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Cavium Networks Inc. (NASDAQ:CAVM)

Q4 2008 Earnings Call

January 28, 2009 5:00 pm ET

Executives

Angel Atondo – Marketing Communications Manager

Syed Ali – President and Chief Executive Officer

Art Chadwick –Vice President and Chief Financial Officer

Analysts

Dan Morris – Oppenheimer & Company

Quinn Bolton – Needham & Company

Sandy Harrison – Signal Hill

Kevin Cassidy – Thomas Weisel Partners

Hans Mosesmann – Raymond James

Sanjay Devgan – Morgan Stanley

[Ali Farth] – [Ferex Capital]

Operator

Welcome to the Cavium Networks Q4 2008 earnings conference call. (Operator Instructions) I would like to turn the call over to Angel Atondo, Marketing Communications Manager. Please go ahead.

Angel Atondo

Welcome to Cavium Networks fourth quarter 2008 financial results conference call. Leading the call today are Mr. Syed Ali, President and CEO of the company, and Art Chadwick, Vice President and Chief Financial Officer.

Before we begin, I would like to remind you that various remarks that we make on this call, including those about our financial results, including revenues, growth margins, operating expenses, design wins, product plans, our competitive situation, market trends and anticipated growth and profitability all constitute forward-looking statements for the purpose of the Safe Harbor Provisions under the Private Securities Litigation Reform Act.

These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our most recent Form 10-K and Form 10-Q filed with the SEC in particular to the section entitled Risk Factor, and to other reports that we may file from time to time with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. These forward-looking statements speak only as of the date hereof and we disclaim any obligation to update these forward-looking statements.

In addition, Cavium reports gross margin and net income and basic and diluted net income per share in accordance with the GAAP and additionally on a non-GAAP basis. Management believes the non-GAAP information is useful because it can enhance the understanding of the company's ongoing economic performance and Cavium, therefore, uses non-GAAP reporting internally to evaluate and manage the Company's operations.

Cavium has chosen to provide this information to investors to enable them to perform comparisons of operating results in a manner similar to how the company analyzes its operating results. The full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today and we ask that you review it in conjunction with this call.

I will now turn this call over to Syed Ali.

Syed Ali

In brief, Cavium’s third quarter revenue was $22.2 million, which represents a 9.6% sequential decrease and a 37% year-over-year growth. Non-GAAP gross margins came in at 55%. The reduced top line and gross margin resulted in non-GAAP operating margins declining to 2%. Non-GAAP net income was $700,000 or $0.02 per share and our GAAP loss was $4.4 million or $0.11 per share.

Art will provide more details on the Q4 financial results and Q1 ’09 guidance shortly. I will now move on to give you more details on our Q4 revenues, along with a general update on the demand environment after which I’ll give you an update on our acquisition of W&W Communications. I will then discuss design wins and new customer and partner relationships.

Last quarter the enterprise and datacenter segment was the largest segment at 59% of product revenues and declined 16% quarter-over-quarter. The remaining segments including consumer broadband, access service provider and software services segment combined to achieve 41% of sales for the quarter and were approximately flat quarter-over-quarter.

Q4 was one of the most challenging quarters in our history. The weak macroeconomic environment coupled with aggressive inventory corrections in the channel set the stage for the challenging environment. We had relatively robust bookings in September and October followed by a sharp falloff in November and December, which led to our preannouncement in early December.

The enterprise and datacenter segment contributed to pretty much all of our sequential quarter-over-quarter decline in Q4. Weakness was especially pronounced in the security segment and in midrange and higher end enterprise boxes.

Our largest customer, Cisco Systems, was relatively strong actually growing about 1% quarter-over-quarter in absolute dollars. The weakness in certain enterprise segments at Cisco was offset by some newer product ramps that helped maintain revenues with Cisco. Other than Cisco, the decline was fairly broad based across our enterprise customer base. This is the first decline we have had in the enterprise and datacenter business since we became a public company in 2007.

In the remaining segments, the broadband segment was the largest and actually grew abut 4% quarter-over-quarter in dollars, in spite of our largest customer in the segment, Sumitomo, declining about 25% quarter-over-quarter. The Sumitomo decline was more than offset by the Actiontec Verizon FiOS business starting to ramp. We also saw some softness in the software and services category.

Overall, the sequential quarter-over-quarter decline was largely driven by our older legacy and security products, while our flagship multi-core OCTEON line saw only marginal weakness, even in this very weak environment. Lower sales and a higher gross margin enterprise datacenter and software segments, coupled with the increase in the broadband business, led to gross margins declining more significantly than we would have liked.

All in all, we saw much lower sequential declines in top line revenues than a large majority of our peers. The primary reason for this has been our large diversified customer and design win base that helped cushion the impact of the softness in the legacy run rate business.

Now, a quick comment about what we have seen so far in Q1. Though we expect this quarter to be a challenging one due to weak bookings in November, December of 2008, we have been encouraged by what we have seen in January, in terms of bookings. Gross booking rates in January have increased back to levels similar to the September, October time frame, if this trend continues through the remaining two months of the quarter, we would start feeling much more optimistic about Q2 '09 and beyond.

Now I would to give a quick summary on the W&W Communications acquisition. During the quarter, we announced and closed the acquisition of W&W Communications. W&W Communications is a fabless semiconductor company headquartered in Sunnyvale, California, with an offshore center in Beijing, China.

W&W Communications is a specialist in market leading, low power, super low latency, and full high definition radio processing solutions, with single and multi-stream capabilities to address the exponential growth of video with a network. This technology enables us to participate in the capture, process, and displaced segments of the video processing market, a market that we were not playing in before.

The video capture market includes all types of video recording equipment ranging from high-end broadcast quality cameras, to IP cameras for video surveillance, video conferencing, IP cameras and Web cams. The video process market needs high channel density and translating and transcoding, for video infrastructure equipment, such as cable head and video systems, IMS gateways, broadcast systems, multi-channel DVRs, video conferencing and MCUs, and gateways.

The video display market, a market that we are particularly excited about, includes LCD screens and flat panel plasma displaces and projectors, where high quality, [inaudible], high definition encode and decode, and low latency are required for display and wireless connectivity. The products have started to sample since Q3 2008 and we are seeing excellent traction in the target market.

I would like to take this opportunity to welcome the W&W Communications team to our family. We are really excited about the market potential for these new video processor products.

I would now like to provide an update on Q4 design wins. This quarter we continued our design win momentum and we comfortably exceeded our internal design win goals for the quarter and for the full year 2008. This was our first full quarter subsequent to our Star semiconductor acquisition and we are pleased to report initial design win for the new ECONO Arm processing line and its road map that we have defined.

Design wins was spread across all four segments and across low-end to high-end price and performance points. We closed multiple new design wins at a number of Tier 1 customers, including Alcatel-Lucent, Cisco, F5, Hitachi, Huawei, IBM, Juniper, NETGEAR, QLogic, Spirent, and VTE.

In the enterprise and datacenter segment, we won major new designs in security and SSL VP and gateways, cyber channels to [Inaudible] gateways, test and measurement equipment, wireless LAN access points, enterprise [IMS] gateways, storage and video processing systems.

In the access and service provider segment, we won significant new designs and wireless network radio controllers, [wiremax] base stations and gateways, LTE/4G gateways, video distributions switches, and APCA AMC boards. In the broadband and CPE gateway markets, we want new designs and fiber to the home gateway, 3G desktop ZYP phones, docking stations and broadband routers.

While we did see some of our customer engagements in our pipeline impacted due to the tough macro economic situation, our overall pipeline of potential new design wins remains very strong at approximately 2X of our quarterly design win rate, which indicates that we should continue to maintain our healthy design win rates.

Now to move on to new products, our entire OCTEON Plus CN5-XX family, along with the development software environment and eco system partner solutions, has reached production or pre-production status. Over 30 new Tier 1 customer designs using the OCTEON Plus processors are expected to start shipments to market during the course of 2009 across a variety of applications.

The OCTEON Plus CN-5000 series is a highly scalable family of multi-core processors from 2 to 12 cores that offers a number of industry leading features and benefits for the networking wireless, storage security applications.

We have also defined road map products for our OCTEON, ECONA, and NITROX families, with innovative feature sets, improved performance, lower cost and power, working closely with these customers and we are making excellent progress towards bringing these products to market through 2009. Finally, we added a new video processor product lines to our portfolio through the acquisition of W&W Communications.

In the fourth quarter, we announced new design wins for the OCTEON processors at NETGEAR and FSR, a French service provider for SMB and fiber to the home broadband applications. We also announced referenced designs with Ralink, a provider of 802.11 and chipsets for wireless high definition video delivery applications, which incorporate our newly acquired line of video processors from W&W Communications.

We also won a number of prestigious awards last quarter. We won the most respected emerging public semiconductor company award presented by the GSA, or the Global Semiconductor Alliance. During the fourth quarter, we were also included in Beloit's Fast 50 and Fast 500 list, recognizing Cavium's high growth. The newly acquired PureVu video processor product line was nominated and won prestigious awards at the CS 2009 in January.

In summary, although the current environment is challenging, we continue to feel extremely positive about our med and long-term prospects. Our fundamental value proposition is unchanged. We have built a comprehensive array of world class products addressing multiple large markets.

We have penetrated and are expanding our presence aggressively, as the world's leading and largest Tier 1 customers. We continue to win designs at increasing rates, which is strengthening our competitive position. We also have a large pool of design wins that will go to production in 2009 and beyond.

We strongly believe that we are extremely well positioned to weather the slowdown and come out as a much stronger company. On that note, I would now like to turn the call over to Art Chadwick, who will provide a detailed discussion of Q4 financial results and guidance for Q1, and after that we'll be happy to take your questions.

Art Chadwick

I'll first go through our Q4 financial highlights and then provide some guidance for Q1 of 2009. So as Syed just described, Q4 was a challenging quarter for us. Revenue for the fourth quarter was $22.2 million, which was in line with our preannouncement we made in early December. Sales for the quarter were 37% higher than the fourth quarter of last year but down 10% from Q3. This was the first quarter in our company history in which we had a sequential down revenue quarter.

Cisco Systems was again our largest customer. Sales to Cisco were relatively flat with Q3 and accounted for 20% of total sales for the quarter. Sales to F5 networks were 12% of sales, the same percentage as in Q3. Sales to Sumitomo declined this quarter and fell to 11% of sales, down from 13% last quarter. Sales to our top five customers accounted for 59% of total sales, as compared to 57% in Q3. And international sales accounted for 45% of total sales, down from 50% last quarter.

In our press release, we announced both GAAP and non-GAAP results, so please refer to our press release for the detailed reconciliation between GAAP and non-GAAP results. Non-GAAP gross margins for the quarter were 55.1%, which was quite a bit lower than our historic margins for a few reasons.

The first is that, even though we are a fabless company, we do have certain manufacturing costs which are relatively fixed going into a quarter. Those costs include the cost of our operations department, final test costs, and mask amortization costs. These costs have increased as we ramped production this year in anticipation of higher sales. However, sales in Q4 decreased. These higher costs, amortized over lower sales, decreased gross margins by more than three points as compared to our forecast going into the quarter.

Our blended gross margins were further negatively impacted by changes in product mix, specifically from a higher percentage of lower margin broadband and consumer product sales, and to a shortfall in higher margin, high-end product and software sales.

Non-GAAP operating expenses for the quarter were $11.9 million. This was an 11% sequential increase over Q3, due to a whole quarter's worth of Star Semiconductor, now Cavium, operating expenses, higher employee costs, and incremental expenses from the acquisition of W&W Communications.

R&D expenses for the quarter were $6.7 million up from $5.8 million in Q3, and SG&A expenses were $5.2 million up from $4.9 million last quarter. Operating margins for the quarter were 2% down substantially from the prior quarter due to the lower sales, lower gross margin and higher operating expenses. Net interest and other income was $380,000, similar to net interest income in Q3.

In addition, we had a nominal income tax credit this quarter. So as a result, our GAAP net income for the quarter was a loss of $4.4 million, or $0.11 per share. Non-GAAP net income was $714,000, or $0.02 per share. Non-GAAP net income excludes $5.1 million in costs, which includes $2 million of stock-based compensation expense, $1.5 million in amortization of acquired and tangible assets, $1.3 million of in-process R&D from our acquisition of W&W Communications, and approximately $300,000 in acquisition-related inventory adjustments.

In December, we completed the acquisition of W&W Communications. Total net purchase price, including fees and assumed obligations, was approximately $20 million. Of this, approximately $10 million was allocated to intangible assets and the balance to goodwill. We ended the quarter with 347 employees, an increase of 55 employees during the quarter, 47 of whom joined from W&W Communications.

Our ending cash balance was $77 million down from $92 million at the end of Q3, due primarily to the cash paid to acquire W&W Communications. Approximately $8 million of the W&W purchase price and commitments were still outstanding at quarter end and were not paid until January, which means that our Q1 cash balance will likely fall below $70 million.

Accounts receivable were $14.1 million, which equates to DSOs of 57 days. This was an increase from DSOs of approximately 49 days in Q3, but still below our long-term target of 60 days. In addition, our AR balance remains very clean with only 1% of our AR balance being more than 60 days overdue. Inventory at the end of the quarter was $17.3 million, an increase from $15.3 million at the end of Q3. This higher inventory was the result of inventory that had been purchased in anticipation of higher expected fourth quarter sales.

I would now like to provide some guidance and how we see the first quarter of 2009. As I had mentioned, the current macro environment is clearly having an impact on our business and we expect this to continue into the first quarter. We currently expect sales in Q1 to be down approximately 10% from Q4. We expect non-GAAP gross margins to be in the mid-50s, consistent with Q4 margins.

Operating expenses will increase in Q1 due to the addition of new employees who joined us from W&W Communications, as well as FICA and other costs to kick in at the beginning of the New Year. However, to partially offset these increases, we are executing a number of cost-reduction actions that should save approximately $1 million per quarter. Those actions include salary reductions for Cavium management, deferral of employee raises, and a number of other cost-saving actions.

We expect that non-GAAP operating expenses in Q1 will be between $12.5 and $12.7 million. We expect net interest income will approximately $200,000, down from Q4 due to lower short-term interest rates. In addition, we do not expect any income tax expense in Q1, due to the expected loss. And based on those assumptions, we believe that non-GAAP net income will be a loss of between $0.02 and $0.03 per share.

The GAAP loss will be approximately $4 million higher due to about $3 million in stock and acquisition-based compensation expense, and $1 million in amortized acquired intangible assets, and our fully diluted share count, used for EPS, will be approximately 41 million shares in Q1.

In summary, we have shown strong sequential growth every quarter since our IPO, until this last quarter when our leveraged model worked against us as revenue declined. Though we are not immune to the effects of the business environment, we do firmly believe that we are well-positioned for the future, and that as the economy turns, so will our operating performance.

And on that note, I'd like to turn the call back to the operator for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dan Morris – Oppenheimer & Company.

Dan Morris – Oppenheimer & Company

First, I wanted to ask Syed about your comment about bookings coming back in January. Is that driven mainly by new products, or are you also starting to see some of your run-rate programs show some life there?

Syed Ali

Dan, it was a fairly broad base and it's a mixture of both the run rate type products and new products going to production.

Dan Morris – Oppenheimer & Company

Art, with regards to the guidance there, how much of the revenues there are already in backlog?

Art Chadwick

Generally, we don't spell that out specifically but given our order rate in November and December, we did start Q1 with a lower than usual backlog. However, as Syed mentioned, January is turning out to be a pretty healthy bookings month. So I think those are the dynamics of the quarter.

Dan Morris – Oppenheimer & Company

Turning to OpEx, now you've added roughly 100 heads now with the Star and the W&W acquisitions. Given current trends, it sounds like you're not really cutting back on headcount, but if you look forward if things continue as they are, is that something that you might consider?

Syed Ali

Dan, obviously we look at expenses on a quarter-by-quarter basis and also look at the market on a quarter-by-quarter basis, but we really don't feel that we will need to resort to anything like large-scale layoffs in the company.

Operator

Our next question comes from Quinn Bolton – Needham & Company.

Quinn Bolton – Needham & Company

My first question is for Art. Art, any of the cost reduction actions you're taking impact the gross margin over time? Can you do anything with the amortization expenses of masks or the operations team to try and get the margins up?

Art Chadwick

So, most of our cost reduction actions affect operating expenses because that's where the bulk of our employees are and that's where the bulk of our normal spending is. However, there are a lot of things we're doing to work on improving gross margins. One of the biggest things we can do is work on increasing sales, because as I mentioned we've got this fixed cost component of our cost of sales to the extent that sales are lower like they were in Q4, then gross margins get worse to the extent that sales increase, then gross margins get better.

But further to that, there are a lot of other actions, such as working on reducing wafer costs, working on reducing assembly costs, improving test yields that'll all improve gross margins.

Quinn Bolton – Needham & Company

There's probably some lead time, I guess with things like lower wafer costs and lower test and assembly costs. Is that something that if you're negotiating now maybe has more of an impact out in the second and third quarter?

Art Chadwick

Yes. That is a very fair point because what happens with inventory is you effectively have to flush your current inventory before you can get the benefit of any cost reductions. That is a very fair statement.

Syed Ali

Just to add something, Quinn, if you take a look at it the gross margins are more impacted by product mix than by anything else. And as I said in my call that enterprise and datacenter segment, which has been a very strong growing segment for us, we faced a decline in Q4 of 16% quarter-over-quarter. That had probably the single largest affect on gross margin, but the higher margin stopped going down and the broadband stuff going up, that had the single biggest affect on gross margins. And as we start getting the new midrange and higher end enterprise products into production, newer products to production that will automatically start improving gross margin at a faster clip than with the other factors.

Quinn Bolton – Needham & Company

Yes. That was sort of my next question. Syed, I think in your comments you talked about some pipeline impact given the economic environment. Is there any way to quantify that? I think in the past you guys have at various conferences said you now have about 500 design wins that could produce annualized revenue of about $400 million. Is that still a good figure, or do you think is there a new cut that you would give given the economic environment?

Syed Ali

The comment that I was making is about the pipeline and not about the design wins that we already have. Regarding the design wins that we already have there are no significant changes associated with those numbers. So the comment I was making was that our pipeline actually would have been much larger had the economic climate been good. But overall, design win rates right now are running at record levels much higher than obviously in 2008 and the pipeline is very good.

Quinn Bolton – Needham & Company

Just a couple quick ones, one, any comments on lead times? What kind of visibility your customers are giving you in sort of the last couple of months? And then, lastly, just a clarification on Cisco, or did you say Cisco was 20% of sales because I thought they were 24% of sales last quarter. So I just wanted to make sure that I got the figures right.

Art Chadwick

What I said was sales to Cisco were relatively flat quarter-to-quarter. I think Syed mentioned they were up 1%, so up 1% quarter-to-quarter. They accounted for 27% of our sales in the fourth quarter and that's up from 24% in Q3.

Quinn Bolton – Needham & Company

I just misheard you, and then the lead times?

Syed Ali

Regarding lead times, generally in this type of climate we are seeing shorter lead times. People are looking at more just in time type orders, so especially kind of the Tier 2 and the smaller sized customers give us much shorter lead times than some of the larger customers like Cisco.

Operator

Our next question comes from Sandy Harrison – Signal Hill.

Sandy Harrison – Signal Hill

Couple points on the design win momentum out there as also the design win atmosphere. I mean, as you talk to a lot of these companies and as you go out and look for the opportunities, have the horizons for when these products are going to market changed? Have they moved out at all? And on that are you seeing in places where you had said design win momentum may have slowed, is that because they're either retrenching or are they sticking with say a current product a little bit longer?

Syed Ali

So let me take the second half of the question first. If you take a look at the design wins itself, the design wins that we are getting are pretty much across all market segments and the total number of design wins that we are getting are actually going up and the design win dollars have also been running at elevated levels.

So the impact of a slower design wins in some areas because some new programs that were supposed to start or where we were supposed to be awarded design wins are maybe being postponed by maybe three months or six months or something like that. So this is pretty much the thing about new design wins, not about existing design wins.

Regarding the existing design wins, there may be overall on a design here or a design there about a one month or a two month or a three month delta, but no significant change, especially in the largest design wins that we are tracking, which are going to generate the biggest upside in revenues.

Sandy Harrison – Signal Hill

Then just kind of looking at your comments about seeing the bookings momentum picking back up, I think somebody asked the question earlier. And then if I look at your guidance, to me it sounds like you guys are being a little bit conservative because if things get back to those levels I think you'd be above what you're talking about doing. Am I reading into that right? Or is there something else? Or were you thinking that January was good and it slowed? I’m just trying to characterize the comments that don't necessarily sink.

Syed Ali

January was a strong month and obviously we'd like to see what February and March brings before we can make any more definitive comments about that, but it's a positive sign.

Sandy Harrison – Signal Hill

Lastly, in some of your new wins including Actiontec and some of those, how is that expected to continue? If you looked at the subs, gross subs out there from Verizon and some of the other folks they looked pretty good for the fourth quarter. What's sort of your initial take on what the first quarter could look like? And then when do you see some of these other opportunities like Sumitomo and others resuming? Is that a first quarter, second quarter or are you still trying to figure that out?

Syed Ali

The Actiontec Verizon business will grow through the first half of the year, Q1 and Q2. So we are expecting to see some good growth there. Regarding the Sumitomo, the decline was primarily driven by some slower demand in Japan for the boxes along with more tighter inventory controls. We expect them to be kind of relatively soft in Q1 also. But getting back into Q2 and beyond, we at this point expect them to start growing again.

Operator

Our next question comes from Kevin Cassidy – Thomas Weisel Partners.

Kevin Cassidy – Thomas Weisel Partners

Overall with these two new acquisitions are there any changes to your overall target model?

Syed Ali

No, I don't believe we have. Art, would you like to comment on that?

Art Chadwick

Kevin, that's a very fair question. I don't think so. And the reason is if you look at the Star acquisition, what we're basically doing there is this design team in Taiwan is really focused on a whole new family of products to address that market segment, which, yes, that has generally lower gross margins, but our newer products will be much lower cost. So we think that the gross margin profile there won't really affect our blended margins.

And in the W&W Communications acquisition, those generally are higher margins to begin with and we think that over time those gross margins probably will come down closer to our long-term model. But if you look at sales in those two segments versus the rest of the company, I don't think it's going to have any significant impact plus or minus to our long-term operating model.

Kevin Cassidy – Thomas Weisel Partners

And with reference to the W&W Communications products, should we expect a design cycle similar to your current products?

Syed Ali

Design cycles here, it really depends upon if there are kind of two classes of products. One is a product which is a retrofit market product. For example, a small box which you can hook up to your [sat] box or to your TV, which essentially allows you to deliver wireless HD instead of using an HDMI cable. Those designs are probably in the nine-month production range. So they are pretty quick. Whereas if you are looking to get designs more into kind of broadcast equipment or television flat panels that is probably a 12 to 18-month cycle.

Operator

Your next question comes from Hans Mosesmann – Raymond James.

Hans Mosesmann – Raymond James

A few questions. In terms of the turns necessary to hit your guidance, how does that compare to say the turns that you required last quarter? I just want to get more of a sense of how this quarter is progressing relative to the guidance and I have a follow-up.

Syed Ali

January, as I said, as December ended obviously the turns number required that we would have needed to hit the guidance we are giving would have been a much higher turns component, but January has been relatively strong. So we are in kind of the plus or minus range of where we should be to hit guidance.

Hans Mosesmann – Raymond James

Fair enough. And then can you give a qualitative commentary on the competition and what's going on at Cisco and how you compete with some of the other guys that are out there trying to get business in the design win area?

Syed Ali

Regarding competition and our competitive position I strongly believe that over the last three to four quarters every quarter we have increased our competitive strength and competitive leadership across pretty much all of our competitor base. So quarter-by-quarter we seem to be getting stronger just based upon the number of design wins that we are getting and the number of new possible design wins that we have in our pipeline.

Hans Mosesmann – Raymond James

Well what I wanted to get to is like who do you come up against often and who, if you're getting all these wins, who's at the other end of that losing kind of proposition then if you will?

Syed Ali

Okay, if you take a look at low end, mid-range and high end the competitive landscape is different. In the low end, in the broadband space this is obviously the most competitive space and here we have pretty much a range of companies that we compete with, Freescale, Marvell, those types of companies, the AMCC, PMC. In the mid-range we primarily compete against kind of Freescale and Intel and in the higher end we primarily compete against private companies like RMI.

Hans Mosesmann – Raymond James

And nothing has changed in that dynamic or are these competitors behaving differently or – that's what I'm trying to get to.

Syed Ali

Nothing has changed dramatically I guess. The only thing is that just because of the number of new products we have the amount of software that has already been ported onto our processors at various Tier 1 companies, all these go to make it easier for us to get design wins and spread much faster within our customer base.

Operator

Your next question comes from Sanjay Devgan – Morgan Stanley.

Sanjay Devgan – Morgan Stanley

I had a quick question for you. I was wondering if you could just elaborate on your commentary regarding the 30 new Tier 1 accounts that you expect to start shipping the [inaudible] down into? If you could just provide some color around kind of timing of these new engagements and maybe if you could just give a sense of what exactly these engagements are? It would be really appreciated.

Syed Ali

Some of them obviously go to production in Q1 of '09, some in Q2 and right, pretty much right across the year. The largest ones in terms of kind of annual revenue potential start in – start by middle of the year to Q3 and Q4.

Sanjay Devgan – Morgan Stanley

And another question, just is more of a technology question, I just wanted to get your opinion. With W&W acquisition you've announced the reference design with Ralink whereby their 802.11n solutions will be used to stream, conjunction with your Codecs, to stream video. I wanted to get your thoughts on 60 gigahertz and how you see that dynamic playing out vis-à-vis your announced reference design win with using an 802.11 solutions provider with the Codec?

Syed Ali

The 60 gigahertz designs are pretty much using uncompressed video. So if you take a look at 1080p60 or 1080p30 to 1080p60, it takes about 3.5 gigabits per second data rate. So what the 60 gigahertz does is essentially sends the data uncompressed. It's a very, very expensive solution. One of the boxes that I have seen has 36 antennas on it, so it's a very, very complex piece of equipment; very, very expensive.

What our solution is is this is the first solution for sending a 1080p30 Blu-ray type quality 1080p30, 1080p60 quality video over standards-based WiFi. And if you take a look at WiFi it can send maybe a couple of hundred megabits per second is the total it can do. So uncompressed is not a possible solution to this.

We are able to compress it in somewhere in the 100X range and that is why we are able to use standard space WiFi. So obviously the product is going to be dramatically lower cost, dramatically lower power and much more interoperable with a range of equipment from TVs to [set out] boxes to broadband routers to PCs because they all have WiFi on it.

Operator

(Operator Instructions). Your next question comes from [Ali Farth] – [Ferex Capital].

[Ali Farth] – [Ferex Capital]

The question I have is given the pipeline of the design wins that you have in the queue, is it fair to assume that basically beyond the March quarter we should see resumed growth both in the revenue and in the margin line for the company, just qualitatively?

Syed Ali

I think over the year, without being too specific about the exact time, we do have a range of design wins going to production and as they kick in we should definitely see a growth and a gross margin expansion over the course of the year.

[Ali Farth] – [Ferex Capital]

And then a second question I have is really related to these competitive questions particularly in the high end. As I understand it really the high end multi-core market is something that's new and is it fair to assume that basically if it's not for your company and perhaps a couple of other companies serving that market, that market will not grow? So should we call you guys sort of you are cooperating to make a market as opposed to competing with one another at this stage given just the infancy phase of that high end market?

Syed Ali

Definitely. We are the pioneers in this market and all of us who are trying to do multi-core which is 4-core, 8-core 16-core or whatever number of cores in the higher core count, we are essentially cooperating to really create this market.

Operator

(Operator Instructions) Your next question is a follow-up question from Quinn Bolton – Needham & Company.

Quinn Bolton – Needham & Company

Just wanted to ask a quick question, you had mentioned that the software and services business is a business – sounded like it was particularly soft. Obviously that sounds like it's pretty high margin, but was just wondering if you could give us any sort color on that software business and do you think that that turns around in the March quarter or does it take longer to turn that business around?

Syed Ali

No, our software and services segment consists of a number of components including selling complete stacks, like IPsec stacks, the PCP stacks, those type of products where we have completely productized them. And they also include some customized services that we do to add some particular features for customers overall.

So in the last, obviously the top run sales business is not a 10% segment. It's less than that but it was soft in Q4 because companies essentially put brakes on spending money in this particular segment. We expect it to kind of run in the flat plus or minus range for the remaining part of the year.

Quinn Bolton – Needham & Company

And can you confirm it's, since it's software I'm assuming it's probably higher than corporate average given that it's a software sale. Is that a good assumption?

Art Chadwick

Yes, Quinn, that is a good assumption. Yes.

Operator

Mr. Syed Ali, I show there are no further questions at this time. Please continue.

Art Chadwick

In that case we want to thank everybody for joining us today. Have a great afternoon.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using ACT teleconference. You may now disconnect.

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Source: Cavium Networks Inc. Q4 2008 Earnings Call Transcript
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