Aquantia Corp. (NYSE:AQ) Q4 2018 Results Earnings Conference Call February 12, 2019 4:30 PM ET

Company Participants

Deborah Stapleton – IR

Faraj Aalaei – Chairman and CEO

Mark Voll – CFO

Conference Call Participants

Ross Seymore – Deutsche Bank

Blayne Curtis – Barclays

Chris Caso – Raymond James

Quinn Bolton – Needham & Company

Hamed Khorsand – BWS Financial

Joe Moore – Morgan Stanley

Gus Richard – Northland

Charles Anderson – Dougherty & Company

Operator

Good afternoon and welcome to Aquantia’s Fourth Quarter and Year End 2018 Financial Results Conference Call. As a reminder, this conference is being recorded.

I would now like to introduce your host for today’s call, Deborah Stapleton. Deborah, you may now begin.

Deborah Stapleton

Thank you. Good afternoon everyone and welcome to Aquantia’s fourth quarter and year-end 2018 earnings conference call. With us today are Aquantia’s Chairman and CEO, Faraj Aalaei; and Chief Financial Officer, Mark Voll.

The purpose of today’s call is to provide information regarding Aquantia’s fourth quarter and 2018 financial results. During the course of this conference call, the company may provide financial guidance, projections, comments and other forward-looking statements regarding future market developments, market share gains, the future financial performance of the company, new products, or other matters.

We want to caution you that actual events or results may differ materially. We refer you to the documents Aquantia files from time-to-time with the SEC, including our most recent Form 10-K filed on March 7th, 2018 and Form 10-Q filed on November 7th, 2018. These documents contain and identify important factors that could cause our actual results — actual future results to differ materially from those contained in our financial guidance, projections, comments or other forward-looking statements.

In addition, any projections as to the company’s future performance represent management’s estimate as of today, February 12th, 2019. Aquantia assumes no obligation to update these projections in the future as market conditions may or may not change.

Also, the company’s press release and management statements during this conference call will include discussions of non-GAAP measures and financial information. These financial measures and a reconciliation of GAAP to non-GAAP results are provided in the company’s press release and related current report on Form 8-K, which can be found at the Investor Relations section of Aquantia’s website at www.aquantia.com.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 30 days in the Investor Relations section of Aquantia’s website.

And now I’ll turn the call over to Aquantia’s CEO, Faraj Aalaei. Faraj, please go ahead.

Faraj Aalaei

Thank you, Deb and good afternoon everyone. In the fourth quarter, we recorded revenue of $29.1 million, which is below our previous guidance range and represents a 12% sequential decrease from the prior quarter. Our fourth quarter results were negatively impacted by weaker than expected demand, primarily from our two largest customers in the data center and enterprise infrastructure markets.

For the year 2018, we recorded revenue of $120.8 million, which was a 17% year-over-year increase from 2017. Year-over-year, our data center business was down 2%, our enterprise infrastructure business was up 21%, our access business was up 350% and our automotive business was up 164%.

In 2018, we continued our strategy of investment in our new growth markets and they have begun to do well. Our non-data center markets grew 48% during the year, validating our diversification strategy. We anticipate these new markets — these new growth markets will continue to help the company expand and diversify its revenue base.

In 2018, we hit several major milestones. We won major designs in the data center switching market that we believe will significantly increase our market share of 10GBase-T, using our new chip — newest chip, which we developed and sampled in 2018. We anticipate production revenue from these design wins to start in Q2.

We also sampled our 40-nanometer products for the enterprise infrastructure market in 2018. As a result, we were able to achieve the broadest design win footprint in our history, ranging from campus switches to the new generation of Wi-Fi 6 wireless LAN access points. Many of these designs will ramp to production in the second half of 2019.

In the service provider market, we successfully launched the KDDI 10G PON service in Japan. We secured several key design wins in Japan market with other service providers and partnered with Korea Telecom to conduct 10G service trials to consumers in Korea.

In the client computing market, we brought several PC OEM customers to production who are now offering multi-gig solutions in their high-end workstations and performance PCs. The significance of this achievement is that we are now a qualified vendor at all major brand-name PC OEMs.

We introduced the world’s first five gigabit USB to Ethernet solutions suitable for mobility markets and enterprise class docking stations. The consumers with laptops that do not provide Ethernet connectors, this solution provides a high-speed, low latency option to connect to the high-speed network in their home or work environment. This is another brick laid in building out a multi-gig ecosystem.

We secured four new design wins with our first-generation automotive products. We believe these design wins will start generating revenue later this year and will accelerate into 2020 as a first car manufacturers reach start of production on the next generation of automotive vehicles.

We continue to be very active contributors in the IEEE work towards standardization of multi-gig for automotive and are happy to report that the first draft was published in January.

Now, let me go through each of our end markets to provide more details on our fourth quarter results and our outlook for each market for 2019. First, I’ll start with our data center business.

As you might remember, in our Q3 conference call, we said that the demand for data center servers have softened based on initial input from our customer. As you all know, in their Q4 earnings call, Intel disclosed the weakness in end-market demand for their data center business.

The softness in demand that started in Q3 extended into Q4, subsequently, our shipments to the server market were reduced in the fourth quarter. As a result, our revenue in the data center market was down 60% [Later corrected by the company to 16%] for the fourth quarter when compared to the prior quarter.

Whereas in the past, when market demand continue to grow, the challenge was to properly manage inventory at our customer. This time, the market demand actually declined, leaving our customer with excess inventory that they had planned to ship.

Subsequent to our last earning call, we received additional information from our customers through late January, reducing their forecast even more substantially. As a result, a sizable inventory has built up at Intel, which will take several quarters to reduce the desired levels for our customer, which in turn, has required us to lower our revenue forecast accordingly for 2019.

To be clear, this is not resulting from the loss of a socket or a design, but a combination of softening end-market demand in 2019, whereas a significant increase was previously anticipated, and the resulting buildup of excess inventory at our customer as a result.

Our shipment revenues to Intel in 2018 were $59 million. Due to the significant change in our customer forecast, we now estimate that the end-market demand for our products in 2019 will be approximately $40 million, which will be served through a mix of new orders of $20 million and the use of excess inventory of approximately $20 million.

Turning to enterprise infrastructure, our business grew 21% in 2018. However, we experienced a slowdown in orders in Q4. As a result, the enterprise infrastructure business was down 29% in the fourth quarter compared to the prior quarter.

The unexpected decline in Q4 stems from the fact that during the quarter we did not receive the purchase orders we were expecting from Cisco. This is due to multiple reasons, starting with inventory buildup with the customer and the transition from their existing products based on our chips to our newer design wins. We believe this is a temporary situation as the fundamentals in the enterprise infrastructure are strong and we expect this business to bounce back in Q2 and return to sequential growth.

Conversely, during the quarter, we saw strong revenue growth from most of our other enterprise infrastructure customers and we expect this trend to continue in 2019. We believe that one of the key growth drivers of multi-gig in the enterprise infrastructure is attributable to the deployment of latest Wi-Fi standards, 802.11ax branded Wi-Fi 6.

As we have previously stated, all our enterprise infrastructure customers building products to this new standard are bullish on the opportunities in 2019 as they believe that Wi-Fi 6 will become a significant driver for multi-gig adoption in the enterprise.

Our access business composed of carrier access and client connectivity was up more than 100% compared to Q3 and up more than 200% compared to the fourth quarter of 2017, as revenues from both markets were up significantly.

As we previously mentioned, our initial efforts in the carrier access market where we deliver multi-gig Ethernet ports on next-generation home gateways, saw early adoption, predominantly in Asia.

I’m pleased to announce that we have now secured significant new design wins in the Japan market, cementing our overwhelming position for this technology in the service provider market in Japan. This win is a result of the high-performance and level of integration in our products compared to our competitors offerings.

This is a remarkable achievement and represents a significant revenue opportunity for us. Using the previous rollout of Gigabit Ethernet PON in Japan for guidance, which started back in 2002, we currently estimate the cumulative revenue opportunity for us in Japan is to reach more than $330 million over the next five years, starting in 2020.

As you are aware, we have been shipping in this market throughout 2018 with KDDI, and we are pleased to confirm that other Japanese service providers are now planning 10G PON deployments in Japan.

We also continue to make progress with our partnership with Korea Telecom in delivering multi-gig service to their subscribers. At this time, we are conducting field trials and have received our preproduction orders with the potential for wide-scale deployments in 2019. Given the number of households in Korea, we currently estimate that the Korean service provider market opportunity for multi-gig could be very significant for us as well.

As part of our connected home effort, at CES, we demonstrated the benefits of multi-gig and Network Attached Storage or NAS, making it faster for users to access their high-resolution movie libraries, large files, and backups.

The engagement with storage providers like QNAP and Buffalo continues to show promise as these vendors see the value in offering multi-gig in their own systems as part of a high-speed connected home network.

We also announced our collaboration with Qualcomm to support the design and implementation of Wi-Fi 6 routers targeted at retail access points and gateways. We expect multiple OEMs to introduce products into the retail market in 2019.

Within our Access market, our client connectivity business was also up significantly in the fourth quarter, in line with what we forecasted on the last quarter — quarterly earnings call. The strength we are seeing in this market is coming from a broad range of PC manufacturers adopting multi-gig capabilities in their next-generation computing platforms. These include design wins for our Multi-Gig AQtion controller, which is designed directly on the motherboard, called LAN on Motherboard or LOM.

This significant as LOM design means that multi-gig feature is not an option, but shifts by default to all customers, selecting the particular platform greatly increasing the served addressable market.

We continue to see more opportunities with these customers and believe we’re seeing an acceleration in the option of — in the adoption of multi-gig LOM implementations. Companies like ASUS, Dell, Gigabyte, and more are offering multi-gig LOM on high-performance PCs and workstations. We anticipate additional LOM designs to enter the market in the coming months.

Likewise, we are seeing an acceleration in the adoption of our AQtion products by computer and peripheral device manufacturers in the form of a Thunderbolt or USB to multi-gig Ethernet controllers enabling our customers to build innovative multi-gig Thunderbolt and USB Type C docking stations and dongles.

Turning to the automotive market, we continue to gain traction with U.S. and global car manufacturers. I’m pleased to announce that we have secured our first automotive OEM design in China, and have already supplied samples for building the first prototypes.

We now have a total of four automotive design wins to our credit, covering three continents with more active engagements in the pipeline. Based on production forecast we’ve received from our automotive customers, we now expect that our 2020 revenues from automotive will be in the range of $5 million to $10 million.

We also announced today that we have entered into an agreement with Sumitomo Electric for us to support new capabilities in our accelerated automotive devices to meet the needs of Sumitomo’s global automotive customer base. Sumitomo is a major Tier 1 technology supplier with a broad range of products for the automotive ecosystem.

Sumitomo Electric’s automotive business generated more than $15 billion in revenue in 2018. Sumitomo will provide connectors, cables, and subsystem capabilities with our accelerate multi-gig Ethernet products that are targeted for in-vehicle networking, enabling new levels of autonomous driving.

As part of the agreement, Sumitomo will provide a strategically significant NRE funding to Aquantia for this development. The agreement will give Aquantia increased exposure to Japanese OEMs as well as Sumitomo’s other international customers.

According to Strategy Analytics, the total number of Ethernet port shipments in Automotive is projected to reach about 600 million ports by 2023. This will make automotive one of the largest market opportunities for Ethernet connectivity in the future.

Finally, let me say that we’re obviously disappointed in our fourth quarter results and our guidance and outlook for our data center business — server business — data center server business in 2019.

While the drop in Intel revenue is a headwind that we cannot completely overcome this year and despite the current inventory level challenges across our industry, we expect non-Intel revenues to continue to grow more than 35% in 2019.

In fact, we expect that each and every one of our non-Intel businesses will see revenue growth in 2019. The growth rate of our non-Intel revenue is the barometer for where our company is heading and how we are executing on our diversification plan.

We are focusing on the aspects of our business that are within our control, namely executing on a technology road map, bringing new products to the market, and securing new customer design wins to expand our footprint.

To bring things into perspective, we estimate that the cumulative SAM opportunity in our enterprise infrastructure and access markets is approximately $2 billion over the next five years, growing at a CAGR of 57%.

We look forward to returning to sequential revenue growth in the second quarter and our expectation is to return to positive comparisons in Q4. We also expect to sequentially reduce our operating losses throughout the year and plan the year with the breakeven results in Q4.

With that, I would like to turn the call over to Mark for more details on the financials for the fourth quarter and 2018 and provide our guidance for the first quarter and outlook for all of 2019.

Mark Voll

Thank you, Faraj. Let me begin with a review of our financial results for the fourth quarter of 2018. Revenue for the fourth quarter was $29.1 million, below our guidance range of $33 million to $34 million. Fourth quarter revenue represented a decrease of 12% compared to $32.9 million in the third quarter and an increase of 5% compared to $27.8 million in the fourth quarter of 2017.

Data center product revenue consisted of $14.7 million or 50% of revenue, representing a decrease of 16% from the third quarter and a decrease of 14% from the fourth quarter of 2017.

Enterprise infrastructure product revenue was $8.9 million or 31% of total revenue, a decrease of 29% sequentially and a decrease of 1% compared to the same period a year ago. Access product revenue was $5.4 million or 19% of revenue, representing an increase of 107% from the third quarter and an increase of 224% from the fourth quarter of 2017.

Automotive product revenue was $113,000, representing a decrease of 56% from the third quarter and an increase of 106% from the fourth quarter of 2017. As you recall, this revenue was from sample shipments to various customers.

Gross profit in the fourth quarter was $15.7 million or 54% of revenue. This compares to $19 million or 57.9% of revenue in the prior quarter and $16.1 million or 57.7% in the prior year fourth quarter.

In terms of our operating expenses for the fourth quarter, total operating expenses were $21.1 million or 72% of revenue. Operating expenses of $21.1 million compared to $21.3 million or 65% of revenue in the prior quarter and $17.1 million or 61% of revenue in the fourth quarter of 2017.

Total non-GAAP operating expenses were $18.9 million or 65% of revenue compared to $19.2 million or 58% of revenue in the prior quarter and $16.4 million or 59% of revenue in the fourth quarter of 2017.

Loss from operation was $5.3 million or 18% of revenue. This compares to a loss of $2.2 million or 7% of revenue in the prior quarter and a loss of $1 million or 4% of revenue in the prior year quarter.

Non-GAAP operating results was a loss of $3.1 million or 11% of revenue. This compares to a loss of $102,000 or 0.3% of revenue in the prior quarter and a loss of $0.3 million or 1% of revenue in the prior year quarter. Non-operating income in the quarter was $358,000 consisting mostly of interest income.

Turning to income tax, our tax provision in the fourth quarter was $525,000 compared to our prior guidance of $400,000 for our fourth quarter tax provision and compared to a charge of $143,000 in the prior quarter.

Our fourth quarter GAAP net loss was $5.5 million or a loss of $0.16 per diluted share compared to the prior quarter net loss of $2.1 million or a loss of $0.06 per diluted share and a loss of $1.1 million or $0.05 per diluted share in the fourth quarter of 2017.

Excluding $2.3 million of stock-based compensation, our non-GAAP net loss in the quarter was $3.2 million or a loss of $0.09 per diluted share. Our fourth quarter net loss compares to the prior quarter non-GAAP net income of $66,000 and a non-GAAP net loss of $0.7 million or a loss of $0.03 per diluted share in the fourth quarter of 2017. Our fourth quarter 2018 loss per diluted share was calculated using 34.9 million shares.

During the quarter, we had two customers representing more than 10% of our revenue. Intel was 46% of our revenue and Cisco was 19% of our revenue in the quarter.

Turning briefly to the full year results, revenue was $120.8 million, an increase of 17% from the $103.4 million in 2017. Gross profit was $68.4 million, representing gross margin of 56.6%, an increase from $59 million and margin of 57.1% in the prior year.

Loss from operations was $10.5 million or 9% of revenue compared to a loss from operations of $3 million or 3% of revenue in 2017. 2018 GAAP net loss was $9.8 million or a loss of $0.29 per diluted share compared to a loss of $5.4 million or a loss of $0.59 per diluted share in 2017.

On a non-GAAP basis, our 2018 net loss was $3.2 million or a loss of $0.09 per diluted share compared to non-GAAP net income loss of $2.7 million or a loss of $0.30 per diluted share in 2017.

Now, let me present our guidance for the first quarter of 2019. Revenue is expected to be in the range of $19 million to $21 million. Our revenue guidance takes into account reduction in orders as our data center, enterprise infrastructure customers sell off excess inventory. As Faraj had said, we expect that each and every one of our non-Intel businesses will see revenue growth in 2019.

Gross margin is expected to be in the range of 53.5% to 55.5% in the first quarter. Our first quarter gross margin will be affected by the lower revenue level in the quarter. We expect to see sequential gross margin growth back to within our target model range of 57% to 62% as our revenue returns to previous levels in the fourth quarter.

Our GAAP operating expenses for the first quarter are expected to be in the range of $20.5 million to $23 million, which includes stock-based compensation expenses in the range of $2.3 million to $2.5 million.

We estimate interest income to be $300,000 and interest expense of $170,000 related to the new lease accounting pronouncement. We estimate our tax provision for the first quarter to be $200,000, and we estimate our first quarter 2019 earnings per diluted share will be calculated using 32.25 million shares.

With regard to our balance sheet, at December 31st, 2018, our cash, cash equivalents, and short-term investments were $67.4 million compared to $67.3 million at the close of the third quarter. Cash flow from — cash flow used for operations in the fourth quarter was $1.3 million compared to cash flow from operations of $7.2 million in the prior quarter.

Accounts receivable of $16.9 million represents 51 days sales outstanding, which compares to $15.8 million or 44 days sales outstanding at the end of the prior quarter. Inventory of $14.5 million represents 3.6 turns compared to $15 million or 3.5 turns in the prior quarter.

That concludes our prepared remarks. Operator, you may now open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. And ladies and gentlemen we will now begin the question-and-answer session. [Operator Instructions]

Our first question will come from Ross Seymore, Deutsche Bank.

Ross Seymore

Hey guys. Just I want to ask a little more clarification on the linearity going forward. And I guess, first and foremost, kind of, what happened during the quarter. I get the inventory side of things, but on the Intel side of the equation, you said it went from $59 million in 2018, now you’re expecting it to be $40 million. Is that the Intel portion or is that data center? And kind of how do you expect the linearity of that inventory burn to go in?

And then similar sort of question on the Cisco/enterprise side. That sounds like that was the bigger surprise in the fourth quarter. What gives you confidence that that doesn’t pull, I guess, an Intel in this case and have an inventory burn that last longer than you’re forecasting into just a rebound in 2Q?

Faraj Aalaei

Okay. So, I think, the question on the Intel side was just explained into more detail. So, in 2018, we shipped $59 million worth of product to Intel. And the reason that — so looking at Q1 and Q2 of 2018, the volumes were growing really nicely. The end market demand for those devices were growing very nicely.

In Q3, the end market demand started to actually head the opposite direction. It started to go down and that’s when we were on the call and said that, hey, we’ve been notified that Q3 didn’t go well, so there’s going to be some softness in the marketplace.

Then you basically kind of take that and fast-forward a couple of months in various iterations, meaning, it became very clear that what we had all ourselves and the customer had thought was going to be actually a growth year a number of ports in 2019, ends up being actually a significant reduction from that view. And so, like I said, these corrections continued all the way up until kind of late in January.

And where it sits today is that we think that the end market demand is going to be $40 million worth of Aquantia’s chips and $20 million of that, they are just going to basically use inventory that they have piled up because of the trajectory that they were expecting and the other $20 million would be product that we would ship to them in 2019. So, our net revenue from them in 2019 is going to be approximately about $20 million. So I think that kind of — that’s the math at Intel.

At Cisco, it’s a bit different at Cisco, because in Cisco you’ve got first of all lots of difference product portfolios that are transitioning from older generation of our device to a new generation of our device. And the overlap is basically it’s kind of a product transition challenge that we’re going to go through. And we think that by the time Q2 comes around, we’re going to be bouncing back up in the right direction at Cisco.

And then the number of SKUs that are being added in 2019 is a lot more SKUs also being added and there’s also the AP business that we expect to grow in there. So, there’s a lot of factors in Cisco that are going to help propel us in the right direction once we get through Q1 — Q4 and Q1.

Ross Seymore

Thanks. That color was helpful. I guess a quick follow-up for Mark. Obviously, you can’t cut OpEx anywhere close to the magnitude of what’s happening in revenue now. But just talk about how you’re prioritizing OpEx and general linearity of what you think OpEx will do in 2019? Thanks.

Mark Voll

Sure. So, we originally expected the increase in revenues during the year, that’s not going to happen. So, we’re cutting OpEx where it’s not necessary or we were planning for some growth. So, we looked at OpEx will largely be flat, so we’ll be incurring some — we’ll be in the loss — incurring significant losses in the first half of the year. But we think as growth comes back in the second year, we’ll be in pretty good shape at that point in time.

Ross Seymore

Got it. Thanks guys.

Operator

Next up we’ll hear from Blayne Curtis, Barclays.

Blayne Curtis

Hey guys, thanks for taking my question. May be just following up on the data center, Faraj. I was just curious you once thought this business will be $60 million of demand, now it sounds like $40 million. So, one, just bridge the gap as to why that disconnect? I know Intel servers have been recently bought, but not by that degree?

And then I guess, as you extrapolate out in 2020, when do you think this bottom — do you think this market can stabilize with solely demand or do you think it continues to fall off?

Faraj Aalaei

So, in 2019, as I said, the original plan or the original forecast for 2019 heading into the earnings call was — Q3 earnings call, was that 2019 was actually going to see a significant growth relative to 2018 in end demand.

And as it turns out, it’s not only not going to see a significant increase; it’s going to see a decrease, right, and that’s what creates that large delta in inventory and that access inventory.

Now looking forward, beyond that, frankly, we don’t see any kind of, let’s say, a competitive type situation that’s going to be reducing the 10GBase-T deployment. This from what we understand is primarily driven by expectation that there will be fewer servers perhaps. That there will be — there is some stuff going on in China that maybe impacting the business.

So, beyond 2019, we see no reason to think that the shipments won’t actually get back to some kind of growth, but it’s very hard to say at this point. We are too far from that to say.

Blayne Curtis

Thanks. And then maybe just a question for Mark. I’m curious on the gross margin. Obviously, I understand the reset with the volumes. But I thought you said you could get back in the range and I guess, by Q4 of 2019. Does that mean, if you look back at — when you’re in that range what the revenue levels is, do you need to get back to that $30 million a quarter to get there?

Mark Voll

That’s correct, yes. So, we’re looking back at most recent quarter we did we were short of $33 million in Q3 of 2018, and we were at 58% gross margin. We need to be back around that level.

Blayne Curtis

Got you. And then if I could just squeeze in one. On the access side, that actually came in nicely, I’m kind of curious, Faraj, you talked a lot about service provider, but can you just talk about what contributed to the performance in December?

And then just I’m trying to understand on a sequential basis into March, all your segments down or could Access still grow? Thanks.

Faraj Aalaei

Okay. So, with respect to the access business, we are seeing, as we have said before, a tremendous interest on the part of the Asians or kind of deploying this 10-Gig PON technology or 10-Gig service technology. And last year, we started to deploy our first one with KDDI and that’s been growing nicely from a customer perspective.

And towards the end of 2018, in December, there were actually several decisions made by other service providers to move forward, make final decisions, if they’re going to move forward, but also getting into the race for the 10-gig service to their customers.

So — and we’ve done a fantastic job — I think our team did a fantastic job of covering all the suppliers and service providers in that market and have done — cut ourselves a very nice footprint.

Now, some of these service providers are going to start deploying in the first half. Some of them, the bigger ones, are going to — I mean, towards the tail end of the year, let’s say, Q3, Q4 timeframe. And as they do, our revenues from, particularly in Japan, should start to see a really nice growth in the step function, I think, in 2020.

And so I thought we have said before of our three ports of multi-gig chips on a per home basis. And given the past track record of these service providers in deploying PON service in their municipalities, we are very bullish about what that means to us.

Blayne Curtis

Okay. Thank you.

Operator

Next up from Raymond James is Chris Caso.

Chris Caso

Yes, thank you. Just on the data center business and I guess, trying to understand what’s going on with end demand there. Obviously, Intel’s data center expectations are lower than probably what, they thought around midyear. So, that explains inventory, but I guess I’m still have more trouble understanding the decline in end demand down to $40 million.

Do you feel — and I guess enterprise servers are not dropping at that rate, do you feel that it’s — the demand for 10-gig ports within those servers, that’s declining and what’s the substitute for that? Or is it perhaps some degree of share of the Intel solution that you sell into? And where do you think that the business is going, if that’s the case?

Faraj Aalaei

Okay. So, as I said in my prepared statements, we are not aware of a loss of socket. We don’t see that at Intel. We also think that Intel itself has not lost any significant kind of market share to its competitor. So, when you try to find answers for why the outlook changes over basically a two-month period to three-month period so drastically, it comes — it has to be done as a result of some macro-level issues.

And if you think about 10GBase-T or frankly any kind of networking opportunity in the server, it’s a function of the attach rate of the servers. That attach rate can come from two places. Folks deciding they don’t want to use 10GBase-T in the enterprise, they want to use some kind of higher speed technology or lower speed technology or whatever the case may be, that’s one.

But the second one could also be that they’re just not planning to buy as many servers in 2019. So, those are the couple of places we think that this might be coming from.

A third element that we know we have had some of these basically servers we bought, obviously in China market, and if there is any slowness going on in the China market, that would answer some of the indications there, that, that could be the part of the market that’s softening.

But all-in-all, it’s not because we’ve lost a socket at Intel or that Intel has lost a big part of its market share to somebody else and that’s the best information we have at this point.

Chris Caso

All right. Thank you for that. I guess, similarly on the enterprise business, perhaps you can go into some more detail about the product transition that you’re anticipating there, that’s having some affect right now. Is that also — did Cisco build some inventory ahead of this transaction? Was it a surprise transition? Perhaps walk us through that and your level of confidence that the business returns to growth in the second quarter?

Faraj Aalaei

Yes. So, we’re in — bunch of these platforms switching — this is mostly a switching side of the business. So, we’re a bunch of these platforms and these platforms have stayed with Aquantia throughout multiple generations. And we had been — Cisco, from time-to-time, obviously, when it launches a product, it looks to basically then cost reduce by using next-generation technologies that are lower power, lower costs. So, we had won those platforms again, so they’re value engineering-type products.

So, what happens is the vendors typically buy chips from both sides, hoping to have a smooth transition of one versus the other. And sometimes when there is — that transition doesn’t happen in that period of time, you kind of start to buy from both. And then you decide you want to do the transition; you don’t need as many ports yet. So, that’s the dynamic that typically happens in these kinds of product transitions and it’s happened to us in this particular case.

So, why it is not a long-term thing is because we see those products getting ready to go to production, those value engineered-type platforms. So, we expect that once they kind of eat up some of the early inventory on those, that the POs would be coming and we’re seeing indications of that already.

But on top of that, we have worked and have won several designs and different platforms and different products at this customer that we expect to start to launch as we go through the year. And those will be also like new SKUs, new platforms that for which we would be receiving orders and ramping up in those more advanced platforms.

So, that gives us comfort that we’re on the right track here. And obviously, with both Intel and Cisco, frankly, the relationships are very good and very positive. Good partnership on both fronts, so.

Chris Caso

If I could just — one follow-up to one of the things you mentioned with the value engineered products. On these new products, next-generation products, is your dollar content similar? As cost is coming down, is that a lower cost per port? And if so, there’s an implication there?

Faraj Aalaei

Yes, every generation of our products, I mean, this is bread-and-butter of semiconductor industry, every generation of products we provide are going to be lower power and lower ASPs. But you do that with the idea that your customer gets that benefit and drives a deeper penetration in the volume and the ports are going to grow. And every indication that we see by the way in the multi-gig market is that, that is the case.

The ports are growing. A lot of the folks as I said in my prepared statements are almost consistent across the board that with the ax products being launched or anticipated launch of ax, a lot more of the IT managers are looking at switches they’re buying and the platforms they’re buying. These are seven-year purchases, and they know that they have to have the multi-gig. So, the number of ports for, let’s say, platform that shifts is increasing. And everything in that area to us looks good and looks aggressive growth.

Chris Caso

Thank you.

Faraj Aalaei

So, just to complete that thought, like, if you take away the issues that we’re going through at Intel, the rest of our business, all of the multi-gig stuff that we’re doing, we’re expecting this year to have over 35% growth. So, that comes from the fact that there is a lot going on in this market, and we’re doing well in all these other sectors.

Chris Caso

Thanks.

Operator

Our next question will come from Quinn Bolton, Needham & Company.

Quinn Bolton

Hey guys, I know you’ve got a lot of questions on the data center. I guess, my question is, if your demand is $20 million of products that you’re shipping, how do we think about that through the year? Or do you not ship anything in Q1, Q2, and you get to kind of a $10 million per quarter run rate, which would be in line within consumption, do you expect more linear shipments through the year. Just help us shape the data center business with Intel in the four quarters of 2019? And then I’ve got a couple of follow-ups.

Faraj Aalaei

Sure. So, as you know, we’re shipping Intel three products. We ship them the ASIC, which was a 40-nanometer, and ASIC at 28-nanometer and a PHY at 28-nanometer. It turns out that the inventory level for these three chips is different and the demand pattern for them is different. I guess, depending on which platform they’re on at their customer, right?

So, where we are going to be shipping during this year for the next, let’s say three or four quarters is going to be lower in the first half, let’s say, right? And then kind of increasing — gradually increasing in Q3 and Q4 of 2019.

Our estimate is that they will be buying $20 million based on the forecast that they’ve given us by product, right. They’re going to need $20 million of fresh product shipped to them and they’ll be chewing up inventory — a lot of inventory that they’ve been collecting over the last couple of years, I guess, with anticipation of this market growing. They’ll be just basically consuming that inventory, so that by the end of the year, by — you get to Q4, they expect their inventories to be exactly kind of where they want it.

Now, as you recall, these things have happened in the past. The last time this happened to us was 2016. And in 2016, we went through a correction then, early in January of 2016, essentially. And then when we came back, it came back and the year actually ended up a lot better than was originally thought at the beginning of that year.

We’re not counting on that this time, because obviously as a public company, we have to count on what we’re told and relay that information. But based on the information that we have, the $40 million consumption, $20 million of it from buying new products they need and the other $20 million basically using a lot of inventory deflected in areas where they see weakness. So, that’s roughly those are the two numbers to keep in mind.

Quinn Bolton

Okay. And the second question on the data center business. You had mentioned on this call that the new 10GBase-T switch business starts to ship in the second quarter. Can you give us any sense how large of an opportunity that might be in all of 2019? Is that a $5 million to $10 million kind of range? Or how we should be thinking about switches that potentially comes in to help offset some of the weakness you’re seeing at Intel?

Faraj Aalaei

Yes. So, it’s too early to say. We know that the platforms that we have won have a major market share in the market today. And as they start to ship, the first platform starts to ship in Q2, and then they’re going to add more platforms basically in Q3 and throughout the year.

And so we expect it to be, let’s say, a material type of revenue coming from this customer in 2018 — 2019, starting with second quarter. But if I had to give you a range, it would probably be $5 million to $10 million this coming year.

Quinn Bolton

Okay, great. And then lastly, just you mentioned the increased traction in service provider market in Japan. If I remember, certainly right, you’ve got sort of three large service providers in Japan that account for 90%-plus share of the market. I know you’ve publicly talked about the KDDI win.

As you look at your Japan business and these other Japanese service provider start to ramp, does it include one or both of the other large service providers? Or are these design wins are some of the smaller Japanese providers?

Faraj Aalaei

Yes, no these are not small Japanese providers. These are the major ones. So, unfortunately, we can’t name names, but these are the ones that build the Japan infrastructure.

Quinn Bolton

Right. Thank you.

Operator

Our next question today comes from Vahid Khorsand, BWS Financial.

Hamed Khorsand

Hi, thank you for taking the call. First question, it looks like your inventory declined year-over-year and sequentially. So, the $20 million of new product revenue from Intel this year, that’s not inventory on hand right now, is it?

Faraj Aalaei

No.

Mark Voll

No.

Hamed Khorsand

Okay. So, none of the inventory that you’re showing now is Intel-related, so there is no price discount that may come out later in the year that you need to move the inventory? That’s what I’m trying to figure out.

Faraj Aalaei

No, we don’t have any risk of the — with respect to Intel, we don’t have any risk of inventory write-down or anything. No and no, we’re not providing discount to move products. We much rather have actually our customers take the natural demand.

Hamed Khorsand

And then, I think I just heard you, Faraj, say that this was inventory that Intel had built up over the years. And just the demand from their end-user customer base did not materialize as they expected. Going forward, I mean, what are the steps you could take to maybe manage that inventory and sales flow better?

Faraj Aalaei

Sure. It’s a good question, and one, frankly, that we spent several years kind of dealing with. First of all, we spend a lot of time with our customers at Intel. They are from all different levels. And I personally go spend a day every quarter in quarterly business review and discuss what’s happening in the marketplace and compare notes and so on. So, this is a very good customer of ours, good relationship and so on and so forth.

So, in the past, what we’ve done is, we put in processes in place to match basically customer forecast to Street models, from forecast from, let’s say, analysts — industry analysts and our knowledge of what’s going on in some of the markets, right?

And then what we tried to do is to stay close to our customers. And when we see those things are getting out of whack with what the customer is buying, we kind of make a point of having a discussion about it and what they see that we’re not seeing, so on and so forth.

Now that has done us well since beginning of 2016 to now. So, why this happened again? Well, this time is actually the problem is different. In that — whereas, in the past, it was always a growth market year-over-year, and to the right, it was easier to do this when you have a sudden turn on the other direction. So, there are two ways to look at this.

One is, okay, what’s the ship out? What’s the demand decrease year-over-year, 2018 to 2019? But the other one is what is the 2019 forecast now relative to 2019 forecast four, five months ago? And that’s where the biggest gap is, and that’s where the trap is for falling into a lot of inventory sitting at your customer. Where the customer has a large forecast and has given you POs and is demanding that you ship them and you see no other data that obviously goes the other way. You ship that and you build that.

And the way the customers look at this is not necessarily by dollar inventory, but by weeks of inventory. So if your forecast continues to grow, your weeks of inventory you have to have on hand continues to grow. But when the forecast heads the other way, that’s the problem, right?

So, whereas, looking at it in June, weeks of inventory on hand that the customer may have looked reasonable given that their view at that point in time of what their forecast was going to be, it becomes unreasonable when you look at it in January of 2019 and that’s the dynamic that has been at work.

Hamed Khorsand

Okay. Thank you for all that detail. And then just capacity speaking, as you’re talking about this now too and you had mentioned about diversifying away from Intel. This seems like one of those opportunities where you can diversify away from Intel and plug in other customers. Is that a risk to capacity where, let’s say, in a year from now if Intel comes back, you may not have the capacity to deliver the POs you’re looking for or–

Faraj Aalaei

No, I don’t think we have any kind of capacity issue. And these — remember that these that were parts that we built for Intel, are purpose-built parts for them, so that there is a process in place between us and Intel, which gives us ample lead time to actually build what they need. We actually build — most of what we build is we built to order because it is the device that’s got — it’s their device and we can’t sell it to anybody else.

So, it’s very simple — in fact, from a PO perspective, it’s very simple. They give us enough lead-time and orders that we go built for them. So, there is no risk of obsolescence and there is no risk of us not being able to build. But our partners, assembly and wafer partners, have supported us when there’s been significant rams going up. So, I don’t anticipate a problem there.

Hamed Khorsand

Okay. Thank you very much.

Operator

Our next question comes from Joe Moore, Morgan Stanley.

Joe Moore

Hi. With regards to the OpEx, it seems like it is quite a bit higher than I thought it would be. And I guess, in the context of the revenue shortfall, I know you said you’re sort of cutting in initial expenses. But what — is that going to be the Q1 number kind of representative of the full year? And then is there a thought if this revenue doesn’t come back quite as quickly that you can be flexible around that to actually think about spending levels?

Mark Voll

Yes, so I think that we — the spending level that we’re giving guidance for Q1 will be at or slightly higher than what we’ll see during the year. We don’t see much change there. Again, we’ve tried to cut back on any operating expenses that’s not really necessary at this point in time. And again, we see growth, particularly — a sequential growth, throughout the year and we think that by Q4, we’ll be back up to record levels where we were in Q3 of 2018.

Joe Moore

Okay, that’s all I had. Thank you very much.

Operator

Next up, we’ll go to Gus Richard, Northland Capital Markets.

Gus Richard

Yes, thanks for taking my question. The AR’s jumped $1.1 million sequentially; can you just give a little color on why that bumped up in the quarter?

Mark Voll

Yes, that’s typically because most of our customers are closed for the holidays. And so, our cash receipts are such that we — really is little or no cash receipts. So, as a result, the DSO increases at typically year-end. We don’t expect that to continue in Q1. We expect to be back to a level of about 45 days sales outstanding, which we have typically been throughout this year.

Gus Richard

Thanks. And then as a follow-up, trying to understand what’s going on in the data center. Is there possibly a transition away from 10GBase-T to Twinax potentially? And the market size for the 10GBase-T is actually smaller than what you all were thinking or is that a possible factor?

Faraj Aalaei

I honestly don’t think so. I remember that the Twinax was there three years or so before 10GBase-T was first started shipping. And all of the trends over the last few years of 10GBase-T has been shipping has been Twinax either constant or going down and the 10GBase-T has been going up. In fact, Twinax has been going down. 10GBase-T is going up. So, no, we don’t see that as a potential reason.

Gus Richard

Okay. Thank you.

Faraj Aalaei

Thank you.

Operator

From Dougherty & Company, Charlie Anderson, your line is open.

Charles Anderson

Yes, thanks for taking my questions. I’ve been bouncing between calls; sorry if I repeat someone’s already been asked. But I guess, I had a question about just visibility, in general. I think we’ve had a few misses on data center. So, I just wonder, as you came up with this $40 million forecast, was there any change in — did you gain visibility at all or is it similar methodology from what you’ve had in the past?

And then in terms of the non-Intel piece, I’m just kind of curious, what you can speak to in terms of the product ramp visibility and specifically maybe on enterprise too with some of the Wi-Fi 6 stuff. Is that a contributor here to any degree? Thanks.

Faraj Aalaei

Sure. So, yes, with respect to Intel, as I was saying before is that we spent a lot of time with Intel trying to understand. This is not the case where, for example, the customer knows and we don’t know. Usually, it’s pretty tight relationship in back-and-forth. We get monthly forecast from them for basically up to nine months out. And they’re very good at providing that.

And as you can imagine, with this kind of news, we’ve been all over this with them in several meetings and calls trying to understand kind of what 2019 really looks like. We think that this is — what we think and we’ve been told that this is really kind of, let’s say, that the current view and that it’s highly unlikely that it’s going to get any worse than this. And there might be possibility for it to get better, but again, we don’t have that conviction. So, what we have conviction is what we’ve communicated based on every piece of information that we have.

Now with respect to non-Intel business, there is a lot going on in non-Intel business. Obviously, the service provider, client computing markets are doing really well for us. Enterprise itself is doing well. The Wi-Fi 6 — some of the Wi-Fi 6 suppliers have already begun to buy good size volume of this technology they need for launching their Wi-Fi 6. We see a number of Wi-Fi 6 manufacturers and SKUs within each manufacturer hitting the market in 2019. And that, by definition, will also drive up increase in switch port shipments.

So, you put all of that together, we see a really nice, robust growth for all of our business with the exception of the Intel business, which is the data center server business. But all the other ones look very healthy and so that’s what we see today.

Charles Anderson

Great. And then just a quick question on gross margin. It sounds like, Mark, you suggested that. We get back to sort of a normal range by the end of the year. Can you maybe just help us with what we’re dealing with in terms of the absorption factor here? Like how much of the cost of goods sold is a fixed expense that has to be absorbed versus just as product mix to any degree that’s shifting things? Thanks.

Mark Voll

So, yes, the effect that you’re seeing on gross margins lower in the first half of the year would typically be because the overall overhead is not been absorbed by a larger revenue amount. So, as that revenue should increase, as we’ve guided, it will increase through the year, expect to see gross margins come back up, again, as that overhead is being observed by a higher revenue level.

Charles Anderson

Got it, okay. Thanks so much.

Operator

Everyone, this concludes our question-and-answer session. I would like to turn the conference back to Mr. Mark Voll for any additional or closing remarks.

Mark Voll

Thank you for joining the call. We want to mention that we will be attending the Morgan Stanley TMT Conference in San Francisco on February 27th; the Raymond James Annual Investor Conference in Orlando on March 4th; and the ROTH Capital Annual Conference in Dana Point, California, on March 18th. If you plan to attend any of these conferences, we welcome the opportunity to meet with you.

This concludes the program. You may now disconnect from the call.

Operator

Thank you, sir. Once again, ladies and gentlemen, that does conclude today’s conference. Thank you for attending today’s presentation. You may now disconnect.

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