Aalaei

Thank you. Thanks again to all of you for joining us today. We appreciate your interest in Centillium and look forward to speaking with you along the way and on our first quarter conference all. We will be presenting at B. Riley & Company Las Vegas conference call and conference on April 2nd. If you’d like to set up a meeting there are or at any other time please call our investor relations line at 510-771-3611. Thank you

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