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Q1 2008 Earnings Call Transcript

Published: 9 May 2008

[Operator:]

Welcome to the NetLogic Microsystems first quarter 2008 financial results conference call. Leading the call today are Ron Jankov, President and Chief Executive Officer and Mike Tate, Vice President and Chief Financial Officer. (Operator Instructions) I would like to turn the call over to Mike Tate.

[Michael T. Tate:]

Please note that our first quarter 2008 results were disseminated by Business Wire after the market closed today and a copy of the release can be downloaded from our website at www.netlogicmicro.com. Before we get started with our financial results for the first quarter, I would like to point out that during the course of this conference call, we will be making forward-looking statements that are based on certain assumptions and expectations of future events that are subject to a number of risk and uncertainties and actual results may differ materially. For a discussion of such risk and uncertainties, please see today’s earnings release, the risk factors in our Form 10-K filed on March 14, 2008 as well as other reports the company files from time to time with the SEC. All forward-looking statements are qualified in their entirety by this cautionary statement and the company undertakes no obligation to publicly update forward-looking statements for any reason except as required by law even as new information becomes available or other events occur in the future. Also on the call, we will be making reference to non-GAAP financial measures. A reconciliation of non-GAAP to GAAP financial information is in today’s earning’s release. The reconciling items between GAAP and non-GAAP are stock-based compensation, amortization of intangible assets, and a fair value adjustment to inventory acquired. These items have been removed from the cost of revenue and operating expenses for non-GAAP reporting. Now turning to our first quarter results. Today we reported net revenue for the first quarter of 2008 was $34.2 million, which came ahead of our prior guidance of $33.8 million. Q1 revenues grew 6% sequentially from $32.2 million for the fourth quarter of 2007 and 46% from Q1 2007. Revenue from Cisco Systems, our largest customer, was approximately $12.7 million or 37% of our total revenues compared with $15.8 million or 49% of our total revenue for Q4 2007. We believe this decline in revenue reflects a work-down of inventories at the board and component levels in the supply chain. Based on current activities, the adjustments appear to have run its course as we have experienced a very strong April and we believe our revenues with Cisco in Q2 will be more inline with end demand as well as benefiting from the ongoing ramp of our new design wins. The decline in our Cisco revenues did not impact our ability to exceed our first quarter revenue goals, as strong turns orders helped offset this decline in revenues with Cisco. These strong turns orders reflect the health of our business and the positive trends underway regarding the adoption of our technology and many growing and end markets and new applications. As a result, our Q1 non-Cisco revenues increased by more than 30% sequentially and over 123% from Q1 2007 to represent a record 63% of our total revenues. Also revenue from Alcatel-Lucent was $3.8 million or 11% of our total revenues for the first quarter compared with $3.1 million or 10% of our revenues for Q4. Our non-GAAP gross margins in the first quarter were 66.1%, which excludes stock-based compensation expense, the fair value adjustments related to inventory acquired from Cypress Semiconductor and Aeluros and the amortization of intangible assets. There is a complete reconciliation between GAAP and non-GAAP gross margins in today’s earnings release. Our Q1 non-GAAP gross margins was ahead of our guided gross margins of 65% given favorable product and customer mix. Q1 GAAP operating expenses were $18.7 million, which included $3.4 million of stock-based compensation and $300,000 for the amortization of intangible assets. This compares with GAAP operating expenses of $21.1 million for the fourth quarter of 2007 which included approximately $5 million of stock-based compensation, $1.6 million for in-process R&D related to the Aeluros acquisition and $300,000 for the amortization of intangible assets. Non-GAAP operating expenses during Q1 were $14.9 million compared with $14.2 million for Q4 2007. Non-GAAP R&D expenses were $10.2 million for Q1 as compared with $10.1 million for Q4. Non-GAAP SG&A expenses excluding stock-based compensation and the amortization of intangible assets were $4.7 million for Q1 as compared with $4.1 million for Q4. The increase in SG&A spending was largely attributed to higher legal and accounting expenses to support the final implementation phase of our international operating structure. Our Q1 tax provision was a benefit of $500,000 or $0.02 per diluted share that reflects the current positive mix of our foreign and domestic bookings and their losses. On a GAAP basis, our Q1 net income was $1.1 million or $0.05 per diluted share compared with a net loss of $4.8 million or $0.23 per share for Q4 2007. Non-GAAP net income for Q1 was $8.7 million or $0.38 per share compared with $7.6 million or $0.33 per share for Q4 2007. We had fully diluted shares of $22.1 million on a GAAP basis and $22.7 million on a non-GAAP basis. With respect to the balance sheet, cash and cash equivalents at the end of Q1 were $55.8 million compared with $50.7 million at the end of the prior quarter. The increase in cash was a result of the continued positive cash flows from operations during the quarter. Our accounts receivable increased to $19.8 million. The increase in accounts receivable was due to some delays in our collection efforts during the quarter due to the implementation of a new ERP system that went live at the beginning of the year. Given our increased collection efforts and continued positive sales linearity in both Q1 and Q2, we believe our DSOs will decline at the end of Q2. First quarter net inventory was $16.7 million compared to $12.9 million at the end of Q4. The increase in inventory is largely due to our positioning of more units at the finished-goods stage in order to support the record level of shipments we have now made in the first month of Q2. Also, given the unplanned decline in Cisco revenues during the quarter, we are carrying a higher amount of Cisco-related inventories in the short-term. Overall, we expect our inventory level to move towards our more traditional carrying levels over the next two quarters. This concludes my review of the quarter results and now I’ll turn the call over to Ron.

[Ron Jankov:]

This continues to be a very exciting time for us. Our engineering execution, product portfolio and design activity have never been stronger as we address the rapidly evolving and emerging markets, which are demanding increasingly higher performance, knowledge-based processing and high-speed physical layer products. As the network transforms in order to handle traffic of higher bandwidth requirements and greater complexity, we are seeing demand for our advanced technology in new markets and new customers and in new applications that did not previously require advanced search processing capabilities and 10-gigabit wire speeds. We have risen to these opportunities with near flawless execution in our product and technology development, including several new 55-nanometer products, and we are seeing an unprecedented push by our customers to ramp our newest design to volume production. This is resulting in a broad based strength across our product applications and a far more diverse customer and revenue base from which to grow. Our ongoing successful revenue diversification was an important factor in the first quarter and our largest customer, Cisco, appears to have experienced some oversupply at the board level and adjusted inventories in their supply chain beyond what appears to be the current demand background. However, despite this adjustment, we were able to exceed our corporate revenue goal with strong growth in other areas of our business, and it appears that the adjustment at Cisco has now run its course and that our shipments to Cisco in the second quarter should more closely match the true demand. Quarter-to-date shipments to Cisco have been very strong and our forecast of shipments and backlog continue to strengthen. One of the most exciting developments in the first quarter was the ramp of our newest design win to Cisco. Our first two NL8000 design wins enjoy their first full quarter of production with volume increasing from the pervious quarter. As we look into Q2, we expect to see continued ramp of these designs as well as the first shipment into the new datacenter switch program. We are also very pleased that we are now shipping pre-production NL7000 processors to Cisco, which are being used in a variety of new carrier-class boxes targeted to IPTV, wireless infrastructure and other advanced applications. We expect revenue of more than $1 million from these shipments to Cisco in the second quarter, which is a very encouraging sign of the rapid adoption of our most advanced parts at Cisco, where we have significant competitive advantages. As these content-heavy systems ramp, they should provide additional growth for us at Cisco in Q3 and Q4. Turning to our individual markets, the 10-Gigabit Ethernet market continue to be strong for us in the first quarter, as both our physical layer products and our knowledge-based processors experienced solid growth. We are beginning to see strong increases in the number of 10-gigabit ports, as enterprises and datacenters upgrade their legacy systems in order to accommodate the proliferation of video and virtualization applications. Further, we are also seeing a transition to next generation X2 modules for our low-power physical layer products, holding market-leading position. Q1 was also the first full quarter of production revenues of our new SFP+ device with EDC support for SR, LR, LRM and Twinx copper cabling and we expect continued ramp in Q2 as we penetrate this market. This product offers the industry’s lowest power consumption and smallest form factor, especially critical IO functionality and performance is beginning to create a major bottleneck in the system performance of next generation design. We are also pleased to see a resumption of growth in the cable infrastructure area of our business, which came in a quarter earlier than we had expected following a soft Q4. The build-out of the cable infrastructure continues to be a strong trend for the adoption of our knowledge-based processors. As cable service providers, they have increased competition from IPTV as they work to deliver fast Internet connections, video-on-demand and Voice-over-IP services. Based on current forecast, this cable infrastructure build-out is expected to be strong for the remainder of the year. We are also excited with the continued positive development in the mobile wireless infrastructure market, as the need and investment in new advanced IP networks accelerates. Strong sales of video and smart phones from Apple, Samsung, Nokia, RIM and others are putting tremendous strain on the legacy carrier networks, and this will accelerate with the anticipated launches of Apple 3G iPhone and new higher video throughput model from Samsung, Nokia and others. As an indication of how much these new devices are changing the network, Google has recently reported in an interview with the Financial Times that they have received 50 times more Web search request from iPhones this year than from any other mobile handset. Also, even as the iPhone is just a 2G device at this point, is estimated that the iPhone users are 6 to 20 times more likely to view video content and 100 times more likely to access a social networking site. The next generation of advanced 3G phones will clearly accelerate these trends. These changes are causing a push to accelerate the upgrade of wireless networks to IP-based technology which can greatly benefit from utilizing knowledge-based processing to accommodate the increased bandwidth, quality of service and billing requirements. We are very excited by the large number of designs pending to ramp with our existing customers such as Alcatel-Lucent, Cisco, Juniper and Huawei, as well as new customers such as Ericsson and Nokia. IPTV was also very strong in Q1. Europe continues to outpace the rest of the world and we are also seeing momentum from our China-based customer shipping into Asia. The exciting thing is that this is a very young market with tremendous growth potential. All indications are that CapEx spending on all IP networks by major telecom carriers worldwide will increase to support the rapidly growing number of subscribers from the roughly 14 million subscribers today to what many expect to be over 100 million subscribers in the next three to four years. This bodes very well for us. Because of the complex quality of service and high bandwidth requirements for video necessitates that these boxes have a very high dollar content of knowledge-based processors. In addition to the IPTV opportunities, we are also seeing continued growth from upgrades of wireline networks as legacy circuit-based networks are replaced with all IP networks. For example, we are now seeing strong signs that the long anticipated next-generation build-outs in Japan and Korea are beginning to take place this quarter. The new Japanese and Korean wireline networks will be some of the most advanced networks in the world and therefore, will be a tremendous opportunity for the heaviest deployment of knowledge-based processing capabilities. The strong trends that we are seeing in all of these service provider markets highlight our customers’ ongoing need for higher performance, lower power and smaller footprint devices that can scale with technology requirements. In fact, we have seen a number of announcements recently regarding next generation switches and routers that can support the bandwidth, scale and service awareness requirements of IPTV, WebTV, VPNs and 3G, 4G mobile applications. These next generation boxes represent a growing TAM for us, as our knowledge-based processors are being leveraged in applications that have not utilized them in the past. Our customers have recently been announcing their own internal next generation ASICs such as Cisco’s recently announced QuantumFlow Processor. These super high-performance ASICs from our customers greatly add to the speeds and complexity of their system, which typically results in a step-up in the need for knowledge-based processors in such equipment. The QFP was designed to utilize our NL8000 family of processors, and our ability to tightly interface with this new ASIC is giving us the opportunity to penetrate several new divisions at Cisco. As another example, earlier this month, Alcatel-Lucent announced that its 7750 service router and its 7450 Ethernet service switch now offer terabit performance in order to support converged Internet traffic. This is great news for us because not only does it underscore the strong trend towards the need for advanced search processing to support video delivered over the carrier infrastructure, it also represents new mobile infrastructure opportunities for us at Alcatel-Lucent. To hit this new terabit performance level, Alcatel-Lucent announced its new 100-gig FP2 chipset. With the initial development of our NL7000, Alcatel-Lucent has continued to work closely with us to ensure that our NL7000 products are further optimized to deliver maximum performance to work alongside their next generation ASICs. As a result, we have recently announced the new NL71024XT that can process tens of thousands of IPv6 headers at 100-gigabit wire speed, which is approximately three times faster than the nearest competitive chip. As our customers design their new terabit routers with these new advanced ASICs, we are seeing many of these new designs incorporate up to four knowledge-based processors per ASIC and up to 30 of our solutions per system. Given this trend of using an ever-increasing number of knowledge-based processors per system, our low power technology has become even more important. Because of this, our customers are embracing the benefits of our integrated breakthrough hybrid technology, combines our advanced Sahasra Algorithmic engine with our leading hardwired knowledge-based processors, which was first introduced with our NL9000. Since our announcement in sampling of this product at the beginning of this year, we continue to see tremendous design activity. Customers are excited to be able to hit unprecedented performance levels, while dramatically lowering power consumption. Now turning to NETLite, the first quarter was a record quarter for design wins for our NETLite product family. This is clear evidence of the strong momentum of pushing layer three functionality into the high volume enterprise switching segment. We are also seeing traction into other cost sensitive applications such as GPON aggregation and other Internet access applications. Now, that our customers have received the next generation packet processors from our partners, Broadcom and Marvell, they are finalizing their product design, which are translating into a record pace of design win closures for us. We continue to expect the first of our customers’ box to go into volume production in the second half of 2008 and these boxes will provide us meaningful growth in 2009. We are also very pleased to announce new additions to our NETLite product family, the NL56615 and NL33A processors developed on TSMC’s advanced 55-nanometer process, and are designed to seamlessly interface the network processors offered by merchant silicon partners such as Broadcom and Marvell. These products have been optimized to support the deployment of next generation IP conversion networks and meet the performance, cost point and low power consumption required by customers to address the growing demand for performing forwarding and classification functions closer to the end user. Turning to now NETL7, we are very excited by the design momentum of our products. In order to leverage the investment in our unique technology across our product portfolio and incorporate deep packet inspection technology in many points of the network, our customers are playing a larger role in determining our product and technology roadmap. To meet our customers’ demands, we developed the NLS205 family of NETL7 knowledge-based processors which is the industry’s first single-chip content processing solution that is capable of scaling from 250-megabits per second to 2.5-gigabits per second line rate without requiring external memory. The NLS205 family of processors is targeted at high volume applications such as security and networking systems for small and medium size businesses and data center servers. This new family of processors is fully compatible with our high-end 10-gigabit per second NLS1005 family processors, allowing customers to scale their developments from entry level 250-megabit per second systems for the SMB solo market to high performance 10-gigabit solutions for the enterprise and service provider markets. Unlike other deep packet inspection solutions, our NETL7 products leverage our unique capability to design semiconductors at the transistor circuit level. This enables the processing of the most mathematically complex Layer 7 task, an order of magnitude faster and in a fraction of the power that can be delivered with traditional semiconductor design. Additionally, our Layer 7 solution builds upon our years of investment in our industry-leading Layer 4 knowledge-based processors and advanced algorithmic technologies. The result is that that our NETL7 solutions can handle the most challenging real world attacks and intrusions at wire speed without compromise, a claim that no other solution can match. The demand for the new single-chip solutions announced this month has been so strong that we’ve already achieved six design wins over two customers including a Tier 1 OEM vendor and we expect to ramp to volume production in early 2009. The introduction of these new products makes our advanced Layer 7 technology accessible to a wide range of applications, which means that we can potentially ship in volumes of hundreds of thousands of units opening up new markets for us and further increasing the TAM for our content processors. In closing, this is a great time for us. The industry continues to upgrade legacy networks, the capability to handle traffic with higher bandwidth requirements and greater complexity. And this is driving the need for our most advanced knowledge-based processors and physical layer products. We are experiencing an exciting expansion of our TAM as our products are being designed into many new applications such as mainstream switching, datacenter switching, desktop switching, metro edge and aggregation as well as core and high end edge routing. Further, our success in bringing to market the most innovative industry leading products continues with near flawless execution and is resulting in record numbers of design wins that will serve as the basis of our revenue growth for several years to come. At this point, I will turn the call back over to Mike to discuss guidance for the second quarter. Then, we will open up the call for your questions.

[Michael T. Tate:]

As we look into Q2, we expect continued growth of our new designs at Cisco as well as continued strength across our other customers and markets. Despite having a record first month of revenues in April and record backlog coverage, we continue to believe it is appropriate to be conservative with our guidance given the volatile economic backdrop. Based on our Q2 revenues to-date and the remaining judged backlog to ship, we expect our Q2 revenues to increase to $36.2 million, representing an approximate 6% sequential growth from Q1 and 40% year-over-year. We expect our non-GAAP gross margins to be approximately 65.5%, which is slightly ahead of our long-term model. We expect non-GAAP operating expenses to increase to approximately $15.6 million, non-GAAP R&D expenses to be approximately $11.1 million, non-GAAP SG&A to be approximately $4.5 million. The increase in R&D reflects our aggressive product development schedule during the quarter. Also in Q2, we expect interest and other income to decrease to approximately $400,000 due to the decline in market interest rates. We expect our tax expense for Q2 to be approximately zero to 1% of our non-GAAP income before taxes. We expect non-GAAP EPS for the second quarter to be $0.37 per share. We expect GAAP EPS for the first quarter to be $0.02 per share. This includes an estimated $4.4 million for FAS-123R stock-based compensation, $3.3 million in the amortization of intangible assets and $400,000 in a fair value adjustment for acquired inventory. Finally, we expect our GAAP share count to be approximately 22.4 million shares and the non-GAAP share count to be approximately 23 million shares in Q2. This concludes our prepared remarks for the call and now we’re happy to take questions.

[Operator:]

(Operator Instructions) Your first question comes from Adam Benjamin – Jefferies.

[Adam Benjamin:]

Can you talk a little bit about, in prior quarters you’ve given a little bit more granularity about some other customers. This time you only talked about Cisco and Alcatel. Can you give some more color on some of the other ones?

[Michael T. Tate:]

We are not going to specifically break down customers below 10%. But what we can highlight is, we saw a good quarter in the service provider space, so Alcatel-Lucent is clearly benefiting from that and with IPTV and as we move through the year we think it will be another good year with Alcatel as they start to deploy their next generation boxes. Also, 10-Gigabit Ethernet, both for the knowledge-based processors and for the PHYs had a good quarter and I think you will continue to see a good port growth for 10-gigabits, especially in datacenter applications, given increased video and virtualization. As we entered Q4, we did see a couple of pockets of weakness at cable in China, but those seem to have now stabilized in Q1. As we look into Q2, China and cable look to contribute for our growth.

[Adam Benjamin:]

Ron mentioned the next generation networks, specifically in Japan and Korea coming back as early as Q2. So, historically Alaxala and Huawei have been the big providers into that. How should we be thinking about Alaxala coming back over time? It was well above the Alcatel levels at one point. How should we be thinking about that going forward?

[Ron Jankov:]

Well going forward, Alaxala also supplies to the Korea market. They are the number one supplier there now as well, and sometimes we forget about Korea, but it’s actually a pretty big country with a big GDP, so that’s pretty exciting as well. Regarding Alaxala’s growth, it’s not going to be a hockey stick up. They expect it to be very, very gradual and to be spread over the next four to six quarters.

[Adam Benjamin:]

But by the end of that Ron, do you expect them to reach the level of where Alcatel is today?

[Ron Jankov:]

Well, I have learned to handicap what they think they can do and in what timeframe. So I think they think they can get there but maybe give it a few more quarters.

[Adam Benjamin:]

On Cisco, I am assuming the number you’ve referred to, of 37%, included the core business that you had historically as well as the TCAM2 you bought from Cypress?

[Michael T. Tate:]

Yes, that includes all revenues of Cisco, yes.

[Adam Benjamin:]

So, going forward, how should we be thinking about that? I assume you expect it to grow, is it just modest growth or is it above your 6% growth that you guided for the whole company?

[Michael T. Tate:]

We don’t want to be specific by any one customer, but I highlight in Q1 that the decline we saw in Cisco appears to be above the softness in demand and even though we’re in a lean environment with a hub that there must have been board level buildup that needed to be digested. So, I think as we move into Q2, we’ll see the Cisco revenues move back towards end demand and then on top of that we have all the new designs that are continuing to grow. We talked about ramping our first two NL8000 designs in Q4. In Q1, we had a full quarter of that and they are projected to continue to grow as those programs ramp into production. We should have another design ramping here in Q2 and even with that, we still have 18 designs left to still ramp and hopefully adding to that. So, going into the second half of this year, I think we are real encouraged by the NL7000 programs. These are more metro boxes that we haven’t participated in the past and even the pre-production orders that we highlighted in the call will give us over a million dollars of revenues in Q2.

[Adam Benjamin:]

The increase, Mike, can you quantify as to how much had to do with the Cisco weakness and how much had to do with the strong orders that you had for April and Q2?

[Michael T. Tate:]

No, I don’t want to specifically break it out that way, but those are two drivers that are having that level of inventory. Clearly, that’s the inventory level that we rather have lower days and it will work that down, but we did decide during Q1 that we needed to bring the lot into finished goods because as we indicated, we had a very strong April, so most of that product had to be shipped here in the first month.

[Operator:]

Your next question comes from Allan Mishan - Oppenheimer.

[Allan Mishan:]

On the Cisco business, was the fall off pretty proportional across the products or was it more concentrated in acquired Cypress business or more concentrated in your existing business?

[Michael T. Tate:]

It was general with the existing programs that we have in place. What was not impacted was the ramp of our new programs, those continued to grow as they are fresh and they are still in a ramp moded. A typical program will ramp over a five-quarter period of time. So, these are still early in that phase.

[Allan Mishan:]

In terms of your existing programs and the acquired, they were both down somewhat similar in terms of percentage.

[Michael T. Tate:]

Yes, we wouldn’t specifically quantify, but generally both had an adjustment.

[Allan Mishan:]

If you are able to eliminate the acquired business, do you still believe that your Cisco business will grow ‘08 versus ‘07?

[Michael T. Tate:]

I don’t think we want to specifically get into acquired versus not, but the core products that we had in Q1 clearly had an adjustment that was demand and inventory-driven but we see those coming back as well in Q2 and with all the new programs ramping we definitely feel Cisco is going to be a solid contributor to our growth in this year as well as into the next couple of years, because we have a pipeline of 19 pending designs right now. Some of these designs actually do not start to ship until the early part of ‘09. So you can see how those will contribute to growth going into 2010.

[Allan Mishan:]

And then thinking about the turns business, last quarter you had said you are expecting basically minimal turns. It turns out that turns business was pretty good. Could you just walk us through what exactly you saw back then that caused you to be conservative? What ended up happening during the quarter that reversed that, and then maybe also tell us what turns you are looking for Q2?

[Michael T. Tate:]

Yes. So back in the January timeframe, we were just reading the newspapers and CNBC just like everybody else and given the volatility and the economic backdrop, we decided it was prudent just to be conservative and guide to the backlog in hand. We typically have 16-week lead times with our customers. So, turns, although we typically will see maybe 10%, 5% turn in the quarter, at that time we went conservative, and that was a good thing we did given the adjustment that Cisco made during Q1. As we look into Q2, just given that the economic backdrop still is a little volatile right now in the strength of our business, we thought it was prudent to again put the same level of conservatism in our guidance. So, as we go to Q2, we are also just guiding to what are shipped to-date plus our view of what we’ll ship in the backlog.

[Ron Jankov:]

Actually, that’s also against a backdrop of a very, very strong April. So, very strong start to the quarter.

[Operator:]

Your next question comes from Arnab Chanda - Deutsche Bank.

[Arnab Chanda:]

Historically, it seems like your non-Cisco business has actually been growing for a couple of years now. It’s just a lack of growth in Cisco that is offsetting that growth. So, do you think that we’re at a point where the new products within Cisco and your non-Cisco business will basically drive in the same direction?

[Ron Jankov:]

We were expecting Q1 to be the start of that, but because of this inventory adjustment that took place at the board level, etc., it didn’t happen in Q1. But when you look across, as Mike mentioned, we have 21 designs of which two have ramped in Q1. Another one minimum will ramp in Q2, and those other 18 are going to ramp over the next five to six quarters. And quite a few of these are quite high in terms of revenue, etc., especially the 7000 wins, which is our most valuable product. So, there is great opportunity for growth at Cisco not just this year, but really for the next three years. I really don’t expect there is going to be a headwind anytime in the near future.

[Arnab Chanda:]

On a year-over-year basis, there is obviously the contribution you are getting from Cypress. When you talk about Cisco in general, I know you don’t want to get in too much detail, but is it fair to say that everything is going to grow but the new products will grow faster or do you think Cypress will tail off while the new products will keep growing, qualitatively how would you think about that?

[Ron Jankov:]

Well typically, in a legacy program, as the volume goes up, which you have a predictable ASP erosion which we’ve always said was 15% to 20%. So that tends to be flattish. So really to get to grow at Cisco you have to be in new programs that are ramping. So, that’s what puts us in a great position right now is that we are going to be ramping not only just a few products, but in many divisions inside of Cisco. So, that’s what’s going to drive our growth assuming legacy is basically flattish.

[Arnab Chanda:]

A question on NETLite, from what timeframe should we expect that to be a significant contributor, maybe 5% or maybe a little higher of revenue growth? Is it late this year or next year, would you say?

[Ron Jankov:]

The 5%, because that number keeps going, getting harder to hit, right, probably won’t be till early next year. But anyway it will be measurable in Q4 but 5% will probably be acquired early next year.

[Arnab Chanda:]

Same type of question on NETL7, I think you made a new product announcement relatively recently to more, higher volume applications. Could you update a little bit on that, when we should expect revenues from that product line?

[Ron Jankov:]

That product line will have significant revenues in Q1 ‘09. There will be pre-production between now and then, but the main boxes that are expected to ramp are scheduled to ramp in Q1.

[Arnab Chanda:]

So by this time we should have design wins, right, if you are thinking about that timeframe?

[Ron Jankov:]

Yes, we’ve got six design wins already.

[Arnab Chanda:]

It seems like a lot of your new products in a sense maybe this requires some explanation, if you look at your gross margins, obviously they have held up very strongly. But if you look at all the new products you are ramping they are almost all in, seems like in end markets that should have better ASP or better margins. So, are your margins, is 65% still a good target or do we think that can be higher than that as we go through maybe this year or next year?

[Michael T. Tate:]

No, we still are modeling the company to be at 65%. There is always a mix of end markets. We’re moving into the service providers and the metro boxes with typically, given those types of applications do have higher margins, but we are also moving into the NETLite type applications and some of these Layer 7 applications, as well are going to go to very high-volume boxes, even go down to the SMB type application, so given the blend of all that, we still feel good about 65%.

[Arnab Chanda:]

You didn’t talk a whole lot about Aeluros. How is that progressing and what your revenue expectations from there versus at the time of the merger, can you talk about that a little bit?

[Michael T. Tate:]

Sure, as we highlighted on the call, 10-Gigabit Ethernet, the end market is doing very well for us. We participate in two ways. We have the knowledge-based processors and that’s doing well and also the 10-Gigabit PHYs. The 10-Gigabit PHYs are in a nice growth trajectory given that the market is transitioning to these X2 modules right now. As that plays out, we are picking up share in the 10-Gigabit Ethernet market. We are also seeing the very early shipments of SFP+ designs as well. That’s nice, and encouraging, but that transition will give us another leg of growth here probably starting in the second half of ‘09.

[Operator:]

Your next question comes from Sandy Harrison - Signal Hill.

[Sandy Harrison:]

If you were to take a look back at your expectations for the 10-gig market, specifically the 10-Gigabit PHY and where you thought it would be, and where you thought you would be when you purchased Aeluros. Could you maybe do a comparison of your thought would be further ahead, less ahead of the market would be slower or faster. Just trying to get a gauge of comparative points of time.

[Michael T. Tate:]

We just completed the acquisition in October, and since then we’ve been very pleased with the integration of the team and the developments that have transpired after the acquisition. I would say from a market perspective the migration from XENPAK to X2 has played out pretty reasonable to where we expected. I think we are encouraged by the design activity around SFP+. That’s probably maybe a little bit ahead. I think the need for 10-gigabit in the datacenter and these application is, I think the end customers are realizing that with great urgency. So that’s probably the positive development, which bodes well for us and to keep the growth going.

[Sandy Harrison:]

Ron, you went through a lot of the growth drivers both from a product perspective as well as the market perspective. And it look like there is a lot of room for growth. If you were to try to give us a little bit more of what market or if you could rank the growth opportunities to give us a little bit of something to focus on. And then also products, the same thing, so what markets do you think are going to be the biggest drivers for you for the next 12 months and then what products outside of some of those you’ve talked about in-depth at Cisco?

[Ron Jankov:]

What’s driving us right now in the current quarter and the next couple of quarters, certainly the diversification or proliferation of our products within Cisco is going to be a big growth driver for us in Q2, Q3, Q4 of this year, and probably for the next three years, I shouldn’t limit to that. But that’s something that’s taking place now that it’s very exciting. We’ve been waiting for it for a long time. And relatively to products, it’s a lot of different products, it’s our 8000, it’s our 7000, it’s our 6000s, even a couple of NETLites. So that’s very exciting, because it is quite broad based within Cisco. I think also first half of this year and into Q3 maybe especially, we are seeing cable and IPTV continue to be strong. It’s just that market, caught its breath a little bit in Q4 and it’s predicting a strong 2008 again, there is a broad base of customers and applications there. Then also, Mike just mentioned 10-Gigabit Ethernet, which both from a KBP standpoint as well as a PHY standpoint, is going to be strong currently and at least for the next several quarters and probably a couple of years. But we don’t like to look much further than next couple of quarters. So, that’s the stuff that’s hitting us right now. The big one is going to hit us, could be as early as six months, it could even be earlier, is wireless infrastructure, and this could be a really big change for us, because this is a market that doesn’t exist today, and across the board whether it’s AT&T or Verizon Wireless or the European companies like Vodafone, etc. They are going to have to do massive infrastructure upgrades to be able to support these new 3G multimedia phones as they become a significant and critical mass of the total phones out there. They actually must change and that hasn’t started yet. When that kicks in that’s going to be very positive and likely to be a long-term trend. If you look a little bit further out, 2009, I think will be the year of NETLite and NETL7. So, those things will kick in, in 2009. We also have a bunch of new customers coming on, like Nokia and Ericsson, Motorola, Nortel and others. So, we have a lot of new applications and customers late this year and early next year as well.

[Sandy Harrison:]

You highlighted that your partners, Broadcom and Marvell from the switch side have introduced their parts and are rolling their parts out. How do you see the market currently rolling out with these newer products? Are you seeing in the next quarter or two? Is there a lot of interest there? Just to try to get a handle on it, on the earlier read as these parts trickle out.

[Ron Jankov:]

Yes, there is enormous amount of interest, also you can refer to Broadcom, I think they announced their report on Monday, the one that attaches to us or today rather. So those two products are tightly coupled. There is a tremendous amount of interest. There is so many designs that’s going on, a much higher degree just because they have such a broad swap of customers throughout Asia and the U.S. and Europe. But anyway, the designs are all being done right now, but it takes six to nine months to take a design from where it is today to volume production. So really it’s not a matter of when, it’s not a matter of if, it’s when.

[Operator:]

Your next question comes from Nicholas Aberle - Caris & Company.

[Nicholas Aberle:]

You talked about Sony Ericsson, Motorola, Nokia, and Nortel. Maybe just a little bit more color on when you think those are going to start ramping, have you have started to see initial ordering from those customers, etc.?

[Ron Jankov:]

Yes, we are shipping them pre-production quantities now, but because these are big telecom boxes, it’s a typically quite a long design cycle. So, I would expect that most of the action from these new customers will be late this year and throughout ‘09.

[Nicholas Aberle:]

Could you just quickly give us an update where you are on total design wins for the company and how many of those are currently in volume production?

[Michael T. Tate:]

Q1 was a record quarter for us with 18 designs. That included a record for NETLite. As we indicated, we’ve been working with the customers for quite a while and we don’t measure designs until we actually get an order and the boards are ready to receive our products. So, right now I think we have a record backlog of designs that are pending to go into production. We talked about Cisco in particular with 19 right now, and just broadly that same indicator is very strong throughout our existing and new customer base.

[Nicholas Aberle:]

Talked about strength in April, was that mostly Cisco-driven in terms of the replenishment of the inventory drain you saw in Q1, or is it across the board, broad based?

[Michael T. Tate:]

I would say it’s pretty much across the board. We had a very good first month for the quarter. We typically do have positive sales linearity and this quarter will be particular strong.

[Nicholas Aberle:]

And you are booking out 16 weeks from now, so you are already looking at bookings activity for early Q3 in terms of the bookings pull there and anything abnormal in terms of the booking activity out further?

[Michael T. Tate:]

We continue to be very encouraged by the visibility that our customers are placing on us and also the strength in our business seems pretty broad, be it in China or is the NGN boxes that we see starting to be built out, telco, 10-gigabit, so we are pretty encouraged.

[Ron Jankov:]

Yes, in Q3, if anything, looks particularly strong from this firm standpoint.

[Operator:]

Your next question comes from Ruben Roy - Pacific Crest Securities.

[Ruben Roy:]

Ron, wonder if you can give us a update at all in terms of timing for 45-nanometer products?

[Ron Jankov:]

We will definitely be shipping 45-nanometer products next year.

[Ruben Roy:]

You mentioned the X2 module, the PHYs going into the X2 module. Can you just give us an idea of where we are in terms of penetration there, what the competitive landscape looks like, what your market share is and what driver the X2 modules can be?

[Ron Jankov:]

Well we think we have greater than 50% market share in that particular market, again, because of our very, very low power technology, and very low noise, etc., small footprint, all of that really matters in that X2 footprint. It’s still another two years before that transition has done its full turn.

[Ruben Roy:]

Mike, you mentioned getting back to traditional inventory levels over the next several quarters. What would you say your target DOI range is?

[Michael T. Tate:]

We can typically go for a 90 to 100 days. That’s partly reflected because we typically do have front-end loaded quarters, so the end-of-the-quarter inventory balances are there to support the first strong month. And also because we are sole sourced it a lot of times in their customs parts that we give our customers comfort on carrying those levels.

[Operator:]

Your last question comes from Cody Acree - Stifel Nicolaus.

[Cody Acree:]

You gave the absolute number I think 18 design wins in the quarter. Can you give any granularity as to the breakup, just by market?

[Ron Jankov:]

Well, one thing we mentioned, we got yet another NL8000 design win at Cisco in the quarter, which takes the total at Cisco to 21 of which two have ramped and one ramping at least in the current quarter. So, other than that it was pretty broadly based. It was a combination of NETLite as well as high-end KBPs. We got a number of new design wins for this recently announced 71024XT. This is a really, really interesting chip, because it carries the highest ASP than anything we sold probably since we have been a company, I’ll have to think about that, maybe with the exception of the first NETL7s. But it’s got a great ASP because we are delivering just an unprecedented amount of performance with this device. And so those designs are very exciting that people are willing to pay the difference between the standard part and the XT, which has a significant premium.

[Cody Acree:]

On the competitive front, obviously, bringing a lot of new products, we are seeing a few competitors talk more about what’s going on in this space. As you are going to market and seeing what you are competing with customers, do you feel like the gap is widening or shrinking, is the environment getting a little more crowded or what’s your view?

[Ron Jankov:]

Yes, I would say that in fact, a couple of things. We’ve brought several 55-nanometer products to market. And we did that very, very quickly and they worked first past silicon, so that gave us a huge advantage over anything that the competition is doing right now. But I think the other thing is we are bringing new technologies to bear. The NL9000 which we announced last quarter is a hybrid technology which includes these Sahasra Algorithmic engines that in combination with the KBP cork in lower power by a 5X factor, which is again something that’s very hard for the competition to deal with. And power is becoming as important as performance in these new applications. So I would say from a overall technology standpoint, we have the greatest strength we’ve ever had relative to competition right now.

[Cody Acree:]

Ron, you gave in your guidance a bit of macro caution. If you remove that macro caution or maybe just give us some color as to how much that weighed on your decisions for visibility or for guidance?

[Michael T. Tate:]

We just decided as prudent in this environment to give little extra conservatism. The strength of our business is affording us that luxury to do that and until we see the backdrop change more from a headline risk, we’ll just continue to run it that way. No, not any indication from forecast bookings or backlog or what our customers are telling us. It is just, again, just given what you see in the papers.

[Operator:]

There are no additional questions at this time.

[Ron Jankov:]

Thank you and thanks to everyone for joining us today. During the second quarter, we will be presenting at the Robert Baird Growth Conference, the Cowen & Company 2008 Technology Conference and the Oppenheimer Annual Communications and Technology Conference. We thank you for your continued interest in NetLogic Microsystems and we look forward to speaking with you in the near future.