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
* Nyquist estimates
Historical Revenue (Consumption) Reporting
* 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.
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