Marvell Technology, Inc.
Q1 2008 Earnings Call Transcript

Published: 17 Apr 2008

[Operator:]

Welcome to the Cavium Networks first quarter 2008 earnings conference call. (Operator Instructions) With that, I’ll turn the call over to Angel Atondo, Marketing Communications Director. Please go ahead.

[Angel Atondo:]

Good afternoon everyone and welcome to Cavium Network’s first quarter 2008 financial results conference call. Leading the call today are Mr. Syed Ali, President and CEO of the Company and Art Chadwick, Vice President and Chief Financial Officer. Before we begin I’d like to remind you that various remarks that we make on this call including those about our future financial results including revenues, gross margins, operating expenses, design wins, product plans, our competitive situation, partnership, goals and prospects, market trends and our anticipated growth and profitability all constitute forward-looking statements for the purpose of the Safe Harbor provision under the Private Securities Litigation Reform Act. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our Form 10K filed with the SEC on March 10, 2008. In particular to the section entitled risk factors and to other reports that we may file from time-to-time with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. These forward-looking statements speak only as of the date hereof and we disclaim any obligation to update these forward-looking statements. In addition, Cavium reports gross margin and net income and basic and diluted net income per share in accordance with GAAP and additionally on a non-GAAP basis. Management believes the non-GAAP information is useful because it can enhance the understanding of the company’s ongoing economic performance and Cavium therefore uses non-GAAP reporting internally to evaluate and manage the company’s operations. Having had chosen to provide this information to investors to enable them to perform comparisons of operating results in a manner similar to how the company analysis its operating results. The full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today and we ask that you review it in conjunction with this call. I will now turn the call over to Syed.

[Syed B. Ali:]

Thanks to everyone for joining us today. Today we are extremely pleased to report another strong quarter with excellent sequential growth and accelerated year-over-year growth. In brief, Cavium’s fourth quarter revenue was a record $18.3 million which represents a 13% sequential and 65% year-over-year growth. Non-GAAP gross margins came in at the higher end of our guidance at 64.7%. Non-GAAP operating margins increased from 10% in Q4 to 12.6% in Q1. These higher operating margins along with the higher revenue increased non-GAAP operating income 42% sequentially. Non-GAAP net income was $2.9 million or $0.07 per share and our GAAP net income was $2 million or $0.05 a share. Art will provide more details on the Q1 financial results and Q2 guidance shortly. Before I discuss design wins, product news and relationships I would like to give some more color on Q1 revenues and a general update about the overall environment that we are seeing. In Q1 we saw broad base growth across all of the major market segments and geographies that we address. Our multiple product families, diverse end markets and tier one customers with new designs going in to production all helped drive strong top line growth. The overall demand climate in Q1 was also robust with gross bookings running at record levels. Demand for our products in production was robust and new products are going to production at or slightly ahead of our internal plans. This quarter we saw continued diversification in our revenue mix. The enterprise and data center segment was the largest segment at 68% of sales and grew 5% quarter-over-quarter. The remaining segment including access service provider, broadband consumer and software services segment combined to achieve 32% of sales for the quarter and grew 34% sequentially. By contrast in Q4 the enterprise data center segment grew 19% sequentially while the non-enterprise data center segment grew at about 5. And, further back in Q3 of 2007 the roles were flipped again with the enterprise data center segment growing 8.5 while the non-enterprise data center segments grew 21%. I would like to again stress here that our product diversity helps us flatten out the more extreme [inaudible] that we would have likely experienced if we were a single product or a single end market company. Our growth this quarter was driven by a number of factors including extremely strong sales to Cisco Systems and some nice growth coming from the access services provider and the broadband segments. Our business with Cisco has never been stronger. In Q1 Cisco was not only our largest customer but also our highest growth customer delivering the highest sequential revenue growth in our history. The growth was broad base covering both the products previously in production as well as new products that went in to production during the quarter. This indicates to us that the products that we are designed in to continue to see a strong demand environment. We had several new products enter the early production phase at Cisco which use both our OCTEON multi-core processors and our NITROX processors all of which helped drive the extremely robust quarter-over-quarter growth. As new products go to production we continue to expand our footprint within Cisco and at the same time diversifying the end applications that we service across low end, middle range and the high end. We continue to also see robust design win rates at Cisco and in fact, at this time they are the number one customer both in number of total number of wins and also the revenue potential from these wins when they go to production. As I mentioned earlier we also had good growth in the access service provider and the broadband market segment. The growth in the service provider segment was driven by new product roll outs of edge and access routers by large tier one customers and prototype builds for ATCA based systems for the wireless infrastructure. We are also starting to see the beginnings of the ramp in the broadband segment of the market. We expect this segment to start contributing good growth in the latter half of Q2 and over the second half of the year. Now, I would like to move on and give you some color on the overall demand environment in our target end markets. Data processing requirements are undergoing a key change in functionality required as VoIP data and high definition video converge to flow on both wired and wireless networks. Web 2.0 applications are mushrooming all over the enterprise and at the consumer. Additionally, network security is becoming a fundamental requirement to not only access data securely but also to provide better protection against intrusion, viruses, worms and other malware. All of this added functionality must now be done at line rates that are increasing tenfold at every node, 10 megabytes to 100 megabytes in the LAN, 100 megabytes to a gigabyte in the enterprise and gigabyte to 10 gigabyte in the data center, access networks and the core. These factors are driving excellent demand for our products that essentially deliver intelligent data processing and reliable application delivery with the highest level of security and very high performance. In the enterprise segment our current and future revenues are derived from new L3 to L7 data and security processing functionality that is being added to the high volume products in this segment such as enterprise routers, switches, wireless LAN controllers, unified track management appliances and LAN optimization boxes which form a major part of the tam for this segment. The attach rates for our multi-core architecture and functionality are still pretty low in legacy equipment and will deliver robust growth for us as more of these platforms go to production. In the data center our growth will be driven by the adoption of new intelligent application delivery platforms in products such as L4 to L7 switches and appliances. In storage there are new functionality requirements such as security, data compression, data de-duplication, content aware archivable search and bridging of fiber channel to IP networks in products such as fiber channel to IP bridges, HVs, storage switches, mass appliances and rate of storage arrays that are driving the adoption of our product. In the broadband sector converged delivery of voice, video and data and network security delivered to the home are the small and medium size enterprise are the primary driver for our products. We will be benefitting from the accelerated deployment of fiber to the home 802.11n in the enterprise and media servers in the home. All of these trends are in these very early stages of deployment and should see excellent growth over the next few years. In the access and service provider wired segments the sheer volume of voice, video and data that needs to be processed and delivered with security by edge and core routers, switches and gateways is driving he design win of both our high end multi-core OCTEON as well as our NITROX processors. In the wireless segment the volume of data is increasing exponentially as more mobile phones add email, web browsing and video capability with 3D today and with high bandwidth 4G LTE and WiMAX in the future. Security of data is becoming a big factor in these new generation networks as more and more phones have these capabilities. The entire wireless infrastructure needs to be upgraded to deliver this new functionality and as a result we are seeing tremendous demand for our products in this segment too. So, if you step back and look, Cavium is now delivering products that provide all of those new and needed functionality for every segment that we are addressing. This is putting us at the front end of several new product cycles whether it is L3 to L7 functionality in the enterprise and data center or intelligent storage and retrieval in the data center, or the deployment of fiber to the home across the world, or the adoption of 802.11n in the enterprise, or the deployment of security everywhere. Our growth is therefore being driven not by incremental increases in sales of products into legacy markets but rather from significant new product cycles across all of these market segments. The adoption slope may vary by customer and market but since these cycles are mostly in their early stage they should be able to deliver strong growth over an extended period of time. This is the reason we believe our products are continuing to see extraordinary market adoption and design win attachment rates as we progress through 2008. On the new product front we continue to execute on a very aggressive product road map by introducing three new families of products since our last call. The first family is our OCTEON Plus 52xx wireless dual and quad-core processor family that integrates powerful control processing, network processing and security capabilities along with application specific hardware acceleration for applications like 3D Transport, 4G Transport or LTE, Wireless LAN Aggregation, WiMAX Base station and WiMAX Transport. This product is based on our high performance multi-core architecture but we also added a number of market specific acceleration factors like wireless protocol processing, support for AL2, robust header compression, KASUMI algorithms, support for over the air encryption and IP tech support for back haul. This high level of integration and hardware acceleration provides three to five times the performance in wireless applications when compared to alternative solutions. The 52xx is a comprehensive wireless solution that addresses all the L2 to L7 requirements for Pico, Micro and Macro base stations and joins the currently available CM54xx and 56xx product family which addresses all the requirements for Macro base stations, RNC and XGSM core transport to offer the most comprehensive top to bottom processing solutions for the wireless infrastructure in the market. The second family that we introduced was our new OCTEON Plus 52xx network processor family. This family integrates up to four cores with integrated intelligent acceleration for packet processing, quality of services, TCPIP and security for entry to midlevel enterprise and access markets. These next generation systems are integrating multiple features including routing, switching with Layer 2 to Layer 7 intelligence, quality of service, access control, gateway functions, firewall, intrusion protection and VPN services. The third family was our new OCTEON Plus 52xx storage services processor family. This family integrates up to 7,000 MIPS with integrated hardware acceleration for storage IOPS, TCP, iSCSI, RAID 5 and RAID 6, data de-duplication and security. These products provide an ideal solution for next generation entry and midlevel storage system such as iSCSI targets, cyber channel to iSCSI bridges, cyber channel over Ethernet adapters, encryption controllers, disc arrays, RAID 6 arrays and de-duplication enabled systems. We strongly believe that these new products have tremendously strengthened our competitive position for high volume applications in all three market segments. These products have already been delivered to multiple tier one customers many of whom had boards ready and some of them already have the boards up and running with our parts in them. Moving on now to design wins I would now like to provide an update on actual design wins. Design win rates were very strong this quarter continuing at the accelerated rates we experienced during the lesser half of 2007. Design wins were broad based across all major market segments but were particularly strong in the service provider and broadband segments. We closed multiple new design wins at a number of our tier one customers like Nokia, Alcatel-Lucent, Cisco, F5, Netgear and [inaudible]. We also won significant size designs at two of the largest lenders in China. We are also starting to close design wins in the storage place with the OCTEON storage services processors that we introduced last year. Last quarter we also had three design wins in the storage space at two tier one customers. In the enterprise and data center segment we won new designs in the L4 to L7 switches, application delivery appliances, voice-over-IP security, private channel to IP bridges and iSCSI applications. In the access and service provider segment we won significant new designs in LTE and WiMAX base stations, RNCs, SGXS and equipment, switch GPRS, and deep packet inspection applications. In the broadband and consumer CPE gateway market we won designs for SCDMA appliances, wireless CPE boxes for wideband CDMA, TD-SCDMA and WiMAX application, 802.11n and IP PBX applications. Our pipeline of potential new design wins across our target market segments has never looked stronger which indicates that we will continue to see accelerated design win rates. We also had a number of customer and partner announcements during the quarter RadiSys Corporation, a leading global provider of advanced embedded solutions introduced Promentum ATCA-7220 dual 16 core OCTEON Plus packet processing module. The industries first blade to enable the highest density of gigabyte Ethernet interfaces in a single slot to provide a complete high throughput wire speed solution for applications such as Radio Network Controllers, session border controllers, security gateways, edge routers and media gateways. At the Mobile World Congress Show CorEdge Network’s a leading developer of potential building blocks for Micro TCA solutions introduced a Cavium networked OCTEON card data card option for its 20 gigabytes per second AMP line card. This data card adds encryption decryption and deep packet inspection capabilities to the 20 gigabytes per seconds based card all in the standard single width AMC form factor blade. GE Fanuc intelligent platforms a leading supplier of open carrier grade advanced package processor solutions across a broad range of markets announced that their lineup of AMC, PCIX, PCIExpress and APCA platforms will be based on Cavium’s current and roadmap products for the OCTEON family of high performance multi-core processors. We also had several partner announcements covering joint reference designs and hardware and software equal system support of Cavium’s processors. Wind River Systems, Inc. a global leader in device software optimization announced the immediate availability of an advanced multi-core device development solution. The solution couples Wind River’s workbench on chip debugging and Wind River compilers with Cavium Network’s OCTEON processors providing customers with a simplified development environment encompassing a complete development ecosystem on chip debugging tools, compilers and comprehensive support. Trango Virtual Processors announced support for Cavium’s OCTEON processor with user data security, adaptive resource allocation, IO virtualizations and power reduction by creating on demand virtual processors across all our 16 cores. Kaspersky Lab extended their support for Cavium’s OCTEON multi-core processors with integration of complete antivirus protection that can be used across a wide range of networking development including routers, switches, access gateways, wireless access points and unified tech management equipment. Also we showcased over 20 OCTEON powered customer products and ecosystem partner solutions at the Odyssey Conference from April 8th to April 11th. On that note I would now like to turn the call over to Art Chadwick who will provide a detailed description of Q1 financial results and guidance for Q2 and after that we’ll be happy to take your questions.

[Arthur D. Chadwick:]

Thanks to all of you for joining us today. I’ll first go through Q1 financial highlights and then provide some guidance for Q2, 2008. As Syed just described Q1 was another great quarter for us. First quarter revenue of $18.3 million continued our history of strong sequential and year-over-year revenue growth. Sales were up 13% sequentially and 65% year-over-year. Cisco Systems remained our largest customer this quarter and as Syed mentioned business with Cisco has never been stronger. Cisco accounted for 30% of total sales for the quarter up from 22% in Q4. F5 Networks which accounted for 14% of sales in Q4 accounted for less than 10% of sales in Q1. But sales of our top five customers comprised 54% of total sales as compared to 55% in Q4 and sales growth was strong across our customer base. Sales to our top five customers increased 12% sequentially and sales to the top 10 customers increased 14% sequentially. In terms of geography 58% of our sales this quarter were domestic and 42% were international which continued our international expansion. In our press release we announced both the GAAP and non-GAAP results. Our non-GAAP results this quarter exclude $847,000 in stock-based compensation and related payroll tax expense and $88,000 in amortized acquired technology. Non-GAAP gross margins remained strong this quarter at 64.7% which was at the higher end of our guidance. Operating expenses excluding stock-based comp were $9.6 million and this was a 7% sequential increase over Q4 due to an increase in both R& and SG&A spending. Non-GAAP R&D expenses increased from $5.2 million in Q4 to $5.4 million in Q1 while SG&A expenses increased from $3.7 million in Q4 to $4.1 million in Q1. Total company headcount increased by 11 employees and we ended the quarter with 213 employees worldwide. We believe that non-GAAP operating margins are an important financial metric of our business and we have expanded operating margins on a sequential basis every quarter since our IPO. In Q1 of last year our non-GAAP operating margins were just above break even. They then increased to 3.7% of sales in Q2 to 6.5% in Q3 to 10.0% in Q4 and now to 12.6% in Q1 of 2008. Non-GAAP operating income has increased even more significantly. Non-GAAP operating in Q1 was $2.3 million and this was 42% higher than in Q4 which clearly shows the strength of our business and the leverage in our business model. This 42% sequential increase in non-GAAP operating income was however partially offset by reductions in net interest income. Interest income was down due to fairly substantial reductions in money market interest rates during the quarter. Net interest income in Q1 was $838,000 down from $1.2 million in Q4 and this alone reduced EPS by a full $0.01 per share quarter to quarter. Non-GAAP net income was $2.9 million or $0.07 per share and though was the same EPS as we reported in Q4 it was the result of very strong gains in our business but offset by lower net interest income and by higher taxes due to alternative minimum taxes this quarter. On a GAAP basis, GAAP net income was $1.9 million in Q1 or $0.05 a share. In regards to the balance sheet we ended the quarter with $95.6 million in cash and equivalents and no bank debt and this compares to $98.5 million in Q4. The decrease in cash was due primarily to higher accounts receivable and inventory due primarily to our growth this quarter. Accounts receivable at quarter end were $13.7 million which equates to DSOs of 67 days. Now these DSOs are higher than our norm but this was primarily due to a onetime event with one customer who delayed a $1.2 million payment until the first week in April. Had that payment been made at the end of the quarter DSOs would have been 61 days which is essentially in line with our long term DSO target of 60 days. Inventory at the end of the quarter was $10.8 million. This was a 13% sequential increase from Q4 which exactly matched our sequential sales growth. I would now like to provide some guidance on how we see the second quarter. In Q2 we expect continued strong sequential and year-over-year sales growth. We also expect continued operating margin expansion and growth in earnings per share. More specifically we expect sales in Q2 to increase sequentially to between $20.4 million and $20.6 million due to increasing customer demand across multiple customers and markets as well as an expected increase in sales to both Cisco and F5 Networks. So, at the midpoint of this guidance it provides for an approximate 12% sequential growth over Q1 which, by the way, is a higher growth rate than the guidance we gave one quarter ago going from Q4 to Q1. Now, I normally don’t talk about backlog but we will say this, backlog for Q1 right now is substantially higher than has been in the past at this point in any quarter and this is especially true for our larger customers. We believe non-GAAP gross margins in Q2 will be approximately 64% down slightly from Q1 due to an expected increase in the percentage of our sales that are going to the broadband and consumer market. Operating expenses are expected to increase somewhere between 3% and 5% sequentially. Non-GAAP operating margins are expected to continue to expand and should increase by at least three points going from Q1 to Q2 and these expanding operating margins along with higher sales should generate non-GAAP operating income that is 40% to 50% higher than it was in Q1. Net interest income in Q2 is expected to be approximately $600,000 or so. This is less than Q1 again, due to the continuing slide in money market rates. The good news for us is that all of our cash is in a very liquid and very safe money market account even though the interest rates have been going down. Stock-based compensation expense is expected to be approximately $1.5 million in Q2. Amortized technology will decrease to approximately $30,000 in Q2 and the income taxes are expected to be approximately $300,000 or so and that’s based on our current NOLs, our international structure and expected alternative minimum taxes. And our fully diluted share count used for non-GAAP EPS should remain relatively flat at just about 43 million shares. So if you do the math this guidance provides for non-GAAP EPS of approximately $0.09 per share. So in summary we are experiencing very strong sequential and year-over-year sales growth across a broad base of customers and markets and due to the leverage in our business model we are expecting solid sequential increases in operating margins, operating income and EPS. In addition we have a very solid and a very liquid balance sheet that provides a very strong competitive advantage and security in today’s environment. And with that I’m going to hand the call back Syed for our closing comments and then we’ll take questions and answers.

[Syed B. Ali:]

Let’s just move to the Q&A and then I will end up with a summary.

[Operator:]

(Operator Instructions) Our first question comes from Sanje Jevjin with Morgan Stanley. Please go ahead.

[Sanje Jevjin:]

Just a couple of questions, you talked about the strength you experienced at Cisco and I was wondering if you could give us a sense of – I know in aggregate only about a quarter of your design wins have gone into production to date – but specifically at Cisco is that percentage greater or less than your total design wins? How are you doing at Cisco in terms of design wins that have gone into production today?

[Syed B. Ali:]

I would say it’s probably the TAM or slightly lower than our overall percentage.

[Sanje Jevjin:]

And as you’re exiting the year, when you look at your design win pipeline do you expect that percentage, that 25% or so, to meaningfully increase? Or how should we view the number of design wins that you’ve had, how should we view them in terms of progressing for the year? What percent do you think will actually have gone into production by then?

[Syed B. Ali:]

You know, Sanje, every quarter or every half year we are adding new design win dollars into the pot, so we expect it to be, on a percentage viewpoint, that is percentage of design win dollars in production, to remain relatively flat from now towards the end of the year.

[Sanje Jevjin:]

And then one final question if I can, Syed? Given in general there’s been quite a bit of concern regarding the macroeconomic environment and especially the demand trends within your served markets and I think on the call you did a great job outlining what you were seeing but given that Cavium is a product cycle story I was just wondering if you can share with us your confidence level regarding your growth prospects for 2008 and 2009 relative to where you were at the beginning of the year? If you just highlight that for us.

[Syed B. Ali:]

I think, Sanje, as I’ve said design win rates are very robust, very strong winning at the major platforms, at the major tier one customers that matter and I think most importantly like I said in the conference call in my opening talk that we are at the beginning of several new product cycles whether it’s in the enterprise, in the data center, in the broadband or in the access and service provider market, so these new product cycles are going to have excellent growth. You know they may be a little bit higher or a little bit lower than we would like them to be but you look at where they are today to where they will be in the second half of the year and in 09 and 010 there will be significant growth in all these major product cycles. So we feel very, very good about our growth prospects in 08, 09.

[Operator:]

Our next question comes from Tim Luke with Lehman Brothers. Please go ahead.

[Tim Luke:]

Syed, I was wondering if you could give some color on what you see being the important growth drivers for the calendar second quarter and as part of that, how you would likely see Cisco trending as a percentage of the sales mix, having gone towards 33% of the business?

[Syed B. Ali:]

I think if you take a look at it in the second quarter growth is up, not only going to come from one market segment, we feel it will be as broad based as it was this quarter, definitely the broadband segment will increase as I’ve said in Q2 and moving on towards the second half of the year. We are going to see some good growth in access and service provider and in enterprise and data center type applications. So it’s a fairly broad based growth with no segment contributing most off it.

[Tim Luke:]

So you think the [inaudible] remains very stable as a percentage of the revenues, maybe lower in the second half?

[Syed B. Ali:]

Yes, Tim, I think it will be 30% plus or minus in that particular range but definitely up from the lower 20s.

[Tim Luke:]

I thought in prior dialog you had said that you thought it would be in the mid 20s for the year, how are you thinking about that now? Are you thinking it might be higher as a percentage of the revenues, is that right?

[Syed B. Ali:]

Yeah, I think we’ve been pleasantly surprised by the strength of the products that we have been designed into. So sort of mid 20s, maybe higher 20s to 30%, maybe a little bit more accurate looking at it for the remaining part of the year.

[Tim Luke:]

Is it fair to say that in looking at your pipeline and looking at your design wins that you would anticipate the year-over-year growth rate for the company should continue to accelerate as you move through calendar 08?

[Syed B. Ali:]

Tim, again you know quarter-over-quarter growth rate right is given by two factors, one being the run rate business and what the increase in the run rate business is and the second element is really new products going to production. So in any given quarter sometimes there will be higher volume of products that go to production which will give a much more substantial jump which would lead really high year-over-year comparisons and in some quarters it may be a little more muted. But again we feel comfortable with the growth rates that we are at now and we definitely think we will see some acceleration moving into the second half.

[Tim Luke:]

Art, if you could just comment on, or maybe Syed, on how you’ve perceived lead times to be and then also just on the inventory level which have been up in line with sales, do you think going forward it’s likely to remain in terms of growth, inventories in line with sales so that you’d see days of inventory stabilizing around this 150 level?

[Arthur D. Chadwick:]

Yeah, I think that’s reasonable given the number of product families and products that we have and the fact that we want to make sure – it doesn’t make sense for us to run super lean and miss the ability to make a sale so I think the inventory levels that we’re at now in terms of days outstanding is about what you should expect going forward. And you saw that from Q4 to Q1. Our inventory increased 13% quarter to quarter, that’s consistent with our revenue growth quarter to quarter and I think that’s a reasonable way to model it, certainly through the rest of this year.

[Tim Luke:]

And just on gross margins, you’re at 64 now, you think it’s going to be – what are you targeting for the end of the year?

[Arthur D. Chadwick:]

We are actually at 64.7% in Q1, our guidance for Q2 is somewhere around 64%. As we’ve always as the percentage of sales in the broadband and consumer space increase our margins will come down modestly over time. So between now and the end of the year we expect it to come down a point or to, somewhere in that range and we’ve been saying that of course since our IPO road show. They’ve been holding up stronger than most of our guidance but over time we expect it to come down just modestly.

[Syed B. Ali:]

And another thing, Tim, is overall gross margins are a function of two things, right? One is obviously higher volume products going to production or lower end products going to production and the mix of that but a second obviously which is a very important factor too is how quickly our costs are coming down. So the reason why we have done much better than we’ve forecasted for the last three or four quarters in terms of gross margin is one is that the product mix has been much more heavier weighted towards the higher end products, but secondly we have been able to bring down our costs a little better than we had expected. So depending upon which one wins you’ll see a little bit less or as Art said a point or so of gross margin reduction.

[Arthur D. Chadwick:]

And, Tim, I’d like to add something to that. We often get the question about gross margins and I think that’s relevant but again we are really managing our business to the operating margin level so our guidance for Q2 for example, gross margins our guidance is that comes down 70 basis points but along with that is higher sales, leverage in our business model so our operating margins we’re expecting to go up more than three points quarter to quarter and I think that’s a relevant point so people don’t just get fixated on the gross margin line but they look at the operating margin line because that’s what we’re working on expanding over time.

[Operator:]

Next question comes from Krishna Shankar with JMP Securities. Please go ahead.

[Arthur D. Chadwick:]

Operator, I think we should go to another question and we’ll try to catch Krishna in a moment.

[Operator:]

Absolutely, our next question comes from Kevin Cassidy with Thomas Weisel Partners.

[Kevin Cassidy:]

Art, you mentioned the backlog was substantially higher going into second quarter, can you give any more details on that, like what percentage of guidance it is?

[Arthur D. Chadwick:]

We generally try not to talk too much about backlog because that can vary from quarter to quarter. What we did think that it important to make some comment on this call, given the uncertainty in the marketplace, people are nervous about what kind of visibility folks have and what I said again is that going into this quarter we have more backlog going into this quarter in relation to what we expect to ship than we have in any recent quarter. And that is a very positive thing and that comment applies even more so to our larger customers. We have a much larger percentage of backlog for our large customers going into this quarter, much larger than we’ve ever had in the past. So we just consider that to be a very important fact in terms of our visibility as to what we think is going to happen in Q2.

[Kevin Cassidy:]

Maybe a question on what went up in operating expenses in the first quarter? It seems a little higher than expected.

[Arthur D. Chadwick:]

Yeah, it’s a little bit higher than our guidance but that’s also primarily because our revenue was higher than the guidance. So were targeting an expansion in our operating margins since revenue was a little bit higher we loosened the valves a little bit on expenses so our expenses grew 7% quarter-over-quarter versus a 13% increase in our revenue. But we increased expenses in both R&D and SG&A quarter to quarter.

[Operator:]

We’ll go on to the next question from Alan Mishan with Oppenheimer. Please go ahead.

[Alan Mishan:]

Question, your Cisco business was up it looks like 50% sequentially, would you characterize that as more the security type products, just shipping more because of higher demand or was that some of the newer OCTEONs finally going into production?

[Syed B. Ali:]

I think if you take a look at the total revenue number it was a very good mix of low end, high end security and OCTEON multi-core processors and if you take a look at the growth, OCTEON multi-core processors probably had the bigger share of the growth.

[Alan Mishan:]

And then did both NITROX and OCTEON grow sequentially for the total company?

[Syed B. Ali:]

Yes.

[Alan Mishan:]

And then with a lot of your growth, especially for the second half depending on the broadband business, can you just give us an idea of which service providers you’re most exposed to?

[Syed B. Ali:]

I think once again, Alan, like I’ve said in earlier conversations that the growth for us in the second half is going to be driven by all four market segments that we address. The reason why we’ve kind of singled out the broadband a little bit more is that it’s starting from a much slower base and it has higher volume implications associated with it. In the second half of the year the broadband segment should see growth from at least a couple of areas. One is fiber to the home deployment in Asia and the second is a launch of multiple Soho and SMB boxes in both the United States and Asia.

[Alan Mishan:]

And then one last question for me is when do you think we’ll see the cross over in revenue between NITROX and OCTEON?

[Syed B. Ali:]

It should definitely be by I would say the middle of the year, give or take.

[Alan Mishan:]

The middle of 08?

[Syed B. Ali:]

08, yes.

[Arthur D. Chadwick:]

08, that’s correct.

[Alan Mishan:]

So it’s almost upon us.

[Syed B. Ali:]

That’s correct.

[Arthur D. Chadwick:]

Yes.

[Operator:]

Next question is from Quinn Bolton with Needham & Company. Please go ahead.

[Quinn Bolton:]

You guys addressed this in the prepared comments, but just wondering if you’ve seen any customers talking about potentially pushing out or canceling new product development programs that you’ve been designed into similar to what we saw back in the 2000-2001 timeframe? Is that kind of activity being considered by customers or are there customers viewing this more as just a temporary slowdown perhaps in enterprise and really pushing forward with new product development?

[Syed B. Ali:]

Regarding this, Quinn, when we take a look across the entire landscape and particularly focusing on tier ones, we don’t see any slowdown itself in the design activity that is going on. In fact in some of the larger tier one customers they’re trying to pull the product in as much as possible to try to get it to market as much as possible so that they have a differentiated product in the market which would probably get them better margins than their existing legacy products. So overall even in the smaller companies than in the larger companies other than the normal plus or minus a month or two month slip that you would see in the normal case there isn’t anything special that we are seeing that causes us any concern.

[Quinn Bolton:]

And then just one for you mentioned the accounts receivable and the $1.2 million payment has that been collected? Was that collected in the first week of April?

[Arthur D. Chadwick:]

Yes, absolutely was. Yes. I had wished that we had collected just a few days earlier, I wouldn’t even have to mention it then but yes, it was collected in the first week of April.

[Quinn Bolton:]

And then just lastly in terms of the strong sequential growth for Q2, any sense you can give us, what percent is that roughly split 50/50 between new products going into production versus just growth in existing platforms or is it heavily skewed one way or the other?

[Syed B. Ali:]

I would say about two thirds or 65 to 70% is based upon existing products ramping because we’ve had a number of customers release new products into the market over the last Q4 and Q1 and the balance is coming from brand new products going to production.

[Quinn Bolton:]

And then does that shift a little bit more towards new products as you get into the second half, given the previous comments you’ve made about service provider and broadband products ramping?

[Syed B. Ali:]

Yeah, I would say because if you take a look at it our earlier designs which are in production were on a prior design basis smaller annual revenues for box and the later design wins we’ve had have significantly higher revenue for box so when you take that metric into account as we go towards the end of this year into early next year, the new designs will start contributing a much bigger portion than the existing designs in production.

[Operator:]

Our next question comes from Arnab Chanda with Deutsche Bank. Please go ahead.

[Arnab Chanda:]

A couple of questions either for Syed or for Art, my calculations may not be right, I was just curious I looked at your top five customers and excluding Cisco it seems like the aggregate of the other four went down. Is that dominated by one customer or did you see declines in all the other four would you say?

[Arthur D. Chadwick:]

No, that was dominated by one and that was F5 and I mentioned that in the call. If you recall in Q4 F5 was 14% of our sales and they decreased to less than 10%, I didn’t mention the percentage, it was less than 10%. So the decrease was really just F5, everybody else I think without exception increased at least in our key customers quarter to quarter. And then as I also mentioned on the call if you look at the top five increased 12% sequentially, the top 10 were 14% sequential growth from Q4 to Q1. So it’s that one customer and I also mentioned on the call for our guidance in Q2 we expect sales to F5 to increase going from Q1 to Q2, they’re been going through this product cycle, working through some inventory and it is very clear to us that the sales to them, and I base this comment on backlog that we have in house, sales to F5 are expected to increase from Q1 to Q2. So it’s not a continuing slide, it’s going to move back into positive territory going from Q1 to Q2 for them.

[Arnab Chanda:]

Second question, obviously you had a big growth in Cisco and there’s obviously been macro concern about what’s going in end markets, do you have good visibility in your inventory there whether – I don’t know you were in the V&Y program where you have other – how you exactly sell to them, could you and to the extent it’s possible, could you describe that a little bit?

[Syed B. Ali:]

I think if you take a look at it there are two aspects of Cisco’s lien program. One is your basic lien program which they have rolled out at all the subcontractors now, the way they keep a very limited amount of inventory and they expect you to have the capability to go plus or minus a forecast number in a certain specified period of time. We are in that program. The second program we would share is the way the management really not in that yet and that is not rolled out pretty much all across this, it’s only done on few very, very high platforms as far as my knowledge goes.

[Arnab Chanda:]

And then one last question, could you talk a little bit about if I can separate your traditional markets you were selling into where you’re ramping versus the new products or new markets such as storage or wireless infrastructure, when do we expect the storage and the wireless infrastructure to start seeing any volume and what type of additional TAM do you think that adds to your current TAM?

[Syed B. Ali:]

If you take a look at the wireless infrastructure we already have started shipping some small quantities for prototyping but the service provider design cycles aren’t long for base stations and those type of equipment so we expect meaningful revenues to start accelerating probably in 09 and more towards the second half of 09 for wireless and very, very similar metrics for the storage side of the equation. In terms of TAM we think on the wireless infrastructure side the TAM for our CPUs is probably somewhere in the $50 to $100 million range and in storage probably somewhere in similar type of ranges.

[Arnab Chanda:]

And then one last question, maybe on the technical side, there’s been some discussion about certain accelerators that are doing what they call themselves, some call it d-packet inspection, some call it Reg X, could you describe how your processor would work in that environment? Is it a competitor, a complement? And that’s pretty much my last question.

[Syed B. Ali:]

Let me also just clarify one thing that I said in the previous which may not have come out very clearly, when I talked about the TAM it really means what potential revenue that Cavium can generate from that market, not the overall size of the market. In terms of the regular expression engines or content co-processors that some of the companies have introduced, first of all in our OCTEON multi-core family we have up to 32 regular expression engines integrated into every one of our high end CPUs. When you want to do up till about a few gigabit of content processing it’s already integrated but if you would like to do 10 gigabit or more you can add an extra co-processor sitting on a PCI or a PCI express box that basically gives you the 10 gig line rate. We did not want to load, because most of the applications run in the low to mid range up till about 5 gigabit, we didn’t want to load the cost of 10 gigabit of content processing into our high end processors which would then be a cost burden to everybody else. So 80 to 90% of the applications require five gigabit and below. We are able to address that with our integrated solutions but anything more they basically can go ahead and use a co-processor.

[Operator:]

Next question comes from Sandy Harrison with Signal Hill. Go ahead.

[Sandy Harrison:]

Just some quick housekeeping items and then I’ll move onto a couple other questions. Just to be clear the point, Art, in giving your view on backlog and one of the things you guys typically have is a pretty good visibility of the quarter going into it, but I guess your point was that you will need even last turns this quarter to hit your 12% which would be the midpoint of the growth than you’ve traditionally needed. Is that a correct assumption?

[Arthur D. Chadwick:]

Especially for our large customers, that is absolutely correct.

[Sandy Harrison:]

And then just to close the loop on the linearity of the quarter and the payment that you received in the beginning of April how did the quarter come in from a revenue and maybe an ordering perspective? I think there was some questions about some of the broader markets slowing in March and obviously with the backlog it doesn’t sound as though that carried through for you. So what sort of linearity did you guys see for the quarter?

[Arthur D. Chadwick:]

In terms of order rate, it was relatively linear. If I show you our operations chart that marks it week by week it’s almost a straight light, nothing is a perfect straight line, but it was a pretty linear quarter.

[Sandy Harrison:]

And just to follow with that, how has April started off with the first couple of weeks?

[Arthur D. Chadwick:]

Good. I mean we’re only two and a half weeks into it, but good. As I mentioned we have a lot of we think a fair amount of visibility into Q2, we feel very good about the guidance we gave for Q2. So I think we’re off to a good start.

[Sandy Harrison:]

And then finally to talk a little bit more you guys are definitely as highlighted by an earlier caller with the question product cycle play and what are some of the – if you look out there at the growth engines and you look out there for some of the opportunities along with that and then, Syed, from your comment just a second ago on your SAM or your short available market for versus the TAM, what sort of growth rates do you guys think you can ultimately put up out there on a year-over-year that you would be happy to see versus those you might be disappointed with?

[Syed B. Ali:]

We are right now experiencing pretty good growth rates year-over-year and I said depending upon how the design wins to production get overlaid in some of the quarters when higher annual revenue design wins go into product, they’ll give us a much better pop. We are very happy with where we are and we believe that there’s still some room for acceleration.

[Sandy Harrison:]

And then lastly from a competitive landscape perspective, one of your larger competitors had a change of management at the top recently and if you look at your relatively small market share in that segment so far expecting it to increase, how would you put your opportunities here for increased market share going forward? Is it something you think is going to continue to accelerate? Do you think you’ve got a pretty steady state rate just from a broader perspective maybe any competitive landscape changes that might change that trajectory?

[Syed B. Ali:]

Pretty much we don’t see, Sandy, any dramatic differences in the competitive climate between the second half of last year and the first half of this year. As you can see every quarter we are introducing a bunch of new products and this just makes us more competitive because we have just the right product for probably more price performance points than anybody in the industry today for our end target markets. With the design pipeline we have and with the design wins that we are winning regularly on a quarterly basis we believe that at least for the foreseeable future we will continue doing as well as we have in the past.

[Sandy Harrison:]

Given the limited number of competitors in the microprocessor world and the fact that it’s not growing a whole lot do you think that you could see any pressure perhaps from the customer base versus core competitors so you’re competing versus internal solutions versus external?

[Syed B. Ali:]

No, actually I think primarily the markets that we sell into we compete with merchant silicon. Probably 99.99% of the cases. The price competition obviously and the low end single core and dual core devices is much more because as more competitors in that market compared to four to 16 core where there’s a lot less competition in that market.

[Arthur D. Chadwick:]

Operator, I think we’ve got time for a call from Krishna and then we’ll do closing remarks.

[Operator:]

Absolutely, sir. Mr. Shankar, go ahead.

[Krishna Shankar:]

I just had one closing question, you gave pretty good visibility on backlog and the business going into the June quarter, any sense – I know it’s too early to talk about the second half, but based on your design wins, pipeline now any comments on how the second half of the year looks in terms of new programs or sequential growth rates?

[Syed B. Ali:]

As I said, Krishna, I think when we review on a quarterly basis or even on a monthly basis all the major revenue bearing programs that we have and looking at them last month pretty much everything was right on schedule or slightly ahead of schedule. We feel pretty good that we should see some good growth going into the second half of the year.

[Krishna Shankar:]

My final question, what is your mix? I don’t know whether you’ve broken out your revenues, Syed, but can you give us some sense for the revenue mix, higher end, four core, eight core and 16 core OCTEON processors, which is some of the single and dual core? I’m trying to assess how quickly the higher end processors are ramping versus the legacy single and dual core chips.

[Syed B. Ali:]

I don’t have the exact numbers but I can give you an approximate idea, Krishna. Roughly the higher end processors which are eight to 16 core is probably in the 60 to 70% range. The mid, which is four core say or the higher end of the two core is probably in the 10% range and the balance 20% or so is in the single core and entry level dual core devices.

[Krishna Shankar:]

And the final question is what about your spending on application support as you bottle off your customer base and end markets, do you worry about supporting a whole bunch of new customers with good application support and what steps are you taking to ensure good software and application support for all these new customers and products that you bring on?

[Syed B. Ali:]

Krishna, we are growing our customer support capabilities especially application support every quarter and pretty much around the world so this is an area that we are focused on because frankly the number of opportunities we see and the number of opportunities we have are just tremendous. If you take a look at our design pipeline if you will of potential design wins that we are working on it’s a who’s who list of every major tier one customer and many of the programs are very, very recognizable programs in that these are some of the highest volume platforms that are out there to win. So this is an area of an absolute extreme focus by us and we will continue to add the personnel and add the right people such that we can continuously support customers and support even new customers as they come on line.

[Arthur D. Chadwick:]

So we’ll do closing remarks and that will be the end of our call.

[Syed B. Ali:]

In summary there are fundamental changes taking place throughout the networking, communications, security and storage markets that are requiring processing power that is a magnitude higher than anything that was previously needed. In addition these markets are requiring specialized LC to L7 intelligence services along with integrated security. Cavium has developed and now has in production multiple product families that address the specific needs in each of the key markets we address. We have now won significant designs with almost every major company that supplies products into these markets and we believe that our design win traction with multiple key customers across multiple markets is evidence that we have the right products for the right market at the right time. Our design wins as well as our sales have increased significantly since our IPO last year and the trend continues to remain very strong. We therefore believe that Cavium can and will grow significantly this year and in future years as more and more of our customers go to production using Cavium based solutions. Again, thank you for your interest in Cavium.

[Arthur D. Chadwick:]

Thanks everyone.