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Q2 2008 Earnings Call Transcript

Published: 5 Aug 2008

[Operator:]

Good afternoon, and welcome to NetLogic Microsystems' Second Quarter 2008 financial results conference call. Leading the call today are Ron Jankov, President and Chief Executive Officer; Mike Tate, Vice President and Chief Financial Officer. My name is [Katy], and I will be your coordinator for today. I would like to now turn the call over to Leslie Green, Investor Relations for NetLogic Microsystems. Please proceed.

[Leslie Green:]

Thank you, Katy, and good afternoon, everyone. Please note that our second quarter 2008 results were disseminated by Business Wire after the close of market today and a copy of the release can be downloaded from our website at netlogicmicro.com. Before we get started with our financial results for the second 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 risks and uncertainties, and actual results may differ materially. For a discussion of such risks and uncertainties, please see today's earnings release, the risk factors in our Form 10-K, filed on March 14th, 2008, and Form 10-Q, filed on May 7, 2008, as well as other reports that 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. The reconciliation of non-GAAP to GAAP financial information is in today's earnings release. The reconciling items between GAAP and non-GAAP are stock-based compensation, amortization of intangible assets, and a fair-value adjustment for the inventory acquired. These items have been removed from the cost of revenue and operating expenses for non-GAAP reporting. I will now turn the call over to Mike to discuss our second quarter results. Mike?

[Mike Tate:]

Thank you, Leslie. Good afternoon, everyone. Today we reported that revenue for the second quarter of 2008 was $36.5 million, which came in ahead of our prior guidance of $36.2 million. Q2 revenues grew 7% sequentially, from $34.2 million for the first quarter of 2008 and 41% from $25.8 million for Q2 of the prior year. Revenue from Cisco Systems, our largest customer, came back strongly in Q2, growing 28% sequentially to approximately $16.3 million or 45% of our total revenue, compared with $12.7 million or 37% of our total revenue for Q1 2008. This strong growth was the result of the continued ramp of new designs, including initial pre-production revenues for some NL7000 designs, which are expected to go into volume production in Q4. We did not have any other customers above 10% of our revenue in the second quarter. Our Q2 non-Cisco revenues were down by about 6% from last quarter, which we believe was largely the result of some seasonality at Alcatel-Lucent heading into the summer timeframe and some softness in the U.S. enterprise market. This was partially offset by strength with Huawei and ALAXALA. Given our strong revenue in July to date and our remaining backlog coverage, we believe our non-Cisco revenues will have a solid quarter of growth again in Q3, with broad contribution from all our major customers. Our non-GAAP gross margins for the second quarter were 66%, which excludes stock-based compensation expense, the fair value adjustments related to the inventory acquired from Cypress Semiconductor in Valeros and the amortization of intangible assets. There is a complete reconciliation between GAAP and non-GAAP gross margins in today's earnings release. Our Q2 non-GAAP gross margin was ahead of our guided gross margins of 65.5%, given our continued strong manufacturing execution. Q2 GAAP operating expenses were $18.6 million, which included $2.9 million of stock-based compensation and $300,000 for the amortization of intangible assets. This compares with GAAP operating expenses of $18.7 million for the first quarter of 2008, which included approximately $3.4 million of stock-based compensation and $300,000 for the amortization of intangible assets. Non-GAAP R&D expenses were $10.6 million for Q2, as compared with $10.2 million for Q1. Non-GAAP SG&A expenses, excluding stock-based compensation and the amortization of intangible assets were $4.7 million for Q2, as compared with $4.7 million for Q1. Total non-GAAP operating expenses during Q2 were $15.3 million, compared with $14.9 million for Q1 2008. This compares favorably to the $15.6 million that we guided to last call, and reflects good expense control during the quarter. Q2 interest and other income was approximately $250,000, compared to our guidance of $400,000. The lower-than-expected amount is primarily due to one-time disposal of approximately $100,000 of assets during the quarter. Our Q2 tax provision was a benefit of approximately $100,000 and reflects the current positive mix of our foreign and domestic book income and losses. On a GAAP basis, our Q2 net income was $2.3 million or $0.10 per diluted shared, compared with net income of $1.1 million or $0.05 per diluted share for Q1 2008. Non-GAAP net income for Q2 was $9.2 million or $0.40 per share, compared with $8.7 million or $0.38 per share, for Q1 2008. Also, our Q2 non-GAAP net income grew 48% from the $6.2 million in Q2 2007. We had fully diluted shares of 22.5 million on a GAAP basis and 23.2 million on a non-GAAP basis. The increase in our share count is largely due to the use of a higher average stock price under the treasury method of accounting. With respect to the balance sheet, cash and cash equivalents increased by $17.9 million in Q2, to end the quarter at $73.7 million, compared to the $55.8 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 decreased to $14.7 million and represented 36 days. The decrease in accounts receivable and DSOs was as expected, given the increased focus on collections, coupled with favorable sales linearity. First quarter net inventory was $16.1 million, compared with $17 million at the end of Q1. As expected, our inventory decreased in absolute dollars and days held. Our days of inventory remain higher than our historical levels, given that at the end of the quarter we have positioned more of our inventory in the finished goods stage to support our strong first month of revenues in July. This concludes my review of the quarterly results, and now I would like to turn the call over to Ron.

[Ron Jankov:]

Thank you, Mike. This continues to be a very exciting time for us. Carrier and enterprise networks are in front of a number of long-term upgrade cycles, as they are being driven to increased bandwidth and network intelligence to handle a new wave of robust and demanding applications being run over their networks. As a result, our customers are deploying and developing next-generation intelligent, IP-based networks to support the increasing speeds and sophistication of these new applications. Our industry-leading product portfolio and roadmap has put us at the center of this transition, as we are enabling our customers to offer enterprises and service providers, systems capable of processing the growing complexity of network traffic, including such applications as IPTV, voice over IP, video downloads, triple and quad-play services, gaming and teleconferencing. In order to support the increasing bandwidth and intelligence required for these applications, our customers are dramatically upgrading the performance and functionality of their high-end data plane architectures. These new system designs are resulting in increasing usage of knowledge-based processors and enhanced layer four through layer seven processing capabilities. Many of these new data plane architectures are centered around our customers' internally developed ASICs, which are designed with a unique custom link to our knowledge-based processors as a fundamental element of the new data plane design. These new ASICs, such as Cisco's Quantum Flow processor, Alcatel-Lucent's FP2 processor and a number of others set to be released by our customers over the next 18 months, dramatically improved system performance over previous generations, delivering orders of magnitude increases in functionality and performance for enterprises and service providers. These new processors also contain significant increases in a number of transistors, demonstrating how the complexity on both our side and our customers' side of the bus are simultaneously growing dramatically, making these custom ASICs a great match for our most valuable knowledge-based processors. This trend comes at a perfect time for us, as our strong engineering execution and industry-leading product portfolio has enabled us to win a significant number of key designs during this critical phase, right when our customers are redefining their next-generation data-plane architectures and ASIC designs. Given the tremendous investment to develop these new ASICs and system designs, utilizing our knowledge-based processors, we believe these programs will have a long life of five to seven years. Further, the large majority of these designs use our sole-source proprietary architectures and proprietary unique programming software, interfaces and instruction sets, making the replacement costs steep and resulting in long-term design wins. The strength of our technology and success is clearly evident by the broad market adoption that we are experiencing. We now have design wins with all of the top 20 communications equipment companies for solutions sold into large enterprise and carrier networks worldwide. This includes designs with existing, as well as new customers, such as ALAXALA, Alcatel-Lucent, ARRIS, Cisco, Ericsson, Xtreme, Force10, Foundry, Fujitsu, H3C, Huawei, Juniper, Motorola, NEC, Nokia-Siemens, Nortel, Tellabs and ZTE. In total, our customer base has steadily grown and the design opportunities have become increasingly diverse. This ongoing diversification has allowed us to adjust to fluctuations in our customers' ordering patterns, as evidenced in the second quarter. As Mike mentioned, some softness in the U.S. enterprise market, coupled with seasonal shipments at Alcatel-Lucent, resulted in a decline in our non-Cisco revenues in Q2. However, strong growth at Cisco, driven by several new designs that continue to ramp in volume, allowed us to once again exceed our revenue and profit goals for the quarter. As we enter Q3, we see our non-Cisco revenues resuming solid growth, driven by a rebound in our revenues with Alcatel-Lucent, following their seasonally slower Q2, as well as a general, broad-based strength driven by IPTV, NTT's NGN deployment, 10-gigabit Ethernet, cable and the emerging global wireless market. In the second quarter, our strong revenues from Cisco were particularly exciting, as we continue to see growth from our first two NL8000 designs and began the initial ramp of a design into a new data center switch. Also, we had strong pre-production shipments of NL7000 processors to Cisco that are being used in new carrier-class boxes. These are design wins for our most valuable products and represent sole-sourced opportunities for us at Cisco as there is no equivalent competitive solution in the market. In the third quarter, we expect to ramp a third NL8000 program into the ASR router at Cisco. We will also begin first pre-production shipments of our high-end NL8512, which currently enjoys a sole-source position. Our NL8512 is approximately twice as valuable as the mainstream NL8000 and demonstrates Cisco's commitment and requirement to use an ever-increasing content of knowledge-based processing in next-generation data plane designs. The overriding market trends that support our long-term growth potential across the entire customer base are also very exciting. In the enterprise market, the adoption of 10-gigabit Ethernet is gaining momentum as a proliferation of video and virtualization applications delivered to growing numbers of Internet-connected devices is driving enterprises and data centers to upgrade their legacy equipment. This is resulting in strong demand for both our physical layer products and our knowledge-based processors. Industry analysts expect the market for 10-gig E5s to grow tenfold in port count over the next five years, representing a 58% compound annual growth rate over that period. In response to this strong projected market growth, we continue to aggressively invest in further broadening our industry-leading product portfolio. During the second quarter, we announced the industry's first quad-core 10-gigabit Ethernet physical layer devices that deliver the highest performance and lowest power consumption for next-generation switches, routers and blade servers, addressing the data center, enterprise networking, storage and service provider markets. These new devices offer power savings and footprint reduction, allowing customers to develop higher density switches and blade centers for next-generation equipment. They are a great addition to our single and dual-port SMP Plus products, as well as our other advanced 10-gigabit solutions, including products for X2, XFP, Fibre Channel over Ethernet, [KR Backlane] and NIC and server applications. This aggressive broadening of our product portfolio is a direct result of the stellar execution and hard work of the 10-gig PHY team, and I am extremely proud of these results, which include two very successful products delivered to our customers in the first half of this year, and we expect additional new product introductions in the second half of 2008. The growth in video and virtualization applications and the increasing need for enterprise networks to support essential Internet features such as quality of service and security are also driving more demanding layer three functionality into the high-volume entry-level enterprise segment. During the quarter, we announced our newest 55-nanometer NL56615 and NL3380 NETLite processors, targeted at a new generation of merchant silicon switches and NPUs. These new NETLite processors support the deployment of next-generation IP converged networks, providing wire speed support of QOS and security on multi-gigabit systems at lower power consumption and higher port density. Following what was a record design win quarter for NETLite last quarter, we added another seven new NETLite designs to the list in Q2. Turning to our wireline and IPTV market, one of the most exciting developments in the second quarter was the beginning of the NGN buildouts in Japan and Korea. We were very pleased to announce that our NL7000 family of knowledge-based processors has been selected by ALAXALA Networks for its high-end AX7800 router that will be shipped into leading carriers in Japan and South Korea. Japan and South Korea are at the forefront of deploying highly sophisticated NGN networks, which completely phase out legacy technologies, replacing them with IP-based services. NTT has been performing commercial trials of the NGN network since 2006 and is now rolling out nationwide deployment to support the successful adoption of broadband fiber to the home and 3G/4G mobile wireless services, as well as, the increasing popularity of video and peer-to-peer content over their networks in recent years. In Q2, we were also pleased with the continued signs of worldwide adoption of IPTV, now with an estimated 16 million subscribers worldwide. While Europe continues to be the leader in IPTV deployment, the number of subscribers in China doubled year-over-year to more than 1 million, representing a new market that is primed for major growth over the next several years. Further, we are seeing growth in IPTV subscribers in the U.S., as large investments by AT&T and Verizon are likely to drive increased penetration over the next several years. This strong growth in IPTV bodes well for us, given our content-rich designs with leading suppliers such as ALAXALA, Alcatel-Lucent, Cisco, Huawei and Juniper. We are also continuing to benefit from the cable service providers offering higher-speed, advanced triple-play services to compete with IPTV. We continue to project good growth from our lead customer, ARRIS, and are excited about our pending design ramps with Cisco and Motorola. Turning to the mobile wireless infrastructure market, this market segment continues to move forward with the adoption of our technology. The recent successful launch of the 3G iPhone, as well as the continued introductions and strong sales of other advanced smartphones is a very positive trend for us. These new smart phones introduce compelling, video-intensive applications, now at speeds that will further accelerate mass adoption. With such increased video and Internet connectivity being delivered to a growing number of unique subscribers, carriers are being required to invest in their network infrastructures with more intelligent IP-based equipment, utilizing our knowledge-based processors. Now, moving to NETL7. During the quarter, we achieved first-pass silicon success and began sampling our recently announced single-chip layer seven solutions. Customer feedback has been very positive, as they were able to quickly and successfully bring up their advanced systems using this breakthrough technology. We will work with our customers to bring these initial designs to production early next year. With the success of our new single-chip family of products, as well as our 10-gigabit layer seven solutions and advanced roadmap, we saw a significant uptick in customer activity, as they now look to take advantage of the unique capabilities of our NETL7 solutions that will allow them to incorporate deep packet inspection at many points in a network. In conclusion, although these are not strong economic times, we believe that our growth in the short and long term is being driven by strong product cycles and industry trends that are converging in our favor. The U.S. market is an important end market for many of our customers' equipment, and weakness here has prompted us to continue to be conservative in our planning and outlook. But strain on networks to keep up with the increasing bandwidth requirements and complexity of today's traffic is necessitating the upgrade of legacy equipment worldwide, regardless of the particular economic backdrop in any given region at any given time. Both we and our customers are entering exciting multi-year product cycles where our broad portfolio of advanced products are being incorporated into a wide array of our customers' products, including many that never utilized knowledge-based processors and 10-gigabit physical layer solutions before. We believe that we have the correct products to address a strong and growing market, and that our opportunities will only strengthen as the economic backdrop improves. At this point, I will turn the call back over to Mike to discuss guidance for the third quarter. Then we will open up the call for your questions. Mike?

[Mike Tate:]

Thanks, Ron. As we look into Q3, given the continued volatile economic backdrop, we will remain conservative with our outlook. For Q3, we expect Cisco revenues to be relatively consistent with Q2, even though we expect to see continued growth from our new NL7000 designs, our first preproduction shipments of the NL8512 and our first-ever ramps into the ASR router platforms. Outside of Cisco, we expect strong resumption of revenue growth following the seasonal adjustment with Alcatel-Lucent and the continued adoption of our technology as our customers continue to deploy next-generation equipment. Based on our backlog coverage, we expect revenues to increase to $38.3 million, representing an approximate 5% sequential growth from Q2 and 39% year-over-year. Our Q3 revenue guidance reflects a very strong first month of shipments to all of our major customers, including Cisco and Alcatel-Lucent and a full backlog coverage for the rest of the quarter. We expect non-GAAP gross margins to be approximately 66%, which is flat from Q2, and slightly ahead of our long-term model of 65%. We expect non-GAAP operating expenses to increase to approximately $16.2 million, non-GAAP R&D expenses to be approximately $11.2 million and non-GAAP SG&A to be approximately $5 million. Also in Q3, we expect interest and other income to be approximately $300,000. We expect our tax expense for Q3 to be approximately 1% of our non-GAAP income before taxes. We expect non-GAAP EPS for the third quarter to be $0.39 per share. We expect our GAAP EPS for the third quarter to be $0.07 per share. This includes an estimated $4.1 million in FAS-123R stock-based compensation, $3.3 million in the amortization of intangible assets, and $300,000 in a fair-value adjustment for acquired inventory. Finally, we expect our GAAP share count to be approximately 22.9 million and the non-GAAP share count to be approximately 23.6 million in Q3. This concludes our prepared remarks for the call and now we are happy to take questions. Operator?

[Operator:]

(Operator Instructions) The first question comes from the line of Allan Mishan, Oppenheimer. Please proceed.

[Allan Mishan:]

Hey, guys, nice job. First, a quick one for Mike, what do you expect the tax rate to be in 2009?

[Mike Tate:]

So for the balance of this year, we are expecting 1% tax rate on our non-GAAP income, and next year probably about 5%.

[Allan Mishan:]

Okay, great. And then for Ron, you gave some details on NETLite in terms of design wins and so forth. Can you give us an idea of whether or not you are expecting revenues from some of those Broadcom and Marvell switch-related platforms in 2008? If so, how significant could they be and when would you see them?

[Ron Jankov:]

It is mainly pre-production in 2008. The real volume starts at the beginning of 2009.

[Allan Mishan:]

Okay, great. Thanks very much.

[Ron Jankov:]

Thanks.

[Operator:]

Your next question comes from the line of Adam Benjamin from Jefferies. Please proceed.

[Adam Benjamin:]

Hey, guys, nice job. I think I recall the same issue with Alcatel in Q2 of '07. So just, Ron, if you can elaborate, is it a similar thing that maybe we should be expecting this kind of seasonal dip next year again?

[Ron Jankov:]

Well, it is a good question. We noticed the same thing, and last year, there was a specific issue with an ASIC they couldn't get delivery on, but nevertheless this makes two years in a row where Q2 is their softest quarter of the year. So I think we are going to be careful about that next year going into Q2 and probably be very conservative with our Q2 going forward.

[Adam Benjamin:]

Got you.

[Ron Jankov:]

I am sorry, I apologize, but their Q3 is very strong and they were very strong in July, so it does seem like it's -- they kind of like get inventories under control before the summer, similar to what some other people do at the end of the year.

[Adam Benjamin:]

I got you. Fair enough. The last two quarters, you guys have guided basically zero turns. Should I assume your conservative nature is the same again this quarter?

[Mike Tate:]

Yes, we once again have guidance to full backlog coverage and it is also coming off an already-strong July to date, but, yes, it is consistent with the last two quarters.

[Adam Benjamin:]

Got you, and then as you look at Cisco, Ron, you went through that really quickly. You have0 also talked about having 21 new programs ramping, three of which would have ramped, including one in the June quarter. Can you update us on that number, and then just go back over quickly the business that you talked about that's going to shift in the September quarter? You went through that pretty quickly.

[Ron Jankov:]

Yes, we had one additional design win in Q2 and one program that ramped into production. So we still have the same number that are still ahead of us. At least one will ramp in Q3. This is in the ASR router, which is an NL8000-based product, and we also -- we have got a number of them primed for Q4 launch, and we have talked about the multiple carrier-class products that are using the 7000. They're continuing pre-production in Q3, but we should go into production in Q4. And we also started pre-production of our high-end NL8512, which is we have always called the high-end portion of the fourth-gen market, where we are currently sole-sourced, and that's into high-end router. So it is quite broadly spread through Cisco. We are winning in new enterprise boxes and new mainstream routers and new high-end routers. It's quite spread.

[Adam Benjamin:]

Got you. And just on that last topic, Ron, competition wise, where do you think you stand versus your closest competitor, and has anything really changed there?

[Ron Jankov:]

Well, I think the one thing that's changed a little bit is a lot of our new designs at Cisco are for the sole-sourced NL7000 product. So, those are really good for us because for the next five to seven years those will always be sole-sourced sockets. So I think that is probably the most significant change in competitive dynamics is that we are increasing our penetration with sole-sourced products.

[Adam Benjamin:]

Got you. That's all I have, guys, thanks.

[Ron Jankov:]

Thank you.

[Operator:]

Your next question comes from the line of Arnab Chanda from Deutsche Bank. Please proceed.

[Arnab Chanda:]

Yes, hi, a couple of questions, either for Ron or for Mike. First of all, it seems like you re being very conservative and that's probably prudent, given the environment, maybe could you talk qualitatively about how you are kind of thinking about that? Are you sort of assuming the new products to ramp at a certain rate and no growth for your kind of legacy things, like the Cypress acquisition or the sort of Gen two, early Gen three kind of knowledge-based processors? How are you thinking about that when you sort of do your internal modeling, as well as guidance? I have a couple of follow-ups.

[Mike Tate:]

Yes, so we're continuing to run the business very conservatively and also give conservative guidance, just given the backdrop right now. In particular for Cisco, though, we are very excited about the new designs, they continue to ramp well, and we added another one to the list this quarter. And what's really positive about the new designs at Cisco, like Ron was saying, its really diversifying our reach within Cisco to a lot of different business units and applications, so we are no longer relying on any one business unit for the growth. And outside Cisco, we had a good quarter in Q2 with Huawei and ALAXALA, and as we look into the second half, it looks like all the customers should contribute to growth, and it looks pretty broad. So we continue to be encouraged by the trends in front of us and also the fact that our customers continue to place very good visibility to us where we're pretty much done with Q3 now and are filling in Q4 and we are encouraged by the ordering patterns that we have for Q4 right now.

[Arnab Chanda:]

That's great. A couple of other questions, maybe about new products. Can you talk a little bit about sort of what timeframe you expect NETLite and NETL7 to contribute strongly, and is that sort of pattern of revenues to be similar to the way you saw your tradition [KPP] when you go from one generation to another, or is it going to be slower or faster, would you say?

[Ron Jankov:]

Well for both NETLite and NETL7, we expect to start to see production revenues in the first half of 2009, and I think they will grow steadily, starting then for several years. It's a little bit early to predict exactly how quickly they will both ramp and how big of a percentage of our revenue they'll be. I think we continue to see lots of new design wins. For example, the NETLite, we had originally targeted only desktop switching, but we're getting design wins into things like GPON aggregation boxes and other -- we'll call it cost-sensitive access equipment. So our NETLite footprint is expanding beyond our original expectations, which is great, but again it's a moving target, then, as to how big that'll be, based on this expanding footprint.

[Arnab Chanda:]

Yes, and one question about the margins. Obviously that's been -- your performance has been consistently exceeding your expectations and has been very strong. Other than NETLite, if you look at all of your other products, is there a reason to expect gross margins to dip down or are they likely to kind of maybe even, based on mix, some of the products could even have higher margin than your sort of target or where you are today? Mike Tate, NetLogic Microsystems - VP and CFO 27 We do have a range of margins by our products, but overall we still think 65% is a good gross margin long-term target for us. We're very pleased to be operating above it right now and pretty consistent at the 66% level. And as we guided to Q3, we expect that to continue. But as you look longer term, just a slight trend down to 65% is probably the right way to think about it.

[Arnab Chanda:]

One last question --

[Ron Jankov:]

Just a little bit more on that. We feel confident in our gross margin model moving forward for a couple of reasons. One, as you mentioned, because of the increasing performance and functionality requirements of the next-generation Internet, our customers are increasingly choosing our most valuable products, which have the highest gross margins. So that's not just a good near-term trend, but also good long-term trend. Also, our aggressive move to the 55-nanometer node, half-node, rather than the 65-nanometer node, gives us an 18% die side advantage for all of these new projects that are going into production, so that also bodes well for our gross margins in 2009 and 2010.

[Arnab Chanda:]

And, Ron, one last question. If you look at NETL7, that's obviously been sort of a greenfield opportunity to expand your market. Can you talk qualitatively about the targeted markets, both networking, as well as servers, storage, et cetera, where you are on the penetration in terms of design wins at this point, security?

[Ron Jankov:]

Sure. Our original design wins were in very high-end security appliances and where the new single-chip designs are going into a very, very broad range of security appliances, firewalls, VPN boxes, et cetera, these boxes that can be anywhere from a $1,000 to $50,000. So it is going to be much more spread out in terms of being delivered at small businesses and places like that. The next big opportunity is as layer seven functionality starts to migrate onto the data plane. Of course, the data plane design is representing an order of magnitude more volume than these security appliances, even the low-end security appliance boxes. So that's where we are concentrating our efforts right now, which you'll start to see design wins and pre-production from that within the next six to 12 months.

[Arnab Chanda:]

Thanks, Ron. Thanks, Mike.

[Operator:]

Your next question comes from the line of Ruben Roy from Pacific Crest Securities. Please proceed.

[Ruben Roy:]

Hi, Mike. I'd like to ask on bookings, I realize that in the last couple of quarters you've come in, you have said you were fully booked for guidance. And I was wondering, is there any difference in bookings? i.e., are you overbooked compared to last quarter at this point? You said you had a strong month of July thus far. Any detail you could provide there?

[Mike Tate:]

Yes, the one thing, the highlight of it is we do hold our customers to lead times, so generally it's 12 to 16 weeks. So when we say we're fully booked now, we will see some incremental demand for the current quarter, but there are lead times that will be positioned to next quarter. That helps [as our] Q2 played out, as well. The bookings have been very strong and continue to be favorable for us. So we are very encouraged by how now Q4 is starting to fill in at this stage.

[Ruben Roy:]

Okay, and then in terms of non-Cisco revenue in Q3, can you tell me if they will be bigger in Q3 than they were in Q1?

[Mike Tate:]

I don't want to be specific to that regard, but we kind of in our guidance at Cisco would be relatively consistent with the Q2 levels, so that by itself implies roughly 9% or so growth in the non-Cisco revenues.

[Ruben Roy:]

Okay, and then for Ron, in terms of the positive trends around the smartphones and wireless infrastructure that you are talking about capacity, et cetera, are there any changes to your thinking on when this market really starts to drive growth for NetLogic?

[Ron Jankov:]

Well, I think we are going to get some business from that market in the second half of this year, but it is just the beginning, and I think we have been talking about that as mainly being a 2009 phenomena. But that is still our thinking. I would say we are pretty much in the same place. We know we are already shifting some stuff into places like Vodafone via some of our customers, some of the people who are ramping more 3G services quicker. I think that will start to play out here in the U.S. with things like the proliferation of these 3G iPhones and the new Nokia phones coming, et cetera. So we are very, very bullish about that starting to contribute second half of this year, but really contributing strongly in '09.

[Ruben Roy:]

Great, and just one last final one. In terms of the ALAXALA strength that you talked about, is that for both Japan and Korea, and how do you see the sustainability of that going through the rest of the year? Thanks.

[Ron Jankov:]

Yes, it was both Japan and Korea and NTT is just at the very first phases of this new deployment. This deployment, we have been told by numerous sources, including the articles you read from NTT themselves, that it will be a steadily increasing deployment over the next 18 to 24 months. So we expect this to be a strong contributor for the foreseeable future.

[Ruben Roy:]

Great. Thanks, guys.

[Ron Jankov:]

Thanks.

[Operator:]

Your next question comes from the line of Sandy Harrison of Signal Hill. Please proceed.

[Sandy Harrison:]

Thanks for taking my call. Good afternoon, guys.

[Ron Jankov:]

Hi, Sandy.

[Sandy Harrison:]

So one of the things that you guys haven't kind of talked about on the Q&A has been what is going on with the [Eloro] stuff in the data center. It sounds like over the last two quarters you guys have gotten more, I guess, for lack of a better term, excited about some of the opportunities there or your visibility into some opportunities have improved there. What are some of the things you think that are spurring that, and is there a point at which this business accelerates or really hits sort of a hockey stick curve?

[Ron Jankov:]

Well, it is always difficult to predict exactly when a hockey stick like that is going to hit, but certainly from a design standpoint there is an enormous amount of design activity around 10-gigabit Ethernet right now. It is a design activity. It is kind of like what happened in mobile wireless a year ago that's just suddenly there is 10 times -- maybe not 10 times, but a lot more design activity than we have ever seen before. So we think that is coming. We think that there is going to be a major transition to 10-gig Ethernet. It is already happening now, but it is going to certainly accelerate, whether it is 2009 or 2010. We are very excited about the product portfolio we have, and these newest devices we are bringing to the market are really industry leading in terms of footprint and power, which are the two big things that particularly the high-density data center are looking for. So we are really excited about it. To answer your question more directly, it is sometime in '09 it is likely when this is going to hit another level of acceleration.

[Sandy Harrison:]

Now, as far as just the overall industry, is there any catalyst that we should be looking for a sort of an adoption of a technology, a particular large customer who is involved in transitions? Is there anything we should be keeping an eye or our ears to the ground on that?

[Ron Jankov:]

Well, across the board, I think you can directly correlate the amount of video that is moving over the Internet pretty much directly with the need to move from one-gig to 10-gig ports. I think also the amount of cloud computing and virtualization that is being done is almost, again, another direct correlation. So number of Internet users, number of searches done, any of those criteria will drive the move from one gig to 10 gig.

[Sandy Harrison:]

And just I am assuming that much of your products are more addressing the optical or the fiber-based 10 gig. Do you guys think that the copper-based 10 gig is something that's worth going after or is going to take off, or sort of what is your position on that market opportunity?

[Ron Jankov:]

Well, our particular focus is in very, very low power, which plays much better to the optical market right now. And at our current size, we are going to stay very, very focused on bringing much more efficient, more integrated and lower-power optical solutions. Right now, I think there is a market for the copper stuff, but it is basically in power-insensitive designs, which is not what we are focusing on.

[Sandy Harrison:]

Got you. And then, Mike, I am going to ask a question that was asked earlier a little different. I mean, you have been conservative, as per your prepared remarks and in some of your Q&A here, you have been conservative on your guidance last two quarters and, in fact, that paid off last quarter with Alcatel and some of the others kind of coming in under expectation. I mean, did you guys see that and that was one of the reasons for guiding conservatively or was it just lucky and then, based upon fully booked here, where we are today, believing that August is usually slow, but you usually see a pretty good pickup in September. Are you able to turn stuff in September if you get orders in it on a typical pickup in the last month of the quarter, or is most of that going to go into backlog, as well, for Q4?

[Mike Tate:]

Historically, we received about 5% to 10% turns order, and that really hasn't changed, but what we are doing is just holding our lead times a little more stringently now. So as we reported at the end of April, there was incremental turns orders, but our lead times had that position in Q3 and, similarly now in Q3, it is toward the end of July now, and so our lead times dictate that turns orders will go into Q4.

[Sandy Harrison:]

Got you. All right, thanks, guys. Appreciate you taking my questions.

[Ron Jankov:]

Thanks.

[Operator:]

Next question is Matt Robinson from Pacific Growth Equities. Please proceed.

[Matt Robinson:]

I wanted to follow on to Sandy's question about the transceiver business. Maybe you could -- I know you are working on a lot of design wins. If you could kind of refresh us when you expect that to start showing up economically, and also just give me a flavor for how many customers north of 5% you had in the quarter?

[Ron Jankov:]

I will answer the first half of that and let Mike handle the second. Design wins typically in the 10-gig PHY market is as -- designs are as complex and difficult and kind of sole-sourced as they are in the KPP market. So essentially it is a long design win cycle and you have to wait a while until things go into production and everything gets qualified. And then it tends to be built for quite a while. So the big number of design wins we are winning right now, you would expect to go into production mid to second half of '09 and into '10. So, as far as when that next big acceleration happens, it is more in that timeframe and that is mainly based on SMP Plus motherboard design. However, we are getting some uptick now in the continuing transition of modules from the older generation XENPAC, which is very high-power, large-footprint module, to the X2 module, which is a lower-power, smaller footprint module. And when in the case of XENPAC we have almost no penetration, in the case of X2 we have greater than 50% penetration. So, as X2, modules take marketshare from XENPAC modules, we will see growth, and that will be pretty steady over the next 18 to 24 months. So we can get growth from this part of the market even before the next big spike in orders starts to take place with SMP Plus.

[Matt Robinson:]

Okay.

[Mike Tate:]

Okay, and then the second part of your question, it is still the same customers that are right below the 10% line. Alcatel typically has been at a little bit above 10% and this quarter a little bit below. Beyond Alcatel, Juniper and Huawei are very strong customers for us, and ARRIS and Foundry and now ALAXALA as well are significant customers for us.

[Matt Robinson:]

Thanks a lot. Thanks for taking my question.

[Ron Jankov:]

Thank you.

[Operator:]

The next question comes from the line of Kevin Cassidy from Thomas Weisel Partners.

[Kevin Cassidy:]

Thank you. You mentioned about NTT replacing its old network with an IP network. Can you name some other telecom companies that you expect to convert and what the timeframe would be for that?

[Ron Jankov:]

Well, I think they are all getting ready for that kind of conversion. They all have to make that conversion going forward. For example, in the U.S., as AT&T and Verizon, a critical mass of their subscribers start to subscribe to IPTV and voice-over-IP versus the historic phone network that they have, they are going to start upgrading a significant part of their networks to IP based. Now, the same phenomenon is happening in the wireless infrastructure, right, as they start to support things like the 3G iPhone with lots of video and other services, for example, Internet connection and GPS, global positioning or location-based applications. They are going to have to, again, upgrade their wireless network as well to IP based. This transition is happening even faster in Europe, where there is a higher uptake in IPTV subscribers, as well as higher use of 3G smartphones. So it is pretty much worldwide. Even in China, we are seeing that. I guess we were surprised by a million IPTV subscribers of China. That was actually ahead of our expectations.

[Kevin Cassidy:]

And I guess from a total available market point of view, do you see this as doubling your enterprise opportunities? Or is it higher than that?

[Ron Jankov:]

I think the service provider switch to IP is very, very early in its stages. So I think we have been talking about somewhere 20% to 25% of our business being in that market, and we certainly expect that to become a much higher percentage of our business in the future.

[Kevin Cassidy:]

Okay, thank you.

[Ron Jankov:]

Thanks.

[Operator:]

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

[Nicholas Aberle:]

Thanks, guys. Just a quick question on China, a lot of chatter during the quarter that there was some sluggishness over there, any color you guys can provide on what type of demand trends you are seeing from that geography?

[Ron Jankov:]

Well, I think that our Chinese customers, in particular Huawei, tend to be very international in terms of their business. They sell a lot into emerging markets, whether it is the Middle East, India, as well as Africa, they are even getting a significant uptick from there. So something like 70% of Huawei business is international, and we think the percentage that we are in, which is high-end switches and routers, it is likely to be an even higher percentage, maybe 80% to 85%. So the localized China market, we don't have that much exposure to it, but even that exposure we do have, for example, we are recently ramping ZTE as a customer. So our footprint in China is expanding, so even if China has less growth, the fact that we are essentially doubling our customer base there, maybe not doubling, because ZTE is not quite as big as Huawei, but still a significant addition, that we expect to see growth out of China for the foreseeable future. And certainly July was strong and the bookings for Q3 are strong from both guys.

[Nicholas Aberle:]

Good. So just a little bit on NL7000. You guys are talking about those design wins starting to ramp starting in Q4. Was that in line with your expectations on timeline there, and is there any way you could kind of quantify how big that opportunity could be once fully ramped?

[Ron Jankov:]

It is consistent with what we have been forecasting for those design wins that we would have continuing pre-production in Q3 with production starting in the fourth quarter, so it has been consistent. We would rather not quantify that, because, again, our customers for those programs, they haven't exactly announced their final forecasts, and we don't want to get ahead of the game on that.

[Nicholas Aberle:]

Would it be safe to say that it is one of your bigger revenue opportunities from a design win standpoint?

[Ron Jankov:]

Yes.

[Nicholas Aberle:]

Perfect. And I am not sure if this makes sense or not, but just thinking about the different generations of [TCAM] products in the market, is there any real difference in the demand trends between gen two, gen three, gen four at this point? And then, secondly, was wondering, is the TCAM2 total addressable market at this point growing anymore, or is that starting to actually decrease the overall market?

[Ron Jankov:]

That market seems to be relatively stable. I wouldn't say it is decreasing yet. I would say it is holding pretty stable. As far as -- I think what we are seeing right now, again, because of the increasing needs of the Internet and enterprises and virtualization, all those different things, that people are moving to the next generation at a faster clip than before. We are seeing a very quick move to gen four and especially gen five products. Our NL9000 was the other one that got the large number of design wins in Q2. So, if anything, we are seeing an acceleration of move to the most advanced generation and architecture that people can use.

[Nicholas Aberle:]

Perfect, thanks, guys. Good luck in Q3.

[Ron Jankov:]

Thanks.

[Mike Tate:]

Thank you.

[Operator:]

Your next question comes from the line of Cody Acree from Stifel Nicolaus.

[Cody Acree:]

Thanks, guys. With regards to Cisco, obviously they went through a period of adjustments to some inventories and now guiding to Cisco being relatively flattish, how do you characterize that outlook or that order pattern? Is there an inventory component? Is it economic, I guess, could you give it a little bit of color?

[Mike Tate:]

Okay, we are in a hub situation with Cisco, so we don't believe there is any kind of unusual inventory builds out there. We wouldn't see it on the component level. It would be at the board level, but it feels like that is in balance right now. I think we continue to be positive on the new product ramps and I think we are just for now taking a conservative view on kind of the existing programs that we have in place right now.

[Cody Acree:]

And then maybe same question, I guess, if you expand that, you are not in a hub relationship I guess with every customer just yet. So how does inventories look as you kind of look worldwide?

[Mike Tate:]

Well, just given the way that we are holding customers at lead time and the appetite for turns during the quarter, we believe we are exiting the quarter in a very lean situation. And so we think inventory is in pretty good shape out there.

[Cody Acree:]

It sounds like lead times are maybe expanding just a bit. Is that correct?

[Mike Tate:]

Well, our lead times with our customers have been pretty consistent.

[Cody Acree:]

Okay, so there is -- is there -- it sounded like you are being a little more stringent on those lead times, pushing some of the turns out into Q4. I guess my question is, is there any reason that you might be seeing some of your customers -- I don't want to use the word double book, but get a little more aggressive on their order rates to make sure that they are getting the product they need?

[Mike Tate:]

We stay pretty close with the customers and we don't believe that is the situation, no.

[Ron Jankov:]

Yes, we have been dealing with these customers for a very long time and we have never brought a line down that I can think of for any of these customers. So I think they trust us that we will get them the product that they have to have, but we just work with them to minimize any inventory that they have, either at the board or chip level.

[Cody Acree:]

Great, great. And then lastly, just numerically, I think you have given us in the past numbers of design wins, Ciscos and non-Ciscos, and how did that work out this quarter?

[Mike Tate:]

It was a record quarter. We were over 20 for the first time, falling about 18 in Q1. So NETLite, in particular, was strong with seven, and then the NL9000s were second, and then we had a good quarter of the physical layer products, as well.

[Cody Acree:]

I am sorry, did you give a number for the NL9000? How many?

[Mike Tate:]

We are not specifically breaking it out, but in aggregate we were a little north of 20.

[Cody Acree:]

And then would you provide Cisco design wins?

[Mike Tate:]

Cisco we had one design.

[Cody Acree:]

All right, very good. Thank you, guys.

[Ron Jankov:]

Thanks.

[Operator:]

Your next question comes from the line of Suji De Silva from Kaufman Brothers. Please proceed.

[Suji De Silva:]

Hi, guys. Nice job on the quarter. So I know your outlook is pretty strong here, but can you talk about the softness in the U.S.? Any color there of timing, Ron, and maybe what areas you saw it in?

[Ron Jankov:]

Well, we are talking about our non-Cisco accounts that supply into the U.S. enterprise market. There is a number of them. I would rather not say them by name, but in all cases it seemed like basically Q2 was just kind of getting things back in balance, because kind of across the board we are seeing a stronger Q3 for those customers selling into the U.S. enterprise. I am not sure if that means that their business went up a lot from Q3 over Q2. It is just that they were in an inventory situation during Q2. So I think we have got all that cleaned up, and so we actually see some growth in non-Cisco U.S. enterprise in Q3.

[Suji De Silva:]

Okay, great, that helped. And then, Ron, you talked a lot about your numerous growth opportunities here. If you step back up can you talk about if any of them you are more optimistic on versus three months ago, your growth opportunities?

[Ron Jankov:]

Well, I would say that we have talked a lot about this 10-gig PHY opportunities. I would say that Q2 there was just a flurry of design activity. I think there is just an enormous amount of designing going on in 10-gigabit physical interface. So that is probably stronger than we were expecting at this point as far as future growth opportunity. We were always pretty bullish on IPTV and wireless infrastructure. I would say that those markets are continuing to be as strong as we expected. Probably the other place where maybe it is a little stronger than expected is the NETLite, and again, that's because we were targeting originally just the desktop switches, and this expansion into things like GPON access, VDSL access, et cetera, that these are opportunities that we really weren't targeting but are showing up in conjunction with our partners, merchant silicon suppliers.

[Suji De Silva:]

Okay, great. And then last question, your Cisco mix went up here and then by the guidance it comes down a little bit here. As we look out longer term, what range do you think the Cisco revenue will be in the mix that you are comfortable with talking about at this point? Thanks.

[Ron Jankov:]

I would say somewhere between the low-to-mid 40s is probably the range we would expect.

[Suji De Silva:]

Okay, great. Thanks, guys.

[Ron Jankov:]

Thanks.

[Operator:]

(Operator Instructions) You have a follow-up question from the line of Kevin Cassidy from Thomas Weisel Partners. Please proceed.

[Kevin Cassidy:]

Thanks for taking my follow-up. Just you mentioned having a lot of designs that are next to your customers' proprietary ASICs. Is there any concern at all of follow-on generations of that ASIC pulling in your function?

[Ron Jankov:]

You know what? We really don't see that happening. In fact, we see just the opposite happening, that we are already talking to our customers about designs that are two generations from now that are going to ramp into 2015 or something, and we see an even greater need for larger, faster, more complex knowledge-based processors in these designs and that they are actually throwing more functionality in our direction because they just can't keep up on their side of the bus. The increased performance and functionality they need to put in their ASIC is even greater than what the next technology node gives them. So they have to offload additional functional functionality to us. So we actually see not only is the trend not working against us, we think it is working in our favor.

[Kevin Cassidy:]

Okay, great. Thanks.

[Ron Jankov:]

Thanks.

[Operator:]

At this time, we are showing you have no further questions. I would like to now turn the call back over to management for closing remarks.

[Ron Jankov:]

Okay. Thank you. And thanks to everyone for joining us today. During the third quarter, we will be presenting at the Pacific Crest Technology Leadership Forum, the Kaufman Brothers Annual Investor Conference, the Deutsche Bank Technology Conference and the Jefferies Technology Conference. We thank you for your continued interest in NetLogic Microsystems, and we look forward to speaking with you in the near future. Thanks.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's call. You may now disconnect. Have a wonderful day.