NetLogic Microsystems Inc. Q4 2008 Earnings Call Transcript

Feb. 4.09 | About: NetLogic Microsystems, (NETL)

NetLogic Microsystems Inc. (NASDAQ:NETL)

Q4 2008 Earnings Call

February 3 2009 4:30 pm ET

Executives

Ron Jankov - President and Chief Executive Officer

Michael T. Tate - Vice President and Chief Financial Officer

Leslie Green – Investor Relations

Analysts

Adam Benjamin - Jefferies & Co.

Reuben Roy – Pacific Crest Securities

Matt Robinson - Pacific Growth Equities

Daniel Morris - Oppenheimer & Co.

Nicholas Aberle - Caris & Company

Sandy Harrison - Signal Hill

Suji De Silva - Kaufman Brothers

Kevin Cassidy - Thomas Weisel Partners

[Awat Shah – Dodd Davidson]

Romit Shah - Barclays Capital

Allan Mishan - Oppenheimer & Co.

Arnab Chanda - Deutsche Bank

Cody Acree - Stifel Nicolaus & Company, Inc.

Gary Mobley - Piper Jaffray

Mark Heller - Merrill Lynch

Romit Shah - Lehman Brothers

Ruben Roy – Pacific Crest Equities

Operator

Good day and welcome to the NetLogic Microsystems fourth quarter and fiscal 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 Lemanuel and I will be your coordinator for today. At this time all participants are in a listen-only mode. (Operator Instructions)

I would now like to turn the call over to Leslie Green, Investor Relations for NetLogic. Please proceed.

Leslie Green

Thank you, Lemanuel, and good afternoon, everyone. Please note that our fourth quarter and 2008 year end results were disseminated by Business Wire after market close today and a copy of the release can be downloaded from our website at www.netlogicmicro.com.

Before we get started with our financial results for the fourth quarter and year end, I’d 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 14, 2008, and Forms 10-Q filed on May 7, August 6, and November 5, 2008 as well as other reports the company files from time to time with the SEC.

All forward-looking statements are qualified in their entirety by this cautionary statement and the company undertakes no obligation to publicly update forward-looking statements for any reason except as required by law even as new information becomes available or other events occur in the future.

Also on the call we’ll be making reference to non-GAAP financial measures. A 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 inventory required. 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 fourth quarter and year end results.

Michael T. Tate

Thank you, Leslie. Good afternoon, everyone. Today we reported that revenue for the fourth quarter of 2008 was $30.9 million. Revenue from Cisco Systems, our largest customer, was $9.8 million or 32% of our total revenue compared with $13.9 million or 36% of our total revenue for Q3 2008.

The decrease in revenues from Cisco was largely related to lower demand as a result of the weakness in the global economy coupled with their efforts to lower inventory levels. Revenues from Alcatel-Lucent were 18% of revenue in Q4. Alcatel’s sequential revenue growth was driven by the growth in shipments of equipment used in mobile wireless infrastructure primarily in the United States and China. We do not have any other customers above 10% of our revenues in the fourth quarter.

Our non-GAAP gross margins for the fourth quarter were 66.9% which excludes stock based compensation expense, the fair value adjustments related to inventory acquired from Cypress Semiconductor, and Aleros and the amortization of intangible assets.

There is a complete reconciliation between GAAP and non-GAAP gross margins in today’s earnings release. Q4 non-GAAP gross margins were in line with our guidance of 67”% and reflect favorable product and customer mix during the quarter.

Q4 operating expenses were $419.7 million on a GAAP basis which included $4.3 million of stock-based compensation and $300,000 for the amortization of intangible assets. This compares with GAAP operating expenses of $20.8 million for the third quarter of 2008 which also included approximately $4.3 million for stock based compensation and $300,000 for the amortization of intangible assets.

Given the current economic challenges, we aggressively worked to control spending during the quarter. As a result, total non-GAAP operating expenses for Q4 declined $1.1 million from the previous quarter and were $15 million compared with $16.1 million for Q3 2008.

Non-GAAP R&D expenses were $10.5 million for Q4, as compared with $10.9 million for Q3. Non-GAAP SG&A expenses were $4.5 million for Q4 as compared with $5.2 million for Q3.

We will continue to be diligent in our efforts to control expenses in this environment, including the minimization of contractors and temporary labor, negotiating costs reductions from our suppliers, and lowering discretionary items such as travel. Although we are being aggressive in identifying cost saving opportunities, we are not impacting our strategic product and technology development and road maps.

Q4 interest and other income was approximately $400,000 compared with our guidance of $300,000. Our Q4 tax provision was a benefit of approximately $1 million. Our Q4 tax benefit is driven by the current positive mix of our foreign and domestic book income and losses and also included the benefit due to the reinstatement of the Federal R&D tax credit.

On a GAAP basis, our Q4 net loss was $900,000 or $0.04 per diluted share, compared with net income of $1.3 million or $0.06 per diluted share for Q3 2008. Non-GAAP net income for Q4 was $7 million or $0.30 per share compared with $9.8 million or $0.42 per share for Q3 2008.

We had fully diluted shares of $21.7 million on a GAAP basis and $23.1 million on a non-GAAP basis. With respect to the balance sheet, cash, cash equivalents, and investments increased $10.6 million in Q4 to end the quarter at $96.5 million compared with $85.9 million at the end of the prior quarter. The increase in cash was the result of the continued strong cash flows from operations during the quarter.

Our accounts receivable at the end of Q4 were $8.4 million and represented 24 days. The decrease in accounts receivable and DSOs were the result of favorable sales linearity coupled with strong collections. Our ongoing target DSOs remain 35 days.

Fourth quarter net inventory decreased by $700,000, and was at $13.7 million compared with $14.4 million at the end of Q3. Our year end accrued liabilities of $25.9 million includes our estimated payment of $15.5 million to the shareholders of Aleros which will be made later this month. This payment represents an earn out obligation that was achieved during 2008. The amount was recorded in Q4 as an adjustment to goodwill.

Now turning to the results for 2008, total revenues for 2008 was $139.9 million. This is an increase of 28% over the $109 million for 2007. Our 2008 GAAP gross profit was 56% compared with 59% for 2007. Non-GAAP gross profit for 2008 which excluded stock-based compensation, amortization of intangible assets, and the effect of a fair value adjustment was 66.3% as compared with 65.8% for 2007. GAAP operating expenses for 2008 were $77.8 million compared with $66.5 million for 2007.

Non-GAAP operating expense excluding stock-based compensation in process, research, and development charges and the amortization of intangible assets were $61.3 million for 2008 compared with $49.3 million for 2007.

Our non-GAAP research and development expenses increased $42.1 million for 2008 from $35.2 million for 2007. Non-GAAP SG&A expenses increased to $19.2 million from $14.1 million in 2007.

Net income in accordance with GAAP for 2008 was $3.7 million or $0.17 per share. This compares to GAAP net income of $2.6 million or $0.12 per share for 2007. Non-GAAP net income was $34.7 million or $1.50 per share compared with non-GAAP net income of $26.7 million or $1.20 per share for 2007.

This concludes my review of the quarterly and fiscal year end results and now I’d like to turn the call over to Ron.

Ron Jankov

Thank you, Mike. 2008 was a very productive year for NetLogic. As a result of outstanding R&D execution, we advanced our technology road map and achieved unprecedented competitive positioning in our market. Over the course of the year, we successfully completed the conversion of our knowledge based processor product line to 55 nanometer process technology, a significant and unique achievement.

Further, we greatly expanded our addressable market with new advance [inaudible] and knowledge based processor products that are becoming essential building blocks in net generation networking equipment including systems targeted for emerging growth markets such as data centers, mobile wireless infrastructure, and network security.

The competitive importance of our 55 nanometer initiative cannot be overstated. This process geometry produces die that are approximately 18% smaller than the 65 nanometer node and that are approximately 70% smaller than the 130 nanometer node where the majority of today’s equipment is based.

Further, the efficiency of transistors at 55 nanometers have allowed us to traumatically advance the performance and functionality of our knowledge based processors while at the same time significantly reducing power consumption considered to be among the most pressing engineering issues for next generation systems.

Our first product that was introduced at this node early in 2008 was the NL 9000, history’s first hybrid knowledge based processor combining advanced search processing capabilities of our knowledge based processor technology with the efficiency and power saving capabilities of our Sahasra algorhythmic technology.

This carrier class solutions introduction was ideally timed when a whole new class of conversion networking equipment was being designed which has allowed us to win important designs with a number of new customers as well as expand our positioning with our existing customer base.

It is the only product on the market to achieve 1.5 billion decisions per second with lower power consumption than previous generation products making it ideally suited for the most demanding carrier class environments. With this product we believe that we have been able to win the majority of fifth generation design opportunities spanning mobile wireless infrastructure, wire line telecommunications, and IPTV applications.

We were also very pleased to announce in April this year a 55 nanometer version of our NetLife product family for the second generation of merchant silicon switches and network processors for companies such as Broadcom and Marvel. The advanced architecture of our NetLife product family that supports higher performance levels and improved cost structure for our customers allows us to achieve gross margins for NetLife that are at the corporate level while servicing the high volume cost sensitive segments of the desktop switching and ethernet access markets.

We also just announced on Monday that if we have reached volume production of our new NL 7512 knowledge based processor family which is a 55 nanometer version of our mainstream third generation enterprise class product family.

One of the devices in this family is 100% backward compatible with our largest volume shifting families of products, the NL 5000 and NL 6000, allowing our customers including our three largest customers to easily upgrade their existing platform to support even higher performance and lower power consumption while leveraging their existing hardware and software investments.

The NL 7512 processor family also includes a version with the expanded instruction set that is currently integrated into our industry leading carrier class NL 71024 XT knowledge based processor, specifically targeted at accelerating the processing of IPv6 packets. These optimizations enable existing architectures to more intelligently process packet headers at wire speed even for the wider and more complex IPv6 addresses.

These optimizations deliver a 300% improvement in IPv6 performance when compared with competing third generation solutions. The expanded instruction set version will target higher ASP sockets which coupled with the dramatically smaller die size will maximize our profit potential for third generation design which continue to be upgraded and proliferated in enterprise and other high performance networking applications.

With 55 nanometer options on our high end, mainstream, and entry level products, we have created a significant barrier to entry for competing solutions and have given our customers the ability to drive enhanced value at ever performance level.

Our R&D execution in 2008 and our physical layer product portfolio was equally impressive. We introduced a comprehensive portfolio of dual port 10 gigabit ethernet 5, which are all now in production. We also announced the industry’s first quad port 10 gigabit ethernet 5 for S&P plus and KR back playing applications.

Finally, in Q4, we announced the world’s first 100 gigabit ethernet physical layer solution for next generation carrier core, metro, datacenter, and access aggregation applications. This solution will enable OEMs to develop 100 gigabit ethernet systems which are believed to be a key step in resolving critical bottlenecks in optical transport, data center, and storage networks.

We also continue to be the leader in X2 modules and there is an ongoing transition from the previous generation high power impact to the more advanced small footprint low power X2 module. In addition we believe that we will continue our leadership as the industry moves to SSP plus technology over the next several years given our broad portfolio of dual and quad SSP plus products 100 gigabit ethernet solutions and our strong design win pipeline.

Another important R&D achievement in 2008 was the advancement of our net L 7 family of deep packet inspection layer 7 processors. We are seeing strong indication that cyber security is increasingly becoming a priority and the interest and design activity from our customer base reflects this sentiment. We believe that we have a very strong competitive position thanks to our continued innovation in this emerging area, resulting in the most complete suite of solutions available to address complex content processing requirements.

Adding to our successful family of 10 gigabit per second layer 7 processors earlier in 2008 we introduced the industry’s first single chip content processing solution that is capable of scaling from 250 megabits per second to 2.5 gigabits per second without requiring external memory. This family of processors for which we commenced volume shipments in Q4 is targeted at high volume applications such as security and networking systems for small and medium sized businesses and data center servers.

Additionally, during the fourth quarter, we reached an industry level best performance with the availability of our NLS 2000 which now provides up to 20 gigabits per second of performance to accelerate advanced layer 7 applications such as intrusion prevention, antivirus, antispam, and application identification.

We are particularly excited about the emerging layer 7 market because the 10 potential is sizable and the highly process complex processing requirements for deep packet inspection creates considerable barriers to entry.

Now turning to some thoughts on the current markets. While the weakened demand environment caused a downturn in our revenues during the fourth quarter, there are several areas of our business that are demonstrating gross potential for 2009.

First, our revenues from the wireless infrastructure market grew in Q4 driven by the worldwide upgrade of carrier network to 3G in order to support strong sales of video and smart phones and continued predictive growth in data subscribers.

Our current customers that support this market such as Alcatel-Lucent saw strong demand which is continuing into 2009. Also in 2009, we expect initial contributions from our newer customers such as Ericsson, Nokia, TelLabs, and GTE. The biggest factor driving our wireless infrastructure business currently is the aggressive investment in the 3G network buildout taking place in China following the awarding of 3G licenses to the three major carriers.

Research reports coming out of China predict a total spend over three years of approximately $41 billion. We have brought exposure to this buildout through numerous design wins with [Wahweh], GTE, and the European suppliers.

Additionally we continue to experience very strong design activity, particularly with our most valuable NL 7000 and NL 9000 families of products that offer special instruction sets to manage complex IPv6 addresses and advanced processing capabilities to support the most technically challenging search processing environments for 3G converged networks.

Although there are many reports of 2009 CapEx spending cuts by carriers, we believe the more aggressive cuts will be for legacy equipment where we have little to no exposure and that their investments in new converged networks to support the growing data and video traffic over mobile wireless networks and cable and IPTV broadband will be more stable.

Factors that drive our business continue to look healthy and mobile wireless market with the continued strong adoption of 3G phones carries our focusing their investments on expanding their 3G capabilities in order to leverage the increasing revenue streams per subscriber which is to drive from their video and data plan and helps offset their decreasing voice revenue.

In a wire lined market, cable and IPTV service providers continue to aggressively compete for customers with the most advanced high speed triple play services. At stake is the revenue stream from downloads of video, video on demand, and faster high speed internet access, as well as Voice over IP telephone service. Here again, legacy voice services continue to drop and the best way to maintain revenues is to expansion into these triple play services.

On the enterprise side of the business, demand has remained fairly week with a couple of notable exceptions. First, NetLife continues to build momentum with strong design win success throughout 2008. We expect a couple of customers to launch in the latter part of the first quarter of 2009 with volume wrapping over the course of the year.

Finally we expect revenues from our largest customer to begin to grow in the first quarter of 2009 as they appear to have made great progress on their inventory reductions and believe we are now shipping closer to their true demand levels.

Several of our new designs with the NL 8000 for high end enterprise switching as well as the NL 7000 for the ASR routers will more substantially contribute to our Cisco business as we move through 2009.

We are in front of a strong product cycle with Cisco. As of our current 27 design wins at Cisco, only 5 are in volume production indicating a very positive product cycle over the next several years.

In closing, tremendous engineering and operational over the last two years has allowed us to advance our technology roadmap both strengthening our competitive positioning and creating new markets for our products that represent additional exciting opportunities for growth over the next several years.

Because of this aggressive and effective acceleration of our R&D efforts in 2007 and 2008, we believe that we are in a great position to weather the current economic environment as much of the spending required to support our product development has already been taken, allowing us to control our costs without sacrificing any strategic R&D initiatives. Our strong balance sheet and positive business model coupled with a full suite of leading edge products and the most robust portfolio of design wins in our history give us the confidence that we will emerge from this downturn an even stronger company.

I would like to offer my sincere thanks to our employees for their continued dedication, enthusiasm, and commitment to excellence that has made all of these accomplishments possible. I would also like to thank our valued customers and investors for their continued support and interest in our company.

At this point I will turn the call back over to Mike to discuss guidance for the first quarter then we’ll open up the call for your questions.

Michael T. Tate

Thanks, Ron. As we look into Q1, we continue to be impacted by the overall weakness in the global economy. We remain very supportive of our customers’ efforts to work down their inventory levels to reflect the current demand environment. We feel we made good progress in this regard in the fourth quarter but some of our customers inventory reduction efforts will remain underway during the first quarter.

As Ron mentioned in his prepared remarks, we believe our largest customer has lowered their inventory levels where we are now shipping more in line with their end demand. Also we see incremental contribution from new design launches with our NL 8000 and NL 7000 with Cisco which should provide increased revenue contribution throughout the year.

As a result and based on shipments quarter to date, we believe revenues from Cisco will sequentially increase during Q1. Other positives will be increased mobile wireless revenues for equipment being shipped into China to support the new 3G equipment buildouts under way by the three major Chinese carriers.

These positive revenue drivers will help partially offset some continued weakness we are seeing and some existing run rate designs, especially for the enterprise, data center, and market applications. As a result, we believe or Q1 revenues will decline to approximately $30.2 million or 2% from Q4. This guidance reflects full backlog coverage plus an expectation for some additional rescheduling of backlog into Q2 in an ongoing support of our customers’ inventory reduction efforts during the balance of the quarter.

We expect non-GAAP gross margins to be 65%. The decrease in gross margins is a result of customer and product mix in Q1. During the course of 2009 we expect an improving product mix and as a result we do not expect further declines in gross margins this year from the Q1 level.

We expect non-GAAP operating expenses to decline to $14.9 million, non-GAAP R&D expenses to be approximately $10.2 million, and non-GAAP SG&A to be approximately $4.7 million.

Also in Q1 we expect interest and other income to be approximately $200,000. The decrease reflects a decline in interest rates given our conservative investment portfolio. We expect our tax provision to be close to $0 given our current levels of US and foreign profitability. We expect non-GAAP EPS for the first quarter to be $0.21 per share. We expect GAAP EPS for the first quarter to be a loss of $0.13 per share. This includes an estimated $4.5 million in FAS 123 R stock based compensation and $3.3 million in the amortization of intangible assets.

Finally, we expect our GAAP share cap to be approximately $22.7 million and the non-GAAP share count to be approximately $23.4 million in Q1.

This concludes our prepared remarks for the call and now we’re happy to turn it to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Adam Benjamin with Jefferies and Company.

Adam Benjamin - Jefferies & Co.

Thanks, guys. Nice job in this environment. First off, as you look at your business, given the sequential decline that you saw not only in Cisco and the increase you saw in Alcatel, it’s safe to assume that all your other customers were down sequentially pretty materially, correct?

Michael T. Tate

There were some pockets of strength in Q4. We did see some ramp in the layer 7 which was a positive and there were some select other customers but yes, the substantial majority of the customers were down sequentially in Q4.

Adam Benjamin - Jefferies & Co.

Then just trying to factor that in with as you look at Q1 guidance you expect Cisco to go back up and you have some other customers working down inventory and you seem to indicate that wireless infrastructure continues to grow, that would seem to imply that Alcatel sees the sequential increase after that large leap in Q4. Just trying to figure out that dynamics and see if that makes sense there.

Michael T. Tate

In Q1 we still see some inventory reduction efforts by our customers so predominantly kind of enterprise applications and the data center exposures, for example on the 10 gigabit, the optical module makers still have an inventory situation that needs to be worked through and some of the boxes that are geared more towards enterprise, I think the end demand environment still is a little sluggish so it’s going to take a little longer for the inventory to clear through but on the positive side, it seems like Cisco has really got their inventories in balance so we’re shipping more in line with their end demand which is obviously an improvement from Q4 and then we’re seeing some incremental contribution from the new designs that we’re kind of in pre-production in 2008 but are starting to gear up a little bit.

Then finally the mobile wireless had a very positive Q4 and not a big [inaudible] in Q1 off to Q4 but definitely a good potential through the potential of 2009.

Ron Jankov

As to Alcatel, we’re not predicting them to go up again in Q1 because they had such a strong Q4 but generally speaking their business is still strong.

Adam Benjamin - Jefferies & Co.

Then if you look at that inventory work down for your customers, Mike, do you think by the time you get to end of Q1 that should be behind you?

Michael T. Tate

It feels like we should be able to get to the bulk of this in Q1. What’s been a very nice positive development is we’re now seeing more expedites and pull ins which are pretty much in balance now with reschedule requests which is obviously a great improvement from where we were in November so we’re encouraged by that and we’re staying very close with our customers’ inventory situation and in our guidance we still have a coverage in our backlog for potential rescheduling out of Q2 just to make sure we try to get all this taken care of this quarter.

Adam Benjamin - Jefferies & Co.

Then just one last question, as you look at a lot of new programs that are ramping at various customers that you guys have been targeting for some time, can you give some commentary obviously without talking about the specific customers but how are you seeing those programs, are you starting to see some of those programs get pushed out further given this environment and just try to get a better understanding of how your trajectory should be excluding the current environment as you go forward given some of those new ramps will make you guys look better than the end market growth.

Michael T. Tate

We’ve always try to be conservative on these new product ramps because these products are getting more and more complex and I really think that’s the main issue. I don’t see a dramatic change in our customers’ targeting of when they’re going to get these products to market based on the economy. I think if anything the heightened competitive nature of the market out there, customers would like to get these products out there as quickly as possible and I think it’s just a matter of the final technical details and qualifications, etc. So, in general, I would say that it should roll out similar to it would have been a non-bad economic environment through the course of 2009. And so it will have a positive impact on us throughout year both in terms of our performance on the top line relative to our peers but also on the gross margin line.

Operator

And our next question will come from the line of Ruben Roy – Pacific Crest Equities.

Ruben Roy – Pacific Crest Equities

Ron, sort of a follow up to that question, has there been a change in design activity? It sounds like design activity remains strong but maybe mostly on the mobile wireless side some desktop switching. What about cable infrastructure, other end markets that you guys service?

Ron Jankov

Well I think that luckily our designs tend to be with very high-valued products that are still in high demand. It’s actually the IP convert boxes the kind of stuff our customers need to get into the marketplace as quickly as possible. So we’re really not seeing a big change in those products that were targeted the market, for example, for the first half of this year and the second half of this year.

And, like you said, certainly [inaudible] infrastructures, one of the hottest places, that’s where we’ve gotten the largest amount of design activity over the last 12 months and that continues. So we see the design activity actually very strong. In Q4, I think Mike may have mentioned on the script, that we had a very large number of design wins in Q4, essentially at the same record pace we were having throughout 2008. And again in Q1, through January, we’re at least on pace to match that.

Ruben Roy – Pacific Crest Equities

In terms of the outstanding designs at Cisco, I think you mentioned only five are in volume production, do you have a forecast of how many of the new designs will ramp in 2009?

Ron Jankov

Well, at least two or three ramp in the first half here. Looks like at least one will get some volume here in Q1 and one to two more we’ll add on in Q2. The closer we get to it, the more definitive it’s become so I think that’s not likely to slip again.

Ruben Roy – Pacific Crest Equities

The last question, with you not predicting [inaudible] Q1, it sounds like some of the initial contributions from the other wireless infrastructure companies could be coming in in Q1. How do you see the ramp going? Is this just a very small initial contribution for some of those customers and do you see a bigger rise in the second half of the year? Or how does the ramp kind of end up for this year?

Ron Jankov

It’s very small for, let’s say, Ericsson, Intel labs, Nokia, VZ, the brand new customers. It’s a very, very small contribution in Q1, so really what’s helping Q1 a lot is very specifically what’s going on in China where we’re very exposed to the new infrastructure build going on there. So before these guys I just mentioned, they will start to shift more in Q2 and it’s a very steady increase quarter over quarter for the next, I don’t know, next ten quarters I would say.

Operator

Okay, our next question will come from the line of Matt Robinson - Pacific Growth Equities.

Matt Robinson - Pacific Growth Equities

Can you comment on what’s going to be a bigger effect on your gross margins in the June and September quarters, between the new geometries for the third generation and the ramp up of newer designs?

Ron Jankov

In Q1, it’s really a product and customer mix. In the near term, we kind of modeled the worst case mix with Cisco in Q1. As we make it through the year, we’ll see a lot more carrier class contribution as the mobile wireless continues to grow and that actually has a positive impact, and then also the increasing mix of the 55 nanometer product as we make it through the year will also contribute as well. So we think Q1 should be the low point at [progressed] margins throughout the year.

Matt Robinson - Pacific Growth Equities

Is there a cycle time to get qualified on the newer geometries, or do your customers all take what you give them?

Michael T. Tate

Of course there’s a cycle time but we recently received qualifications for our first 55 nanometer product at our largest customer so we’re very, very excited and pleased by that and that opens up a lot of doors because we can do bridge quals with our other 55 nanometer products at that same customer. So kind of the biggest barriers have been crossed.

Matt Robinson - Pacific Growth Equities

So should we assume that you got like a 14-week cycle before you start to move those products?

Michael T. Tate

It’s looking longer than that. We expect to start shipping 55 nanometers to our largest customer in the second half of the year, but probably in Q3 rather than Q4.

Matt Robinson - Pacific Growth Equities

Should we expect that [Wahweh] will show good sequential performance in the current quarter?

Michael T. Tate

We think that’s part of the position that we have in China Mobile is with [Wahweh] so they should contribute growth in Q1. A little change in demand for them has helped them clear up their inventory quicker than in some previous years.

Matt Robinson - Pacific Growth Equities

Do they have a shot at being your second largest customer?

Michael T. Tate

Well, Alcatel has gotten quite big for us so I think that’s still a ways to go for that.

Operator

And our next question will come from the line of Daniel Morris - Oppenheimer & Co.

Daniel Morris - Oppenheimer & Co.

Just talking a little bit about the 55 nanometer transition there, can you quantify how much or how far we are in terms of mix in that transition?

Michael T. Tate

It’s a very, very small mix right now. It will change steadily over the course of the year. I mentioned how our largest customer will start to use it in Q3. But also we’ve transitioned 100% of the net light backlogged to 55 nanometer as well and I mentioned a couple will start production very late in Q1 and ramp throughout the year. So it could get up to 10% plus of our business by the end of the year. I know it’s always a slow, steady progress but we’re moving that direction actually to achieve close to 10% in the first calendar year of production which is very strong.

Daniel Morris - Oppenheimer & Co.

Okay, and with most of your design activity phase five 55 kind of behind you, I guess you’ll be turning now towards the 40 nanometer transition. Can you talk a little bit about how maybe [inaudible] cost associated with that transition will compare 2009 versus 2008 with the 55 nanometer?

Michael T. Tate

For ’09, we will be making an aggressive push to 40 nanometer but the good thing for us is we were very aggressive in the last two years of 55 nanometers and the move from 55 to 40 is not a big incremental step up in the cost to develop the product so it shouldn’t create a real burden on our R&D line.

And one other thing we did, because we’ve actually been working on 40 nanometer for a couple of years now, and a lot of the IT we needed for 40 nanometer node which can be a a bit expensive as the math cost, we procured that IT in 2008, so again it also decreases the net delta effect of going to 40 versus 55 for this year.

Daniel Morris - Oppenheimer & Co.

Okay, and just one other question. Talk a bit more about the layer seven products and with the introduction last quarter how that’s tracking and is it mainly more focused on the security appliances or how is that roll out going?

Michael T. Tate

Well, security appliance is a broad thing. It’s a large, $100,000 plus security appliance for our 10 to 20 gig solutions, but also we have these $1,000 firewalls for small business which could be where a lot of the growth is, particularly from a volume standpoint in 2009. So those single-chip products have lots design wins into very high volume boxes, so that could be the most exciting segment for us this year.

Looking to next year, where the design activity is expanding into more of the mainstream switches and routers and things like data centers, we think there’s opportunity to get another [inaudible] next year.

Operator

And our next question will come from the line of Nicholas Aberle - Caris & Company.

Nicholas Aberle - Caris & Company

Just to start off, any changes or quantitative commentary you can provide on lead times?

Michael T. Tate

From our supplies or with customers?

Nicholas Aberle - Caris & Company

Customers.

Michael T. Tate

No, we continue to hold our customers to the 12 to 15 week lead times. We’re generally sole sourced into their programs, very strategic so they feel comfortable placing that type of backlog with us and as we showed with them in Q4, we will work with them in case things change like it has in November and did some reschedulings. But that does afford us pretty good visibility and we are NOW feeling IT in Q2 now and that’s the benefit of that.

Nicholas Aberle - Caris & Company

And then with respect linearity in Q1, I mean is it extremely front end loaded as usual?

Ron Jankov

We typically run a front end loaded quarter and Q1 will be no exception to that.

Nicholas Aberle - Caris & Company

Just looking at Japan and Korea, it looks like that business started to pick up in the middle of last year and then started to rollover with the rest of the customers. Anything new there that’s going to help gets us started with the [inaudible] those customers again?

Ron Jankov

Yes, I would say that we thought exactly what you’ve said right there. So we have seen it roll off and our expectation is for it to stay relatively depressed this year so we’re not forecasting a bounce back in 2009 in either Japan or Korea.

Nicholas Aberle - Caris & Company

And then with respect... You say full backlog coverage for Q1, but you’re actually assuming a little bit of deterioration in the bookings or the backlog. Is there something you’re seeing that’s making you concerned about the integrity of the bookings, or is this just general cautiousness with respect to the environment?

Ron Jankov

It’s the latter. Always we are very aggressive about making sure we don’t shift anything in the current quarter that the customer doesn’t absolutely have to have in the current quarter because we really like to keep the inventories as low as possible in the chain. In this kind of environment, we’re that much more diligent in doing that than we would be in a normal environment or even let’s say than last year. So we’re working very hard to make sure that there isn’t any inventory in the channeling at the beginning of Q2. So we’re proactively encouraging customers who don’t have to take product this quarter to take it next quarter.

Nicholas Aberle - Caris & Company

Any update on the competitive environments? Anything you’re seeing out there with respect to Renaissance or IDT or Spans or anything like that?

Ron Jankov

I would say that the competitive environment is stable I think that with the exception of us so aggressively moving forward on 55. So we’re the ones shaking that environment up.

Nicholas Aberle - Caris & Company

So should we think of 55 nanometer transition in the back half as being a positive driver of gross margin?

Ron Jankov

Yes.

Nicholas Aberle - Caris & Company

Last question, you guys almost have $100 million in cash now. It seems like there’s a lot of struggling startups out there with some decent IP. Are you guys actively looking to [inaudible] acquisition?

Ron Jankov

Well, I think the IP is what we are interested in and so what we’re actively trying to do is use as little cash as possible to get as much IP as possible, maybe at the expense of doing outright acquisitions which can potentially hit your OpEx in a bad way. So we’re looking at a lot of stuff like you said there’s a lot of very interesting IP that could become very reasonably priced, but we’ll try to be very selective and very cautious with our use of cash and also in how it will affect our OpEx going forward.

Operator

And our next question comes from the line of Sandy Harrison - Signal Hill.

Sandy Harrison - Signal Hill

Just kind of talking a little bit about the 100 gig market you’re seeing, what sort of competitive landscape? We haven’t heard a whole lot of that and what are sort of your expectations on when that product will start to be looked at and when customers may begin to put it in their product plans?

Ron Jankov

Well, right now we’re the only solution right now for 100 gig, we’ll call it reasonably non-exotic solution for 100 gig. It’s a very, very small market and it’s been a very nascent market as well. It’s not going to drive our revenue this year or even next year, but what it does is it deepens the engagement we have with our customers and the fact that we can be their partner on 100 gig just makes it that much more likely that they’ll use us for 10 gig and 40 gig and other kinds of technologies. So we did this in cooperation a couple of our partners and our biggest customers and so I think we’re getting a lot of good add-on business because of our leadership there.

Sandy Harrison - Signal Hill

So if you look at your product solution, and this sort of goes along with a question asked earlier, if you look at your product solution where you’ve got a very stable and sort of up-and-coming physical layer solution and then further in the box you’ve got your other solutions for doing the processing, is there is a Mac product that is needed or something that you would do? Or is that typically the customer’s secret sauce and you guys aren’t going to sort of cross that boundary?

Ron Jankov

That’s exactly right. I think the fact that we haven’t gotten into our customers’ secret sauces has helped us to maintain a very, very close relationship with those customers. And when you’re talking about the Mac, there’s 30, 40 different ones you’d have to be able to support because each customer has a unique one. And then of course with all of our partners, which we have ten active network processor customers now that they each have different ones as well, so for us to stay neutral there has been the best solution for us and allows us to partner closely with everybody.

Sandy Harrison - Signal Hill

And you talked a little bit about one of the areas where some of the greatest inventory is is actually in the optical module market. What do you think was behind that? Is it that some of the equipment that was expected to rollout didn’t rollout, or is it that the providers who were going to install it were pushing things out?

Ron Jankov

I think it’s more of the nature of the module business itself that the module makers build up a lot of product and then they bid at the big OEMs to get the business on whether it’s a quarterly or monthly basis. So not everybody gets the order and everybody’s built up inventory so I think that in a situation where the demand goes down, it just really accents what was already a volatile kind of quarter-to-quarter environment there.

Sandy Harrison - Signal Hill

And then my last question, when you look at what’s happening with 3G and the licenses and the build-out, typically how far are you in front of the order pattern and so some of the RFPs for 3G deployments are expected to be issued later this quarter for perhaps second quarter shipping. Are you guys typically going to ship in this quarter or are you going to ship in a quarter closer?

Ron Jankov

Well, I would say that we’d be consistent with the fulfillment of that RFP not with the quotation of it. We’ve been very, very consistent with our customers, both in terms of on-time delivery so they can count on us to deliver when we’re supposed to, but also that they know we need lead-times as Mike mentioned because our stuff is also sourced and custom. So they work with us to give us a 12 to 16 weeks lead-time on those kind of things.

Operator

And our next question will come from the line of Suji De Silva - Kaufman Brothers

Suji De Silva - Kaufman Brothers

In terms of the [inaudible] infrastructure ramp, particularly in China, what makes you comfortable that it’s not going to be an inventory crush, that that’s going to be a steady ramp the next few quarters?

Ron Jankov

Well, we got this disability into Q2 already with that build-out, and the word keeps coming that they’re kind of just getting started. They basically had no 3G licenses in China until January, so we’re very, very early into this $41 billion spend that they’re talking about. So I guess we feel pretty good that it’s not going to be a one quarter phenomenon.

Suji De Silva - Kaufman Brothers

Very good. And then, I don’t know if you covered this already but Mike, can you talk about the number of design wins you had in the quarter perhaps by product, if you have it?

Michael T. Tate

Sure, it was a pretty strong quarter given the environment. It was over 20 again following a strong Q2 and Q3. For Cisco, we closed out three more designs which brings our total to 27 in this new product cycle and we also had good designs for the NetLite in that NL 9000 and in the 10 gigabit Cisco layer products.

Suji De Silva - Kaufman Brothers

And last question, you guys talked about 5 of 27 ramping and it sounds like from your commentary that two to three or a bit more might be ramping in the first half. Ron, is that the kind of pace the Cisco products coming online we should think about in second half ’09 and 2010, maybe in a three to four per half a year. Is that kind of the rough run rate or will it accelerate perhaps in 2010 given the number you have?

Ron Jankov

Well, it would have to accelerate at some point so I guess the further out makes it easiest for us not to have to change what we said. So we’ll go with what you said. Two to four in the second half and accelerating in ’10.

Suji De Silva - Kaufman Brothers

So you are calling out at this point that some of that should accelerate in 2010? Is that correct?

Ron Jankov

Yes, that’s what’s currently scheduled at Cisco.

Operator

And our next question will come from the line of Kevin Cassidy - Thomas Weisel Partners.

Kevin Cassidy - Thomas Weisel Partners

In your inventory, how much of that is older product and how much is 55 nanometer expecting for a new ramp?

Ron Jankov

We don’t really break out the components of our inventory but just given where the 55 nanometer products are and their ramp cycle, there’s not too much built up in our inventories right now. It’s mostly the current volume products that are comprising our inventory. You know also just on our inventory, because of the nature of our quarters being front-end loaded, we typically carry a little more in finished goods than your typical company which wraps more dollars around the units. So Q4 was no exception to that where we had over half of it in finished goods.

Kevin Cassidy - Thomas Weisel Partners

Okay, thanks. And you had mentioned a payment to Alero’s owners. Was that you sold more of the 10 gig than expected?

Ron Jankov

Yes, we had to earn out in the definitive agreement when we acquired them in October of ’07 and part of the earn-out was revenue milestone so they achieved a certain level of revenues and this is a payment on that.

Kevin Cassidy - Thomas Weisel Partners

Okay, is that over then?

Ron Jankov

Yes, this concludes the earn-out.

Operator

And our next question will come from the line of [Awat Shah – Dodd Davidson].

[Awat Shah – Dodd Davidson]

Just a couple quick questions. Mike, on wireless, is there any way to quantify how much wireless was as a percentage of revenue this past quarter?

Michael T. Tate

It actually gets kind of difficult because we will sell the same product to customers that will use it in wire-line and wireless design so we can only really talk about it qualitatively. As Q4 played out and Alcatel was very strong, we actually studied it to make sure we weren’t overshipping and in doing that, we found that there was strength in the U.S. with AT&T and also with China so we got that kind of feedback. But that’s the limit to how well we can actually quantify it.

[Awat Shah – Dodd Davidson]

So going back to your guys’ previous conversation, you said 10% revenue from wireless in ’09, that’s going to be hard to quantify but probably going to be able to able to exceed that, is that what I’m hearing?

Michael T. Tate

I was referring to the 10% of our revenues from 55 nanometer technology. So that could be a combination of NetLite into desktops switching, also this new 7512 into our largest customer as well as some new wireless design.

[Awat Shah – Dodd Davidson]

And then particularly with the wireless thing real quick, I know you guys mentioned already but do you guys expect then maybe the second half of the year to be stronger for wireless versus the first half? I mean, I know it’s just one segment of your market, but how should we thinking about that business?

Ron Jankov

We think it incrementally builds up through the year. Right now, we definitely see a lift from China in the back half of the year. We hope that continues and our expectations are that it does, and that we also will be adding in the new customers that we’ve had long-standing designs with, Ericsson, and [inaudible] and Nokia. Which in those designs are a multi-year cycle as well so those should actually build and I think provide us growth in ’10 and ’11.

[Awat Shah – Dodd Davidson]

Okay. And then Mike, in terms of the way sell into like an Alcotel-Lucent versus a Cisco, I mean is it they’re both [inaudible] I’m assuming and both relatively the same kind of selling cycle?

Michael T. Tate

Well, the dynamics with Cisco, it’s through a vendor managed inventory program that Cisco manages so we recognize revenue when they pull it out of the hub, so that inventory at the hub is on our books and deferred revenue. The Alcotel that we ship directly to their contract manufacturers.

[Awat Shah – Dodd Davidson]

And then the last question is just a housekeeping question on tax rates for’09, should we be thinking still 3%?

Ron Jankov?

Given the current view of profit levels, it will be closer to 0% for the year.

Operator

And our next question will come from the line of Romit Shah - Barclays Capital.

Romit Shah - Barclays Capital

Hi, Ron. I’m just trying to get my arms around all the comments regarding the top one and one question I had is given how lean inventories are today at Cisco and the number of programs you have in the queue, I think you said something like 22, are you planning for your Cisco business to grown this year?

Ron Jankov

Well, I think what we don’t want to make a position on yet is how the legacy business will do so we all know there’s some weakness in the legacy business in general for enterprise and data centers. So once that stabilizes, clearly these new programs are going to incrementally add to revenue. What the net effect will be overall for the year, it’s too early to say but clearly with any stabilization on enterprise and data center, these new programs will drive us to a higher number.

Romit Shah - Barclays Capital

Are you guys able to quantify the $10 million in Cisco business you did in Q4, how much would legacy?

Ron Jankov

I’d say pretty much all the revenues in Q4 were, just because of the timing of the new product ramps, you know how earlier in the year we did have some new product ramps, but they built up some inventory. Some were pre-production types of builds and these sorts of things so it was a pretty nominal amount in Q4 from the new designs.

Romit Shah - Barclays Capital

Okay, that’s very helpful. Thanks a lot.

Ron Jankov

And likewise, the bulk of the growth in Q1 is from new designs.

Operator

And at this time, I show no more questions in queue. I’d like to turn the call back over to Ron Jankov.

Ron Jankov

Okay, thank you and thanks to everyone for joining us today. During the first quarter, we will be presenting at several conferences around the country. We thank you for your continuing in NetLogic Microsystems and we look forward to speaking with you in the near future. Thanks.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Good day.

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