Peraso Inc (PRSO) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the MoSys second-quarter 2014 financial results conference call. My name is Meena, and I will be your operator for today. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to Beverly Twing of Shelton Group Investor Relations.

Thank you, Meena, and good morning, everybody. Joining me today on today's call are Len Perham, MoSys' President and Chief Executive Officer, and Jim Sullivan, Chief Financial Officer.

Before we begin today's discussion, I would like to remind everyone that this conference call will contain forward-looking statements based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Such statements are made in reliance upon the Safe Harbor provisions of Section 27a of the Securities Act of 1933 and Section 21e of the Securities Exchange Act of 1934, which include but are not limited to benefits and performance expected from use of the Company's embedded memory and interface technologies and integrated circuits; expectations concerning the Company's execution and results; expected benefits of the Company's ICs; product development; achievement of IC design wins and timing of shipments of the Company's ICs; predictions concerning the growth of the Company's business and future markets and business prospects, strategies, objectives, expectations, or beliefs.

Forward-looking statements made during this call are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Additional information concerning factors that could cause actual results to differ materially from any forward-looking statements made during this call are contained in the Company's most recent reports on Form 10-K and Form 10-Q filed with the Securities and Exchange Commission, in particular in the section titled Risk Factors and in other reports that the Company files from time to time with the Securities and Exchange Commission. MoSys undertakes no obligation to publicly update any forward-looking statements for any reason, except as required by law, even as new information becomes available or other events occur in the future.

Thank you for your attention. I will now turn the call over to Len Perham, Chief Executive Officer of MoSys. Go ahead, please, Len.

Thank you, Bev. Good morning, everyone. I will begin today's call with a few highlights and then provide more details on our second quarter. I will then turn the call over to Jim for a review of our second-quarter financial results prior to opening the call for your questions.

We are attracting more opportunities for both the Bandwidth Engine family of products and the LineSpeed family now than we were at this point last quarter with solid activity worldwide. We won multiple new design wins in the second quarter, although it was not as strong as we had anticipated. There were a few design win opportunities in the sales funnel that we expected to finalize but didn't. However, I suspect we are going to close those in the third quarter or the fourth quarter, for sure.

At this point in the year, we continue to believe we should approximately double design wins year over year. IC sales were up significantly in the second quarter over the first for both Bandwidth Engine 1 and 2. As a result, we shipped more IC devices in the first half of 2014 than in all of 2013. However, it's important to note we have still not seen our earliest customers make full releases to production. That is, we have not seen the inflection point, as I call it, which is one way of saying that our customer is moving or has moved from engineering oversight into full production with its end carrier or service provider customers.

Until we experience that, we will not see predictable volumes quarter over quarter, nor will we see the large deltas period to period that will take us more swiftly toward profitability. There are several points that can be made regarding these early design win customers.

First, the customers seem to be in good shape as far as their equipment is concerned, and as far as we know, they have no outstanding issues. Two, implications in some cases are that the systems have been deployed to end customers, and system-level evaluations and qualifications are now in progress. Three, regardless as mentioned above, we have not seen the full manufacturing releases yet for our higher volume design wins. Four, until we see this full release, we will not appreciate the full impact in volume requirements on a period by period basis. And finally, fifth, once the design is completed by our customers, there is not much that MoSys can do to accelerate the process. It is for the most part nearly 100% beyond our influence.

During the quarter, we made progress setting the stage to drive costs out of our back-end manufacturing flows. We were successful in negotiating and implementing new hourly rates for the use of the testing and the burn-in equipment we utilized at our subcontractors, and we are pushing to do parallel testing, which will substantially increase the unit-per-hour throughput rates of our products.

As mentioned last quarter, the impact of these gains will not be noticeable until in the fourth quarter because the volumes are still relatively low. However, we're moving in the right direction. These changes will be implemented initially on BE 1 and then on BE 2. Additionally, we anticipate simplifying the manufacturing flows over the next few quarters to further reduce costs and shorten manufacturing through time run rates, consequently allowing margins to further increase.

In regards to the Bandwidth Engine 2 family, as mentioned on last quarter's call, BE 2 is now fully carrier-grade certified, and cost-reduction plans are currently being implemented with the intent to reduce each unit cost and increase margins as fast as possible. You might recall that our second wave of design wins with our Tier 1 customer were BE 2 based, and we anticipate this customer will be releasing systems to production later this year.

Looking at the type of opportunities that BE is competing for today, it appears that working in conjunction with 28-nanometer FPGAs, BE 2 is very suitable for 100-gigabit-per-second systems and working with a now emerging 20-nanometer families of FPGAs, is ideally suited to 200 gigabits and beyond performance levels and next-generation systems.

We believe the window of opportunity for BE 2 and applications of this nature is just now opening up.

Turning to the Bandwidth Engine 3 family, Bandwidth Engine 3 is currently well in the chip level verification and timing closure. However, the magnitude of this activity is such that tapeout may well be pushed out into the fourth quarter and may not quite get into this quarter.

As you may recall, MoSys's strategic plan for Bandwidth Engine products has been from the beginning to first solve bandwidth efficiency problems the industry is struggling with via the use of our internally developed and patented GigaChip interface. Second, to solve header processing memory access time challenges by developing a unique chip architecture which is not only very fast but also extraordinarily low latency. We accomplish this on BE 1 and substantially improved it on BE 2. And finally, we intend to build more and more intelligence in each generation of networking memory. That is Bandwidth Engine. BE 1 solved bandwidth efficiency issues and supports access rates up to 100 gig, while BE 2 can manage the access requirements up to 200 gig and a bit higher and offers the customer a fair number of hardwired intelligent offload choices whereby he can reduce the load on his expensive SoC or high-end FPGA. BE 3 can handle access rates in support of 400-gigabits-per-second system performance levels and offers the customer a programmable, intelligent offload feature. The customer now has the opportunity to offload from the packing processor engine tasks that he realizes will slow it down and could be better accomplished elsewhere than in his very expensive SoC or, as I mentioned before, high-end FPGA.

Let me reiterate that BE 2 is a much higher performance version of BE 1, offers hard-wired intelligent offload, and is substantially lower cost than BE 1 because it was designed utilizing a more advanced process node.

That said, BE 2 can and will obsolete BE 1. However, it will not obsolete BE 3. BE 2 and BE 3 serve substantially different purposes in the system, and we expect to see them share space on the same line card in many applications. As a matter fact, we have already seen a few schematics that illustrate that both BE 2 and BE 3 are on the same line cards.

We have not declared these as wins yet. They are looking down the road a ways at higher performance systems, but it's very encouraging to see people doing this.

While all of our BE progress is certainly exciting in its own right, we've made great progress on our 100 gig LineSpeed product families, as well. If you recall, we mentioned now and then that we might take out a few high-performance LineSpeed elements in the first half of 2014 that had the potential to set new benchmarks.

Well, we have one. In the next few days, we will be delivering reference boards to a number of the top-tier potential customers with a soon-to-be-announced LineSpeed solution that appears to provide a unique combination of features at performance levels not previously demonstrated. I cannot say much more than that today since the product hasn't been announced yet; however, I am hopeful to announce designs at one or more top-tier customers in the second half of this year.

As with this call, we're well into characterization, and the part is looking very good. We will be pushing hard to get this product to final characterization; to deal with any troublesome bugs that need repairing; and win orders for shipments starting in the second half of 2015 and then ramping into some decent volume in 2016 and beyond. This is an exciting opportunity for the Company, and we are moving it swiftly as possible to capture it.

We are continuing additional developments for our LineSpeed product family, targeting the volume commercialization of 100-gig platforms and high-speed SerDes technology, targeting volume customer designs in late 2014 and 2015. The capability of the LineSpeed product family is significant, and we're very excited about its prospects and the market it serves.

In closing, let me make a few comments regarding our recently announced alternate sourcing arrangement with GSI. We're very pleased to have entered into this technology partnership as it is a significant milestone for MoSys. It provides our customers and potential customers the comfort of having multiple sources of supply for key differentiated components.

It also provides the opportunity to collaborate on future products critical to fast-moving advancements we are seeing in the network infrastructure. Furthermore, this dual-sourcing relationship should allow both companies to grow their served available markets.

As we have mentioned on previous calls, our goal was to engage with a partner who can provide an alternative supply, a partner that also complements our business objectives and our market strategies. With GSI, we have shared a goal to expand market opportunities in the joint commitment to maximize the potential benefits of this partnership to both companies and as well to our customers.

Customer feedback on our choice of a partner is very favorable as GSI is a respected key vendor to some of the largest networking equipment manufacturers. We believe this dual-sourcing relationship will also in certain cases get customers over the hump and make them more willing to do business with MoSys, even though we are still a small and relatively unknown new IC provider.

Currently we have embarked on cross training at the engineering and at the marketing levels. MoSys intends to alternately source the GSI SigmaQuad 4E family, and GSI is planning to alternately source both BE 2 and BE 3.

We believe this partnership will also enable us to leverage GSI's more established and broader base customer list for as yet untapped market opportunities and will open the door for MoSys to approach as yet untapped potential customers.

We have also initiated joint sessions with a number of potential customers, which demonstrates that our efforts to collaborate and support each other have already borne fruit. During these joint presentations, the discussions included not just current opportunities, but also an opportunity to discuss products that could be developed, co-developed, utilizing technology that resides in one or the other of our libraries and to serve the future system challenges confronting our shared customers.

We are very pleased to have GSI on board in such a key partnership role, and we look forward to this being a very successful long-term partnership.

In summary, during the second quarter, we continue to make measurable progress in several areas. We secured additional design wins, increased unit shipments and revenue sequentially.

We also made further progress on new product developments to both the Bandwidth Engine and the LineSpeed families, and we achieved a major milestone by establishing a dual-sourcing and technology partnership with GSI.

As the industry transitions to 100 G, 100 gig, and higher system-level performance, interest and momentum for our Bandwidth Engine and LineSpeed product families should continue to grow. Remember that while we here at MoSys have been talking about the transition to 100 gig and higher system-level performance for several quarters, we're still very early in that transition, and 100-gig and higher performance systems are still in the minority. However, we do expect the transition to continue to accelerate. We are well-positioned to capitalize on these favorable market trends and remain focused on doubling our design wins over last year, bringing down manufacturing costs on the Bandwidth Engine family of products and working with our customers as they ramp to production volumes, which will drive our future revenue and enable us to get to a cash-flow positive state and drive our shareholders' value.

It is for certain that we're pushing very hard right now to finalize both BE 3 and our next generation LineSpeed product families because there are substantial opportunities for them in today's market. However, once these products are out and verified as being robust and ready to go in market, we will be taking a very hard look at how our revenue ramp is progressing, and we will take all necessary steps to bring costs down to a more reasonable or most reasonable level.

This concludes my prepared remarks, so I will turn this call over to Jim for a review of the second-quarter financials. Jim?

Thank you, Len, and good morning, everyone.

During the course of my comments, I will make several references to non-GAAP numbers. Unless otherwise indicated, each reference will be to an amount that excludes stock-based compensation expense and intangible asset amortization. These non-GAAP financial measures and a reconciliation of the differences between them and comparable GAAP measures are presented in our press release and related cover report on Form 8-K, which was filed with the Securities and Exchange Commission today and can be found at the Investor Relations section of our website.

As a reminder, starting last quarter, we began reporting our IC product revenue separately from our IP licensing and royalty revenue, which is now being reported as a combined amount. Prior period amounts have been reclassified to conform to this presentation.

Now let's review our second-quarter financial results. Total revenue was $1.8 million compared with $1.3 million in the first quarter of 2014 and $1.1 million in the second quarter of 2013.

Product revenue from the sale of our integrated circuits was $1 million in the second quarter of 2014 compared with $0.6 million in the previous quarter, reflecting increased shipments of our IC products.

Second-quarter 2014 product revenue reflected $0.17 million of revenue recognition and the reversal of sales reserves reported in prior periods.

Royalty and other revenue for the second quarter of 2014 was $0.8 million, consistent with the first quarter of 2014. Royalty and other revenue is primarily comprised of royalties received from semiconductor customers whose products include our IP, as well as small amounts of revenue generated for maintenance and support services related to legacy IP license agreements.

GAAP gross margin for the second quarter of 2014 was 42% compared with 57% for the prior quarter and 93% in the year ago quarter. The sequential and year-over-year decrease in gross margin was primarily due to increased IC sales, which carry lower gross margins in royalty and other revenues.

In terms of our operating expenses for the second quarter, total operating expenses on a GAAP basis for the second quarter of 2014 were $7.9 million compared with $8.9 million the previous quarter and $7.4 million in the second quarter of 2013. Total operating expenses included $0.3 million for amortization of intangible assets and $1 million in stock-based compensation expense. The sequential decrease in operating expenses is primarily due to lower stock-based compensation expense, decreased engineering costs associated with the development of new products, and lower professional services fees.

Research and development expenses were $6.4 million compared with $7.1 million in the previous quarter and $6 million in the second quarter of 2013.

Selling, general, and administrative expenses were $1.5 million compared with $1.8 million in the previous quarter and $1.5 million in the year ago period. On a non-GAAP basis, total operating expenses for the second quarter of 2014 were $6.6 million compared with $7.1 million in the previous quarter and $6.2 million in the year ago period. On a GAAP basis, net loss for the second quarter of 2014 was $7.2 million or $0.14 per share compared with a net loss of $8.1 million or $0.16 per share in the prior quarter and a net loss of $6.4 million or $0.15 per share for the second quarter of 2013.

On a non-GAAP basis, net loss for the second quarter was $5.9 million or $0.12 per share, which excluded intangible assets, amortization and stock-based compensation expenses totaling $1.3 million compared with a non-GAAP net loss of $6.3 million or $0.13 per share in the previous quarter and a loss of $5.2 million or $0.12 per share in the year ago period. Net loss per share for the second quarter of 2014 on a GAAP and non-GAAP basis was computed using approximately 49.5 million weighted average shares outstanding.

Now turning to the balance sheet, as of June 30, 2014, our cash and investment balance was $40.1 million compared with $45.7 million as of March 31, 2014.

Total headcount was 114 employees compared with 111 employees in the previous quarter. Of our total employee count, more than 80% are in applications, engineering, and research and development, including 25 located in India, consistent with the previous quarter.

As of June 30, we had 49.6 million total shares outstanding.

This concludes my prepared remarks. At this time, we would like to open the call for a question-and-answer session. Operator?

(Operator Instructions). Gary Mobley, Benchmark.

I had a question about your long-term gross margin outlook on the product side. I appreciate the comments, Len, on how you are trying to fine-tune the supply chain and particularly on the back end. But once Bandwidth Engine 2 starts to ship and once you get all of these supply chain inefficiencies out of the system, do you anticipate having product gross margins somewhere in the neighborhood of 55% to 60%? I believe that is the target you talked about recently. Is that still what you have in mind?

Yes, that is correct. The Bandwidth Engine family brings a lot of value to the customer's system design and architecture, and there is no reason to think this isn't a 60%-plus gross margin product family. And although the learning curve on pricing is a bit steeper, I would expect that the LineSpeed products are going to enjoy very strong margins, as well.

Okay. You mentioned that closure of design wins here in the second quarter was a little sluggish. Should I take that to mean that you were unable to secure that second Tier 1 OEM as a customer of Bandwidth Engine 2?

We didn't announce a new Tier 1 customer this morning, but the comment I made was more related to the fact that on last quarter we had a pretty strong quarter in terms of bookings or design wins, if you will. And I made a comment on that call that it looked as though second quarter was going to be on an equal footing or I implied that. And I simply was making the point that we left a couple of things in the sales funnel this quarter that didn't get across, and I just wanted to pull a continuous thread, if you will, from last quarter to this quarter. I wasn't really addressing anything about Tier 1s.

Okay. And with respect to the developments, some of the newer products, the LineSpeed, just as a point of clarification, the tapeout of Bandwidth Engine 3, is that a one-quarter delay? And with respect to LineSpeed, did you mention -- as a point of clarification, did you mention that you anticipate revenue from that product group to ramp in the second half of 2015?

And that is it for me, thank you.

Actually, we have been targeting the third quarter for a Bandwidth Engine 3 tapeout. But if I went all the way back to the beginning of time, I think I was probably talking about the leading edge of second quarter. And for various reasons, some of which have to do with changing features or feedback from customers or the usual stuff. I would say it has moved from over its lifetime of getting designs from the beginning of the second quarter to now we are looking probably into the first half of the fourth quarter, for me to be conservatively safe. I think that is reasonably conservative.

And Gary, if you can, come back online and regarding LineSpeed, please restate that.

Sure. Did you mention that you anticipate revenue ramping for LineSpeed in the second half of 2015?

Yes, actually, I was making mention of the fact that a product that we were doing around here in a skunk works mode has come out, and it has demonstrated some performance levels that, as I called it, not previously demonstrated.

And I think that we're going to have reference boards out to a half a dozen or more places now this week or the next few days. And interestingly, they are almost all Tier 1 type people. And we should -- it won't take as long for that kind of product to ramp up its bandwidth engine where you have to accommodate a serial I/O and some new chip architecture, if you will. So I think it's possible that we could see the beginning of revenue in 2015 in a few cases. But I wanted to make the point that it will be the second half of 2015, and then we would see something fairly significant going into 2016 and beyond.

So yes, there would be a bit of revenue in 2015, but as with everything, it's hard to project how late in the quarter -- second half it will be. But we should get a little there. But that is the point I was trying to make.

All right. Very clear. Thank you, guys.

Krishna Shankar, ROTH Capital Partners.

Len, regarding the limited visibility on the product revenue ramp currently, is all of that due to Bandwidth Engine 1 and your customers not giving you follow-on production orders and significant volume? Or do you see any potential delays in Bandwidth Engine 2 revenues, also?

Actually, the first products that should get released into full manufacturing at our customer's customer, if you will, would be the Bandwidth Engine 1 products that we won early in... I'm going to say the last half of 2012, in Asia.

And I think that what we have is, in some cases now, the end customer has done field appointments and trials. I forget the exact term they used to describe that. But they have our customer's systems out running here and there in field deployments. And they do that for a while. And I guess they look for some kind of a ppm, parts per million failure rate to make sure the system is running well sitting in a real-world environment. And that is something that is going on now, and it's an area we're not too familiar with and we get limited visibility into. So we don't know when it ends.

We don't think our customers have any reason to think that their products aren't going to be successful. We don't think they have lost the business because they are all working on contracts. It's just taking a bit -- something is a bit strange to us. We haven't been that close to that in the past I don't think. At least I haven't.

The second generation of products that we won, which were likely in mid-2013 or something, the second round of design wins came out of the Tier 1 company that we're very close to, and they were doing BE 2 across a number of different line cards and edge routers. And I think that's still moving along reasonably well. It was three different projects, and a couple of them are moving on schedule. One of them may have been slowed up a little, but at this point in time with limited visibility, those are all motoring along. And I think if I didn't say so, we expect to start seeing something in the way of a move from field deployment, if you will, and trials with their end user to some volume -- indication of volume increases in, I believe, the last quarter of this year. At least that is what we think they are projecting right now and then increasing more in 2015.

Great. And then on the LineSpeed product line, you mentioned some unique superior performance attributes. Is this related to short-reach or long-reach applications? Can you talk a little bit about the potential applications for your new LineSpeed product?

Yes, actually, when you talk about the LineSpeed products that we have today, you're really talking about a couple of things. And they are -- you want to be able to transmit your signal over some distance from very short reach to short reach to long reach. And you want to be able to transmit over that distance at a minimal power level, at a significant speed, and you don't want to see any signal distortion.

So some combination of those would be where we think that we have demonstrated performance levels perhaps at distances and powers and with some signal integrity behavior that seems to be generating a fair bit of excitement at the customer's desk.

Okay. And then, Jim, can you say anything about bookings during the current quarter and the trajectory of what you might see in terms of revenues or shipments in 3Q? I realize visibility is limited, but can you comment anything on the slope of shipments and the gross margins for the third quarter and for the second half of the year?

Yes, following up on -- I will take the gross margin first since that was a question Gary had asked about, as well.

As we have said on previous calls and probably said here today, we likely won't see the gross margin improvements until early as fourth quarter this year that we will be reporting first quarter next year. So they will stay pretty low. They obviously were negative this quarter, primarily due to some higher testing costs. We had to do a firmware upgrade on some BE 2 units, pull them back in, send them back out. More for our benefit than the customer's, but that added some extra costs and pushed us into the negative.

But I do expect those to improve. As Len said, we did already get some cost reductions agreed that will start taking place.

I would also comment that if you look at our balance sheet, inventory was very low at the end of June, which actually was a timing issue. Probably would've been a lot higher a couple of days later.

But looking at revenue in the third quarter and the lack of visibility, all I can say at this point it will be flat to down based on the backlog we have at hand and sitting here on the 22nd of the first month in the quarter. Obviously, the size and stage we're at, that can change at any point in time. So I don't want to be overly negative or harsh. But right now with the visibility I have, it will be flat to down, although I do expect the fourth quarter to be up, based on what we're seeing.

Great. Thank you.

Jeff Schreiner, Feltl and Company.

Thank you for taking my questions. Len, is there something that MoSys can start providing, maybe some quarterly metrics? I would certainly look at maybe a target date for cash breakeven. Are there metrics that investors can start to look at and measure the Company's success by? Now that we are four years into this transition as an IC company, how can investors benchmark where we are today and where we should be 12, 24 months from now as MoSys continues to work on new products, which is LineSpeed, BE 3, and start to ship initial productions? Are there some metrics you can provide just to help us with that?

I will let Jim comment as well, but fundamentally right at the beginning of this journey, we made the point to our shareholders that what we were undertaking was to some degree a venture capital startup in a publicly traded company. And we are traveling to that zone right now that privately held companies go through before they turn in the ramp and the ramp starts going north, and they start moving toward profitability or even into profitability, and then they go do an IPO.

If I use that model, we're not at the point where we would be ready to do an IPO yet. I take a look at what happened to NetLogic or for that matter a few other companies I could talk to as well. It takes a couple of years to figure out what to do, a couple of years to implement it, and a couple of years to figure out if it worked.

We said that while we are traveling in this zone where customers might place a fairly significant, i.e., a few thousand or thousands or probably not as many as 10,000 units, that they pour into systems and they got out into field trials and field deployments. And then they might go quiet while their customers are evaluating the behavior, the performance levels, the failure rates of the machines that our customers have built, that is a still period for us.

And we have taken the position right along that until we got beyond that, we wouldn't start to try to provide guidance. It's just too erratic. So I'm going to let Jim comment on this, but until we make that turn and we start seeing predictable 12-month or even beyond forecasted unit requirements, it's difficult for us to say anything rational and provide the information to let you gentlemen build up some -- perfect the models you would like to create.

Jim?

I think you summarized it well, Len. The item we talk about, although we don't quantify and set up as a metric, is design wins. And as you can infer from Len's opening comments, there's certainly lumpiness there and timing of design wins, et cetera. We had design wins sitting on the cusp at the end of the quarter, which, as Len said, are likely to come in Q3, Q4. I don't know if Len explicitly said it. We've had some timing issues with customers transitioning to 20-nanometer FPGAs. So we are sitting waiting for that transition to happen. We are pretty certain there will be design wins, et cetera.

The other challenges that all design wins are not created equal. So one design win with Tier 1 could equal multiple design wins elsewhere. And volume estimates we get are obviously just that from customers. They don't want to tell us too much in early stages, et cetera other than you are in my schematic. Stayed tuned. I will be in touch when I need parts, et cetera. So we've had a lot of discussion internally, but haven't felt it's time to put that as to a metric.

On the other point, I think Len summarized it well, too, about our challenges and giving guidance. And certainly the recent -- the lack of visibility that we reported last quarter and still see today further supports that at this stage of the Company it wouldn't be appropriate to give guidance.

With regard to breakeven, we closed the quarter with $40 million in the bank, which at current burn levels just taking the burn for the first half of the year leaves us almost two years of cash.

So I'm not in a position right now to look out into 2016 and project our burn and the adequacy of our cash, especially in this current environment with the lack of visibility.

That said, too, I think as Len commented toward the end of his prepared remarks, once we get some of these products out here with the next generation Bandwidth Engine and LineSpeed, we will be in a better position to take a harder look at costs. Right now it is challenging with driving towards getting these new products out.

Okay. And then just coming back just to that statement in terms of design wins, as a metric that is certainly a helpful metric, could you just give us a total number of Bandwidth Engine design wins to date and breaking it out by BE 1 or BE 2?

So I can comment on that. In the beginning of time when we started winning designs back in 2012, of course, they were all BE 1. And then as BE 2 became available and remember that part was designed to be able to provide a specific solution to a verse mode application or an access speed application or even some intelligent offload applications, it was unique the BE 2 was -- and not only that, it was scaled so that the die is significantly smaller and lower cost for us to build.

We crossed over probably, oh, let's just say, the beginning of this year so I don't think about it too much so that the activity per bandwidth engine in the sales funnel was swinging heavily to BE 2. If we were to break it down in exact detail from what we saw on the sales funnel at the end of this most recent quarter, there would be not very much activity about BE 1, substantial activity with BE 2, and even the emergence of a bit of activity around BE 3.

So basically in today's world, you should assume that what we've talked about in our design win area is Bandwidth Engine 2. We're not going to close any deals on BE 3 until we can provide some reference boards and demonstrate in physical reality that the party is doing what it should do and that you can interface to it and talk to it and so on and so forth.

And just a follow-up based on some of the commentary around gross margin. Obviously negative this quarter. Does it stay negative next quarter when we're looking at it, Jim?

And I think you guys talked about seeing some of the improvements maybe by first-quarter 2015. Does that mean that those improvements lead to a gross margin greater than 50% or just a positive gross margin? Just to wrap it up, when are we going to get to a greater than 50% gross margin on Bandwidth Engine?

So, first off, let me comment that I actually went over it with the manufacturing team, and we negotiated some better costing for ourselves. It became effective on July 1, and there are some other milestones we made that are going to be effective on August 1. We're still moving at reasonably low volumes. We're not going to be in the business of trying to build a lot of inventory around here. We're better off with cash than we are with silicon sitting in some storeroom somewhere.

So the volume is going to be relatively low, and you really do have to drive some volume before you are going to start seeing a steep decline or a steep incline, let's call it, in gross margin as opposed to a falloff of the variable costs to go in the incremental units and getting dramatically smaller. But the fact is -- I will let Jim comment as well. 50% gross margin is probably 2015, but it probably won't be the first quarter. Jim, what do you think?

Certainly I am not in the habit of projecting negative gross margins going forward, and my projections show positive gross margins for the next two quarters going forward.

I believe on the last call and I probably said this before with Bandwidth Engine 1, we're going to struggle to get anything above the low 50% range -- around 50%. It is a big guy, 65 nanometer, et cetera.

But certainly with Bandwidth Engine 2, we are in a position to drive costs lower with a much smaller die and, frankly, the benefit of Bandwidth Engine 1. So I think your timing is spot on. But certainly I anticipate being above 50% in 2015.

Okay. And last question for me, just in terms of overall mix in calendar year 2014 from Bandwidth Engine, what would you guys say based on the limited visibility you have the mix is going to be between Bandwidth Engine 1 and Bandwidth Engine 2?

In 2014?

Yes.

So we projected from time to time that the largest volume should be BE 1 in 2014, but that BE 2 should be coming on pretty strongly.

Quite frankly, in light of these field deployment trials and so on and so forth, I don't have a good feel for it now. I will let Jim, again, comment as well. The average selling price of BE 2 is somewhat higher than BE 1. In terms of revenue, I suppose BE 2 could cross over. But we should see revenue from BE 1 and BE 2 running along through 2014, and then in 2015, BE 2 should quite dramatically pull away. Jim?

Looking at the quarter we just ended and looking out through the remainder of 2014, I would probably call it about a 70% BE 1, 30% BE 2, looking at shipments. Obviously, shipments because of sell-through, et cetera, don't correlate with revenue recognition. Particularly our Bandwidth Engine 1 shipments go through distributors in Japan versus Bandwidth Engine 2 is mostly going straight to customers.

But I would put it right now at about a 70%/30% mix for the year. It's probably a little bit higher than that in the first half of the year, more skewed toward Bandwidth Engine 1.

Okay. Thank you for your time, gentlemen.

Quinn Bolton, Needham & Company.

Just wanted to come back, Len, the lack of visibility sounds like it is really just the trialing process that you're customers are going through at operators around the world. And it sounds like you just don't have great visibility as to when those trials end and when you move into volume production more so than designs are getting upgraded from BE 1 to BE 2. It's that that is not what's really going on. It's really just the trial process.

Yes. There is absolutely no BE 1 being upgraded to BE 2 going on in the system, in spite of the fact that people oftentimes switch to a part that has higher performance or lower power, whatever.

The Bandwidth Engine family of products is running very fast serial I/O, and it's not trivial to start changing something that runs at the speeds of today's systems. So BE 1 is not being upgraded to BE 2. That's just not going on.

New systems will go BE 2. New opportunities may go BE 2. It will be a while before we see anybody trying to cross over.

Okay. And then I don't know if you have commented, but obviously you're waiting for some of the existing design wins to ramp, and again, it sounds like a lot of that is going to be determined when the trial activity ends and when volume production orders are released.

But if you look at your design pipeline today and the value of those design wins, can you give us some sense -- do design wins in hand today to the extent that they all ramp the volume production, does that get you 50% of the way to breakeven? Does it get you to breakeven? Can you give us some sense how dependent are you on new design wins to get to breakeven versus what you already have in hand today and you are just waiting for production orders to be released?

I am going to let Jim comment on this, as well. My opinion is that we're doing very, very well in our strong center of activity in Asia, and I can see that ramping fairly nicely over the next couple of years. But in terms of when we think we will cross over, I will let you comment on that, Jim.

Sure. On past calls, I think this question has come up as far as quantifying exactly what you are asking, Quinn, as far as quantifying design wins, et cetera.

I think previously we have said our existing BE 1 design wins could amount to $10 million to $15 million of annual revenue over time, looking back to the design wins that we had back in 2012 and a couple in 2013. And some of these FPGA-based design wins could run anywhere from $5 million to $20 million a year when running in full production.

Obviously, design wins, which we continue to pursue on the higher end, custom SoCs, ASICs, can be $25 million and higher.

So when I look at your point of where we are at to get to a breakeven level, which I've said in the past is probably on a quarterly basis around $14 million of IC revenue, we are a good chunk of the way there with the design wins we have. We obviously need to close more here, particularly with BE 2, and then obviously have some contribution from LineSpeed to put us over the hump.

Great. And then you made the comment about taking a look at expenses once you complete the tapeouts of the new LineSpeed product and Bandwidth Engine 3. Can you give us some sense if production orders continue to be pushed out, is that where you take a hard look at expenses, or if you start to see the release of volume orders, do you sort of maintain the OpEx level at roughly current run rates?

So we have added some headcount this year, and anybody that -- so we have been adding some headcount this year. So the bottom line is, we have a window of opportunity to get through with both the Bandwidth Engine family and the LineSpeed family. And in the case of Bandwidth Engine, we're trying to meet some chips to becoming available at partner shops so that we meet each other at a certain point so that we are characterizing parts on the same boards and so on and so forth.

And once we get past that, we're going to be able to take a look at the organizational efficiency and so on. So ordinarily when we're waiting for a company's revenue to catch up with its cost basis, you try not to add anything to the cost basis. But the fact is, in order to make the window in time, we have driven costs a little bit hard, and we have used some consultants and so on and so forth. And we will definitely appraise cutting back on external costs and pulling things back to a more sensible level while revenue catches up with costs here once the products are out and looking good.

I think I would just add to that, Len, another benefit for 2015 will be lower tapeout and back-end costs with BE 3 and the next generation LineSpeed and, as you referred to on the call, some of these side projects on LineSpeed. So we will be able to take those costs way down in 2015. They will hit us here in the second half of this year, but will not recur in 2015 as we regroup and look ahead to what the next product is.

Got it. But it sounds like there is no -- anticipation today is that you would not cut into the core R&D capability and development pipeline for future LineSpeed or Bandwidth Engine 4-type products. It's really the consultants and some of the additional costs you've added this year to hit the schedules for BE 3 and LineSpeed.

That is exactly right. It's very, very difficult to build a team like this, and you don't build the team with the idea to do something and then be rid of the team. The heart of the Company is that team. So we have done a lot of external stuff in order to create these chips. They are pretty sophisticated, and especially BE 3 is incredibly sophisticated.

So some of the external costs to make all of this happen can be cut back, and we just need to get through the window, and then we will take a look at that and meter things back. And Jim is right. There is a very, very high level of engineering creating products at BE 3 and, indeed, the LineSpeed family, as well. And we won't have any tapeouts of that level of complexity in 2015. It just won't happen. So we will look into a more cost-effective year that year and, hopefully, significantly increasing revenue as well.

Great. Thank you very much.

Thank you, sir. You have no more questions at this time. I would now like to turn the call over to Mr. Len Perham for closing remarks.

Yes. Thank you all for coming and listening to us today, and thanks for the very thoughtful questions.

In closing, I would just simply like to say that we are traveling along the path of a publicly traded venture capital startup, and the signposts that we see along the way are signposts that we are familiar with. I am never satisfied with how long it takes to get each thing done, and I'm always amazed at what kind of a stumbling block that can come along to take a day here or a day there. So as far as I am concerned, everything we are doing is a day late and should have happened sooner.

But the fact is, I think we are going in the right place, and we're seeing familiar things happen, and we're optimistic we're going to get to the right place. We really appreciate you guys getting up or tuning in and listening to us this morning. And we look forward to letting you know how we're doing again next quarter, and hopefully we will be making some substantial progress to the end goal that we all want to achieve.

Thank you very, very much. Bye now.

Thank you, sir. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day. Thank you.