Vitesse Q208

Vitesse provided a “State of the Company” update, most likely it’s last ad-hoc quarterly call as audited results are expected to be made available by next quarter. We analyze their core business trends, including discussions about Chinese GE-PON, an update on EDC/SFP+ 10GbE, and the impact of removing distributor incentives. While Vitesse is cheap when compared to peers the risk of an unanticipated short-term revenue decline poses an unseen risk.

We have not written about Vitesse since last August, when we changed our opinion about the company after the announcement of the storage divestiture to Maxim (see “Vitesse Sells Storage“). The company’s valuation has dropped nearly 50% since then and merits closer examination.

Q208 Consumption was $55.5M, a figure that represents the dollar amount of product end-customers took delivery of. They expect to begin reporting a traditional revenue number once audited results are completed, though they expect to continue recognizing customer revenue on a sell-through basis, a move we applaud.

Revenue (Consumption) Breakout

	Q107	Q207	Q307	Q407	Q108	Q208
Consumption	$61	$57.5	$60.5	$60.9	$54.9	$55.5
Carrier	22.6	17.83	24.8*	27.2*	18.7	21.7
Enterprise	13.4	17.83	20.8*	21.0*	18.7	17.2
Non-core	25.0	21.85	14.9*	12.7*	17.8	16.6

* Nyquist estimates

 

Historical Revenue (Consumption) Reporting

	Q306	Q406	Q107	Q207	Q307	Q407	Q108	Q208
Consumption	$53	$59	$61	$57.5	$60.5	$60.9	$54.9	$55.5
Networking	28.1	28.9	29.9	29.9	32.7	36.5	27.5	29.5*
Storage	16.4	15.1	16.4	12.3	9.5	9.1	12.8	14.6*
Storage (Sold)		5.0	5.0	5.0	5.0	4.9	2.4	0
Ethernet	8.5	10.0	9.8	10.4	13.3	12.2	12.1	11.4*

* Nyquist estimates

The company has completed a remarkable transformation away from using distribution channels for revenue buffering and has sector leading DSO’s on receivables of 27 days- AMCC’s is 36 and PMCS’s is 33.

Vitesse indicated it has stopped offering 2% Net 10 incentives for rapid payment which will consume working capital while raising gross margins 2%. Their distributor, Nu Horizons, can borrow money at near LIBOR rates, and surely took advantage of this profitable arbitrage. Since Vitesse now has sufficient working capital it is a sensible move to end this practice. We see most small/mid cap semiconductor companies moving in the same direction (AMCC and PMCS are doing this) and expect this to impact the P&L of their distribution partners. (See (NUHC) )

Margin guidance was in the range of 55-60%, lower than what we had expected in the past. From the Q&A on the call it appears the company is not yet operating in this range but expect to shortly. The halt of payment incentives may accelerate this.

The company has opex of 23.9M with 3.0M of audit/legal fees included and is operating at it’s stated long term opex target is 21M, which is 38% of current revenue; AMCC is at 59% of revenue, PMCS is 49%. Vitesse’s operational efficiency is notable but what is not yet known is what whether the company can grow or even sustain revenues with this level of investment. We believe that focusing the company on Ethernet only and applying it to the carrier and enterprise markets should give it maximum cost leverage, but we do not believe that Vitesse that much more productive than AMCC and PMCS.

Other notes:

• Networking revenues were up but by our estimates not at the levels they were 9-12 months ago.
• Ethernet over SONET/SDH was highlighted as a growth area with revenues expected to ramp over the next 3-5 years. Vitesse claims 70 wins though this includes companion chips like Ethernet PHY’s and MACs.
• Huawei and IBM were the two 10% customers. China was strong compared with previous quarter
• The company won a GE-PON FTTH design in the ONU, or customer located box with their 6-port Gigabit Ethernet switch. This is almost certainly a design at Huawei or ZTE, which are two of the three leading vendors for the Chinese GE-PON deployment. Chinese GE-PON ONU shipments will not break 250k this year but this is a significant validation of the company continued leadership in low power Ethernet switch/phy technology. The likely silicon vendor alongside Vitesse is PMC-Sierra or Teknovus. More discussion of this topic can be found in the discussion of PMCS Q108 results.
• Vitesse re-iterated their success in the X2 module based EDC (referred to as 1st generation EDC on the call). Our checks conclude that while Vitesse is not yet out of the running for the next-gen SFP+ E
  DC (ultimately, a higher volume opportunity) they are not leading. Cortina and AMCC occupy this position.
• The company emphasized the potential of using EDC technology in backplane applications - referred to as KR. We believe this is the true high volume opportunity. Unfortunately for Vitesse it appears that Broadcom and AMCC have already made significant inroads in this area.

Conclusion 

While the progress made by the company over the last 12 months is admirable, particularly in supply chain management, we believe the company faces risk of a decline in non-core revenues. The cash flow issues of the previous 12 months without a doubt forced the company to accelerate the usage of non-core assets for cash through the use of aggressive end-of-lifes (EOLs). We cannot argue with this decision as it provided vital operating cash. But little detail has been provided on this issue and whether EOLs were conducted on products outside the “non-core” segment. The significant risk of a secular decline in revenues that we identified last August is still present.

Author is long AMCC and short NUHC