NetLogic Microsystems Inc. Q2 2009 Earnings Call Transcript

| About: NetLogic Microsystems, (NETL)

NetLogic Microsystems Inc. (NASDAQ:NETL)

Q2 2009 Earnings Call

July 29, 2009; 4:30 pm ET

Executives

Ron Jankov - President & Chief Executive Officer

Mike Tate - Vice President & Chief Financial Officer

Leslie Green - Investor Relations

Analysts

Adam Benjamin - Jefferies & Co.

Ruben Roy - Pacific Crest Securities

Nicholas Aberle - Caris & Co.

Sandy Harrison - Signal Hill

Allan Mishan -Brigantine Advisors

Matt Robinson - Wedbush

Kevin Cassidy - Thomas Weisel Partners

Sukhi Nagesh - Deutsche Bank

Dan Morris - Oppenheimer & Co.

Gary Mobley - Noble Financial Group

Arnab Chanda - Roth Capital

David Wu - Global Crown Capital

Auguste Richard - Piper Jaffray

Alex Gauna - JMP Securities

Cody Acree - Stifel Nicolaus

Operator

Good afternoon and welcome to the NetLogic Microsystems’ second quarter 2009 financial results conference call. Leading the call today are Ron Jankov, President and Chief Executive Officer and Mike Tate, Vice President and Chief Financial Officer.

My name is [Keisha] and I will be your coordinator today. At this time, all participants are in listen only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions)

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

Leslie Green

Thank you, Keisha and good afternoon, everyone. Please note that our second quarter 2009 results were disseminated by Business Wire after market close today, and a copy of the release can be downloaded from website at, netlogicmicro.com.

Before we get started with our financial results for the second quarter, 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 4, 2009 and Form 10-Q filled on May 5, 2009, as well as other reports the company files from time to time with the SEC.

Additionally, we will be making specific forward-looking statements and financial guidance regarding our third quarter 2009 operating results. The guidance is given based on an estimated merger date with RMI Corporations on August 31, 2009, and projections provided to us from RMI Corporation. However, this merger date is still subject to regulatory and shareholder approvals and accordingly may change.

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 and 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, acquisition-related costs and interest income on a bridge loan to RMI Corporation. These items have been removed from the cost of revenue, operating expenses, interest income, and income taxes for non-GAAP reporting.

I will now turn the call over to Mike to discuss our second quarter 2009 results. Mike?

Mike Tate

Thank you, Leslie. Good afternoon, everyone. Today, we reported that revenues for the second quarter of 2009 was $32.5 million which compares favorably to our previous guidance of $32 million and represents a sequential increase of 7%.

Revenue from Cisco Systems, our largest customer, was $11.1 million or 34% of our total revenue, compared with $9.7 million or 32% of our total revenue for Q1, 2009. Revenues from Cisco grew nicely given stabilization in the enterprise markets coupled with revenue from new programs that are in the initial ramp face.

Revenues from Alcatel-Lucent were $5.3 million or 16% of revenue in Q2 as compared with 16% of revenues for Q1. The growth in revenues from Alcatel reflects continued positive contribution from worldwide 3G wireless and IPTV wireline ramps. Revenues from Huawei were 10% of revenues compared with 13% of revenues in Q1. We do not have any other customers above 10% of our revenues in the second quarter.

Our non-GAAP gross margins for the second quarter were 66.7%, which excludes stock-based compensation expense and the amortization of intangible assets. There is a complete reconciliation between GAAP and non-GAAP gross margin in today’s earnings release. Our 66.7% compared favorably to our guided gross margins of 66% and was largely driven by favorable product mix during the quarter.

Q2 GAAP operating expenses were $22.8 million, which included 5.8 million of stock-based compensation, 1.3 million in the acquisition-related costs for IDT and RMI and $300,000 for the amortization of intangible assets. This compares with GAAP operating expenses of $19 million for the first quarter of 2009, which included approximately 4.1 million of stock-based compensation and $300,000 for the amortization of intangible assets.

Total non-GAAP operating expenses for Q2 were $15.3 million compared with $14.5 million for Q1 2009, which was inline with our previous guidance with the growth being largely attributed to increased product development and tape-out related expenses. Non-GAAP R&D expenses were $10.7 million for Q2 as compared with $10 million for Q1 2009. Non-GAAP SG&A expenses were $4.6 million for Q2 as compared with $4.5 million for Q1 2009.

Q2 interest and other income was approximately $250,000 on a GAAP basis. Our non-GAAP interest and other income excludes $125,000 related to interest recognized on a $15 million bridge loan we provided RMI in June. During the quarter, our Q2 tax provision was a benefit of $1.9 million, which was due to a better than expected mix of our foreign and domestic book income and losses.

On a GAAP basis, our Q2 net loss was $2.2 million or $0.10 per diluted share compared with a net loss of $3.9 million or $0.18 per share for Q1 2009. Non-GAAP net income for Q2 was $8.4 million or $0.35 per share compared with $6.7 million or $0.29 per share for Q1 2009.

We had fully diluted shares of 22 million on a GAAP basis and 24.1 on a non-GAAP basis. With respect to the balance sheet, cash, cash equivalents and investments decreased slightly $600,000 in Q2 to end the quarter at $88.3 million compared with $88.9 million at the end of the prior quarter.

The decline in cash reflects the $15 million bridge loan we issued to RMI. Excluding this note, we had another strong quarter of positive cash flows with over cash flow $11 million in operating cash flows in Q2.

Our accounts receivable was $8 million and represented 22 days. The low DSOs were the result of favorable sales linearity coupled with strong collections. Our ongoing target DSOs remains at 35 days. Second quarter net inventory decreased by $1.2 million and was at $9.7 million compared with $10.9 million at the end of county 2009.

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

Ron Jankov

Thank you, Mike. This is a great time for NetLogic Microsystems. Our results in the second quarter came in ahead of expectations as we are seeing improving demand for products across our end markets, including enterprise and 10 Gigabit Ethernet, as well as continued momentum in the wireless and wireline infrastructure markets. Further, the second quarter was another very strong quarter of design wins, with emphasis on our most advanced solutions designed in 55 nanometer technology.

We also won a key Tier 1 design with our newest 3rd generation 20 Gigabit NETL7 product, which was announced in April. We are excited by the strength of our business and the positive product cycle that we are entering, and we believe that our successful acquisition of IDT’s network search engine business and our pending merger with RMI positions us for a significant expansion of our business potential over the next several years.

One of the most visible drivers of our business in 2009 and beyond is the worldwide upgrade to wireless and wireline converged IP networks. Although there are many reports of CapEx spending cuts by carriers, we believe the more aggressive cuts are related to legacy equipments, where we have little to no exposure, and that carrier investments in converged networks are continues to increase in order to support the growing data and video traffic over mobile wireless networks and IPTV broadband.

In particular, we are seeing strong growth in the worldwide upgrade and expansion of 3G mobile wireless telecommunications infrastructure capacity, and are seeing positive indicators that this build out will continue for several years as the rapid adoption of smart phones and the proliferation for bandwidth intensive applications for these devices puts a strain of network capacity, and impacts the consumer experience.

Further, a number of wireless operators have recently committed to deploying 4G Long-Term Evolution networks in the next two years, including, Verizon Wireless, MetroPCS and US Cellular in the United States, NTT DoCoMo and KDDI in Japan, TeliaSonera, Tele2, and Telenor in Europe and China Mobile.

The development of 4G networks is particularly exciting because the use of knowledge based processers to achieve the desired performance levels continues to increase significantly, even from the currently content heavy 3G networks. This is very positive for NetLogic, as we have broad based exposure to both 3G and 4G build-out to nearly every major OEM, including Alcatel-Lucent, Cisco, Datang, Ericsson, Fujitsu, Huawei, Juniper, NEC, Nokia Siemens, Tellabs and ZTE, among others, and expect to see a prolonged revenue growth cycle from this market.

For example, Cisco’s XR 12000, high-end carrier-class edge router is ramping up for us in third quarter, and will use 12 of our newest 55-nanometer devices for line card. Alcatel-Lucent has also continued to be strong for us, even in the typically weaker summer months, as a result of strength in both worldwide 3G, and IPTV infrastructure.

As we look into the second half of the year, we also expect to receive material revenue from Ericson and ZTE for the first time as the routers utilizing our knowledge-based processors were launched in Q3. We also expect Nokia Siemens and Tellabs to contribute to our revenue growth in 2010.

Similarly, the increase in rich media content is driving the worldwide wireline market build out as cable and IPTV providers compete for Triple-Play customers. In a second quarter, we experienced increased demand from customers in this market such as ALAXALA, Alcatel-Lucent, and ARRIS. Our backlog in customers forecast indicates continued growth in the second half of 2009.

Turning to enterprise, while we maintain a conservative outlook for this market in 2009, we are seeing positive indicators that the weakened demand in inventory digestion, that has affected enterprise over the last several quarters has shown improvement.

Our revenues from Cisco are up in the second quarter, and are expected to further improve in Q3 as a result of new design launches and mainstream switching. Further, we continue to see strong design activity at Cisco, as we close on five more new design wins during the quarter, indicating that our most valuable products will be heavily represented in the development of next generation equipment.

Also, we are expecting to see growth in our enterprise revenues from Brocade in the third quarter, both as a result of its expanded distribution channel leverages IBM’s sales force, as well as a result of its architecture that uses a higher content to knowledge-based processors as a differentiator to bring higher levels to Layer 4 processing to the enterprise segment.

In the entry-level desktop switching market, more and more equipment now utilizes knowledge-based processers to accommodate high quality video, and the additional functionality of IP phones. In the second quarter, our initial NETLite design wins continued to ramp at several customers, and we expect more programs to reach live production in the latter half of the year, including those from larger desktop switching OEMs.

Based on our collaboration with these leading, OEMs, we were pleased to announced last month the availability of our NL33100 NETLite processor family that’s supports the deployment of next generation IP converged networks, including IPv6 routing, protocol tunneling, Virtual Private LAN Services, and voice-over-IP management.

This new product family delivers double the performance in IPv6 database density, providing the cost point, feature set, and lower power consumption required by customers to address the growing need for advanced functionality and high volume, entry-level, enterprise switches and routers.

Our design wins for NETLite knowledge-based processor family continue to gain momentum, as we close on five new designs during the quarter, indicating the long-term potential for this market is exciting and building. Turning to our Physical Layer Solutions, we continue to experience very strong interest in our suite of advanced products, and address a critical bottleneck in carrier core, metro and datacenter networks, as a result of the proliferation of video and virtualization applications.

We recently began sampling industry’s first, single-die quad-port 10 Gigabit Ethernet PHY devices, which are manufactured in the advanced 40 nanometer process to deliver the highest performance at lowest power consumption for next-generation networking and communications equipment.

Also, the customer response to our NLP10000, industry’s first 100 Gigabit Ethernet PHY solutions have been very positive. This solution is also manufactured in TSMC’s advanced 40-nanometer process and offers customers unprecedented scalability for data-center, metro and long haul applications.

We believe that we are the only company to offer 100 Gigabit capable PHY silicon demonstrating our commitment to leading edge innovation and superior execution of our technology roadmap. We currently have backlog for NLP10000 from a number of Tier One OEMs and are engaged with many additional companies.

Turning to Layer 7, we are very pleased by the strong response that we are receiving from our newest NLS2008 knowledge-based processor, which is the industry’s first processor capable of deterministically performing Layer 7 content-aware processing functions at over 100 Gigabits per second.

This chip which was announced in April is already generating backlog with Tier One vendors, highlighting the critical need for more intelligently managed network utilization and security. The breakthrough in performance of this device allows of our Layer 7 technology to be designed directly on the data plane of switch and route line cards and would be able to deterministically every bit of every packet at wire-speed.

The data plane design opportunities represent a significant step-up in volume versus today’s Layer 7 designs on the control plane. Also, we are very excited that our NETL7 Layer 7 knowledge-based processor were used by the leading supplier SMB firewall equipment to enable the additional functionality of intrusion prevention, Malware detection, antivirus, anti-spam and application identification, all at wire speed.

This new model won best of show at Interop Las Vegas may 2009 as well as at the recent Interop in Japan. This product is stated to have 20 times intrusion prevention performance of currently available competitive products. The single-chip NETL7 processor used in this application provides the higher performance, unified threat management and Intrusion Prevention services for high performance security, routing, and switching services targeted at distributed enterprise environments.

Before closing, I’d like to give you an update on our plans to merge with RMI, which is expected to occur later this quarter. First, the Logistics had the merger on proceeding as planned and going smoothly. Second and most importantly, customer response is very strong and significantly exceeds our expectations prior to the merger announcement. Current customers of RMI are excited about the potential enhanced manufacturing support and financial strength of the combined company.

As well, many of our customers, they are hesitant to design with private companies have shown strong interest in designing with RMI products to take advantage of their industry-leading performance, assuming the successful conclusion of the merger.

It appears that the industry is primed for a major move to the use of multi-core processor. Similar to the growth drivers that are opening up new opportunities for our knowledge-based processors and high performance physical layer products, the ever increasing bandwidth and complexity of today’s IP traffic, coupled with the rapidly evolving technological requirements of these services are causing a shift in the data plane processing market from the use of single core processors to highly programmable multi-core processors.

The nature of packet processing involving a steady flow of unique packet information aligned almost perfectly with the parallel processing capability of multi-core processors. Equipment manufacturers have been investigating and designing your next-generation converged IP applications to take advantage of the dramatic performance and functionality offered by multi-core processor.

Following this investment cycle, which began a few years ago, we believe the ramp of multi-core processors has poised very strong growth as it began to be deployed in the advanced 3G, 4G wireless, IPTV, security and storage markets.

Going forward networking and communication performance requirements are increasing so rapidly that customers need even more performance than are offered by current Multi-core processors. To address the increasing complexity and bandwidth requirements, RMI is currently ramping XLR processor uniquely offers [four way] multithreading, an advanced processing technique to provide a breakthrough increase in throughput will also lowering power consumption.

This technology coupled with XLR super pipeline 1.5 Gigahertz core which is 50% faster than competing multi-core products gives RMI dramatic performance advantage and packet processing. This has allowed RMI to garner a very large percentage of design wins in the most performance demanding applications, such as Layer 7 content processing and 3G, 4G base stations and network controllers and media gateways.

RMI is at the very beginning of this cycle. As Most of the design wins in these areas have not yet ramped line production. Further we were pleased to participate in the launch event for RMI’s newest XLP platform which was very well attended, particularly by high level representatives of many Tier One customers, as well as a host of eco system partners.

As a testament to RMIs commitment innovation, the XLP product family will feature the highest performance and power efficiency of any competitive product on the market and have ideally suited for advanced network packet processing environment, such as security, storage, and wireless infrastructure where the multi-core, multi-threaded architecture is extremely beneficial. The XLP processor is design on TSMC’s 40-nanometer node offering tremendous benefits over available and announced competitive solutions.

In closing, this is an exciting time for us. Our knowledge-based processors in physical layer products are addressing a critical need in managing increasingly bandwidth intensive and complex IP network traffic enabling us to outperform the general semiconductor market. Also our advanced Layer 7 products are receiving tremendous design activity as our customers develop new equipment that can intelligently manage network utilization and enhance network security.

Further, the early transition of our product line to 55 nanometer process node has been very successful, with strong yield performance and rapid customer adoption, allowing us to achieve unprecedented design win success, and strong gross margins in key markets, that will ramp over the next many years.

Our continued focus on technology leadership, coupled with our expanding customer diversification, give us confidence in our ability to achieve healthy growth in our business in 2009 and beyond. Further, our pending merger with RMI significantly enhances our business potential, and creates additional value for our customers, employees and shareholders.

At that point, I will turn the call back over to Mike to discuss guidance for the third quarter, and we’ll open up the call for your questions. Mike?

Mike Tate

Thanks, Ron. Our guidance for Q3 will include the effects of both the acquisitions of IDT’s network search engine business, as well as the pending merger with RMI Corporation. Our acquisition of IDT’s network search engine business closed on July 17, and our guidance reflects a partial quarter.

We expect our merger with RMI Corporation to close around August 31. The RMI merger is still subject to our shareholders and regulatory approval, so this date could change. Today’s guidance assumes an August, 31 close.

As we look into Q3, we are encouraged by the broad strength of our business across the enterprise, wireless, wireline and 10 Gigabit markets. We believe our customer’s inventory is at reasonable levels, and revenue growth is being driven by new design ramps, and positive market trends.

Based on these factors, we believe our Q3 revenues; excluding contributions from any IDT and RMI product sales will grow approximately 8% from Q2 to $35 million. We expect the revenues from the IDT network search engine business to contribute approximately $4.2 million in additional revenue, and that the RMI business will contribute approximately $6.8 million in additional revenue for the month of September.

Combined, we expect our revenue to total approximately $46 million for Q3. The estimated revenues for both the IDT and RMI do not include estimated sell through of inventory held at their distributors on the closed date of the transactions. Under purchase accounting, we will not be able to recognize such revenue. Therefore, the numbers do not reflect the true run rates of these businesses.

We expect accounting for the distribution sell through to have a nominal effect in Q4. So, we expect the revenues to approximate full run rates for both acquisitions in the fourth quarter. The guidance for the NetLogic revenues reflect full backlog coverage, plus an expectation for some additional rescheduling of backlog into Q4.

We expect combined non-GAAP gross margins to be approximately 66%. We expect non-GAAP operating expenses to increase to approximately $21.1 million, non-GAAP R&D expenses to be approximately $14.6 million, and non-GAAP SG&A to be approximately $6.5 million.

On July 17, we borrowed on our new $55 million debt facility to fund the purchase of IDT’s network search engine business. With the outstanding debt, we estimate interest expense of approximately $600,000 in Q3. We expect our tax provision to be near $0 in Q3. We expect our non-GAAP EPS for the third quarter to be $0.32 per share.

Given the complexity of the purchase accounting surrounding our two acquisitions, as well as the timing of the RMI merger, we are not in a position to provide guidance on a number of our GAAP income statement items. Our Q3 non-GAAP earnings do not include stocks based compensation, amortization of intangible assets, fair value adjustments for inventory, interest income on our bridge loan to RMI, payroll taxes on certain equity awards to the RMI employees, and further costs to be incurred for the acquisition and integration of IDT and RMI.

We expect our GAAP share count to be approximately 24.4 million shares, which includes an estimated 2.2 million shares for the RMI merger, and the non-GAAP share count to be approximately 27.2 million in Q3, which includes an estimated 2.6 million shares for the RMI merger and the related RMI employee equity awards. The RMI related shares are weighted to assume an August 31 merger date, and being outstanding for one third of the quarter.

This concludes our prepared remarks for the call. Now, we’re happy to take questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Adam Benjamin - Jefferies & Co. Please proceed.

Adam Benjamin - Jefferies & Co.

Hi, guys. I was just curious about your RMI guidance as well as IDT, I know that includes some discount to the sell through of the inventory, but I just want to be clear Mike, as you look at that $6.8 million, that’s really just one month. So, how should I be thinking about that on a full quarter basis?

Mike Tate

Sure. RMI concluded Q1 with $17.1 million in revenues, and they have a pretty reasonable growth profile going through the year. So, our guidance for September reflects one month of a quarter at that run rate, with a slight reduction for the amount that they sell through distribution. They run generally about 50% of their revenues through distribution in a given quarter. Hopefully, that gives you enough color on that.

Adam Benjamin - Jefferies & Co.

Yeah, I was just trying to get a better sense of what it look like on full quarter basis because it seems a little bit higher, but obviously the business is doing a little bit better than it did in the first half. That’s fine.

Then in gross margin, I wonder if you could just break out the pieces and then the puts and takes there on the 66, you did higher in the quarter. You’ve been tracking a little bit better. Can you kind of break out the core business? The IDTI contribution, the RMI and how you get there and then talk a little bit about the 40-nanometer and how that could play into maybe more so next year?

Mike Tate

Okay. Yeah, so for Q2, we did 66.7 which is a little higher than our guidance of 66. So we’re entering Q3 with good, positive margin momentum. And this is being driven largely by increased shipments into the carrier space 3G and wireline and [Telco] really uses our most valuable products, so that that’s a good margin trend for NetLogic and that will continue in the second half.

As you look into Q3 specifically, the IDT business is a lower margin profile than NetLogic, partly because it’s a more enterprise-focused, but we look at the IDT products and it’s kind of similar to what we experienced with Cyprus. We see a lot of opportunities for cost reductions and we are already aggressively attacking those. So, we are hopeful of seeing margin improvement as the new owners of that business line.

The RMI business on a pro forma basis is running about 64% right now. So it’s not far off from our business. And just given the continued growth of the XLR and XLS product lines, we see a coupled with our manufacturing flow opportunities for margin improvements there as well.

Adam Benjamin - Jefferies & Co.

Then just one last question on the customer side. Maybe, Ron, if you can talk a little bit about any specific customers that have kind of come in sooner than you think in terms of their ramp or also that are pushing out in terms of not only for this year but into next year? Thanks.

Ron Jankov

Well, I think what we’re pleased with is a very steady and continued ramp of 3G, 4G wireless in particular. It seems like that market is so hot that our customers are bringing those boxes to market on time and they are ramping maybe if anything at least as good as what we’re expecting.

It’s a very profitable segment, and that applies to pretty much all of our products; knowledge-based processors are used there, we’re getting design wins for NETL7 there. We have 10 Gig five designs there and RMI has lots of designs there as well. So, I think the continued, we’ll call it rapid execution and growth of that market is, I’ll call it better than expected?

Operator

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

Ruben Roy - Pacific Crest Securities

Mike, can you talk a little bit. I think you’ve mentioned something about linearity in the quarter, and I think I missed it. But just in terms of how the order patterns went through the quarter. Did they get better towards the end of the quarter and how they’re shaping up thus far as we look at in September quarter?

Mike Tate

Sure. We continue to try to run a front end loaded quarter for shipments. So, on business models, we are trying to achieve 50% of the revenues in the first month and we’ve been hitting or exceeding that so far this year. And that looks to continue in Q3.

Ordering pattern though, that’s generally a little bit more linear. I’d say as the business is growing and the bookings have also been picking up as well. So we’re seeing positive trends in our bookings rates.

Ruben Roy - Pacific Crest Securities

Okay. And then, Ron, on the 4G side, you talked a little bit about the content differential and a 4G box first is the 3G box, I think you gave an example of Cisco and 12 parts in that box. Can you just remind us of what that differential is versus the typical 3G box, maybe detail and ASP or number of parts?

Ron Jankov

Well, it’s both ASP and number of parts. The 4G network is much higher bandwidth as you know, and also it’s expected to have a lot higher video content and maybe even equally important is also that Internet access and Internet usage is expected to be done over 4G. This is both for the phones, the smart phones as well as the dongles for our notebooks and being built into netbooks in the future. So, there is really a huge profile for 4G.

The other big thing about 4G is, in 3G we are mainly represented in the backhaul, the aggregation points, the radio network controller aggregation points as well as the edge routers and core routers that connect everything together. What’s different about 4G is that the IP processing is so intense that we actually move out to the base station itself when it’s the first point of contact for those smart phones. So, that’s much higher volume and really is a brand new market for us starting with 4G.

Ruben Roy - Pacific Crest Securities

Okay. Then just the last on the RMI, XLP, is that on track to sample in Q4 of this year?

Ron Jankov

Well, I’d rather not comment on RMI’s specific details prior to the merger. The XLP design is going forward at an excellent pace. I think the merger has accelerated that development rather than slowed it down. Other than that, I’d rather not...

One thing I can say is that again, I can say is that the XLR, which is the current 8-core quad-threaded device or 32 thread device, where they just did an announcement about a month ago of upgrading the performance of that to 1.5 Gigahertz, and that product is very early in its stage of deployment. However, we’re seeing lots of new design wins, as well as ramp starting, particularly in the wireless infrastructure segment, but also in network security and high-end switches and routers. So, we’re very early into the XLR deployment.

Operator

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

Nicholas Aberle - Caris & Co.

Thanks. So, on Cisco, you guys saw a nice uptick for Cisco in the quarter, and you suggested that had Cisco would continue to grow for you in Q3. Should we think about that business growing at similar growth rates or how should we be thinking about that?

Mike Tate

I don’t want to predict specific growth rates for any specific customer, except that Cisco has the potential to do very well for us, just given the enterprise market seem to stabilize, so a run rate programs seem to have found firm footing. We also have a number of new designs that should be layering in over time to provide growth. Ron, talked about on the call that we now have 36 designs, of which 31 are still pending to ship. So, we think we’re in great position for growth at Cisco.

Nicholas Aberle - Caris & Co.

Got you. So, we should be thinking about the run rate business actually being just kind of flattish sequentially, and then incremental growth coming from new program ramps or is the run rate business actually going to improve a little bit?

Mike Tate

Just to be conservative, and after what the enterprise markets has gone through, we’re happy with stable right now, and that’s the way we’re modeling it. If it’s just stable then we’re positioned to grow. If it does better, then that will do even better.

Nicholas Aberle - Caris & Co.

It’s definitely encouraging given the seasonality associated with their business. You said five new designs win in the quarter at Cisco. So, any granularity on what type of applications those are for?

Ron Jankov

It was quite broadly based. We had at least one, and another one in mainstream switching, we keep them up in that area. We also had one in edge routing. I think there may have been a couple of them there. So, I have to check exactly where they were, but it was pretty well spread out. There might be a couple of them in the mainstream switching as well.

Nicholas Aberle - Caris & Co.

Got you. Any commentary around sustainability of the nice growth that we’ve seen in China 3G as we head into the back half?

Ron Jankov

We’re modeling relatively moderately right now, but just in the last several weeks, we’ve seen some bullish signals coming out of there, so that could probably be a little bit better than we’re expecting. The exciting thing for China for us in Q3 and Q4 is that ZTE, the second largest Telco guy in China after Huawei is ramping for the first time.

Also, Ericsson, which is the largest non-China suppliers into the 3G/4G network in China is ramping for us for the first time in Q3. So, we feel really good about China in the second half.

Nicholas Aberle - Caris & Co.

Perfect. On the gross margin, I am pleasantly surprised by the 66% guidance given the mix gets a little bit worse. As we move into Q4 and IDTI and RMI come into full contribution, should we be tempering our gross margin assumptions a little bit into Q4?

Mike Tate

Yes, I believe the model that we have is still 65%. I think we’ll be close to that right there. We’re still looking at ways to improve product costs on the IDT front to see if we can do better than that, but it will be close to 65%.

Ron Jankov

Also, we’ve been very encouraged by the trends that RMI is seeing, and again, as the XLR which is their most profitable product, similar to our high-end knowledge-based processors, is the fastest ramping product for them. It’s really quite early in its product ramp. So, they have a favorable bias to their gross margin even before the manufacturing efficiencies that we’ll bring to bear once the integration happens.

Nicholas Aberle - Caris & Co.

Got you. The $55 million debt facility, is the plan to take care of that incrementally over the next couple of quarters with cash flow or you guys are going to let it set for a while? What’s the plan for the debt?

Mike Tate

We did a partial draw on it in July to fund the IDT acquisition. We think the debt facility and our strong cash flow from operations gives us adequate liquidity given the nature of our business models. There is really not that much needs for cash for our day-to-day operations. So, we think we’re in a good position to be paying off the debt in pretty quick pace.

Nicholas Aberle - Caris & Co.

Got you. Just one last question on cash flow, $11 million and cash flow from ops in the quarter, that’s pretty nice on a percentage of revenues basis. Is that a good proxy or is that bumped up by something in the quarter?

Mike Tate

No, it’s good. If you look at our non-GAAP net income, usually that’s a good proxy for our cash flow. We’ve been overachieving to that over last couple of quarters, just given that the balance sheet is in a very good position as well. However, as you try to model our cash flows, regarding our non-GAAP net income, that’s usually the best proxy.

Nicholas Aberle - Caris & Co.

Perfect. Good luck in Q3 guys.

Operator

Your next question comes from Sandy Harrison - Signal Hill.

Sandy Harrison - Signal Hill

Yes, thanks. So, obviously guys, a couple moving pieces here with partial quarters and pieces of business just coming in and so forth. Mike, I guess when you guys have talked about the RMI, you would put out a preliminary model, I think it was around $2.50 in revs and $1.60 in EPS for 2010. Do you have any changes to that, and been able to dial into that any further as you moved along or is that still pretty much the direction you’re headed?

Ron Jankov

Yes, so when we announced the RMI acquisition, we put out a number of $275 million and $1.60 a non-GAAP EPS and we feel very comfortable with that the more we, the year gets closer the more comfortable we feel about it.

Sandy Harrison - Signal Hill

You’ve got a couple of nice opportunities, Ron you talked about your prepared remarks, a couple of new customers and even Cisco coming back. If you were to kind of characterize and maybe force rank some of your better growth opportunities in the second half of this year versus some of the broader growth opportunities in 2010, how would you look at those?

Ron Jankov

Yeah, this is one of those nice times when it seems like every single segment of our business is growing in the second half. To rank order on them, again this is not real scientific but just kind of from a feeling, I would, Telco, both 3G infrastructure and it’s not just China, it’s happening in the U.S. and even Europe is starting to order some equipment again.

Then, of course, IPTV which is continuing to add subscribers I think the Telco guys have finally woken up that their old wireline business, the legacy wireline business is going to go away and they better replace it with IPTV. We see a strong investment there and continued drawing forecast from our customers.

So that that kind of combined would be number one. I think maybe number two is brand new customers. Ericsson and ZTE are huge customer potential for us and it’s great to see our first production volumes added on this quarter and again, this is just a tip of the iceberg, they’re just getting started. We should see strong growth from those two customers steadily for the next two or three years as we have 20 design wins with each and only a couple of them are getting started now and that will proliferate.

Also, as they replace their legacy boxes with these new boxes and more and more of their customers qualify these boxes. I’d say that’s number two. Well, maybe number three I would say are the new products; NETL7 and NETLite. You know I talked about them on the call, the big SMB design, that has a potential to be many – you know that’s just in SMB, so the units can be very high on that and also with the high-end, the 20 to 100 Gigabit solution. So that’s exciting.

It seems like suddenly the customers are seeing an urgent need for securing the network and also for managing the bandwidth and you’d really need to have Layer 7 capability to do that; and of course they are light. After many years of design wins and hard work, it’s finally ramping. It looks like its going to be ramping steadily for a couple of years. If you blow that then actually everything else is okay. It’s good. Think that business is good. Enterprise is good. The rest of our business is solid as well.

Sandy Harrison - Signal Hill

All right. Then the last one for me would be a quick hit on the physical layer products. What’s the pricing environment looking like over there and I think that there was some inventory questions and also sort of the technology transition SFP plus and how is that progressing and with probably one of the lowest costs it sounds like given your process note. How does that position you for any changes in the competitive environment?

Ron Jankov

I think the high end of Fi market, particularly the high end of the Fi market is a little bit misunderstood. People assume that a customer can design in company X’s 10 Gigabyte on Monday and design in company’s Y is probably on Wednesday. It’s not like that at all. These are very, very difficult designs, signal integrity designs on the PCBs and over the connectors et cetera is very, very difficult. This design takes a typical 12-month kind of cycle similar to KDP.

So these designs are very sticky and also very technologically difficult, again, to work with. So they tend to be very, very sticky and the pricing in this area, we see it attracts similarly to other products. So in that you got to compete in the design win, but once you have it, it’s relatively stable there after. So I don’t see dramatic changes in that pricing environment for 10 Gigabit Ethernet.

Now, clearly, 40-nanometer gives us a huge advantage. The fact that we can put four ports on a single die. We’re the only company that can do that. Packaging is a major issue with these products. Again these packages are very technologically advanced and expensive. So if you can use one package instead of two it gives you right [off the bat] a huge cost advantage.

Also, again, a single die is cheaper that be two die from a testing logistics and every other standpoint and of course 40-nanometer technology gives us better performance profile and significantly lower power. So we feel it gives us a significant competitive edge.

Operator

You next question comes from Allan Mishan - Brigantine Advisors.

Allan Mishan -Brigantine Advisors

What is the full run rate that IDT will see in Q3? Then same question for RMI, if it was fully consolidated and you were recognizing everything?

Mike Tate

Well, we did file the 10-K with IDT’s financials earlier this month and in that, their last full quarter was a $8 million quarter. It gives you a sense of the run rate there. Then again for RMI, they did a $17.1 million in Q1 and they have a pretty healthy quarterly growth rate given all the drivers for growth that they have. However at this stage, I think that’s about all we can say.

Allan Mishan -Brigantine Advisors

Okay. Then on the IDT business, how does that split between Cisco and non-Cisco. Also, how does it split between gen 3, gen 2 and gen 4?

Mike Tate

Generally it’s going to be about 70% or so Cisco; but more growth coming from non-Cisco just given where the product ramps are there, and it’s a healthy mix of gen 2 at this stage.

Ron Jankov

One thing to add to that is that, I’d say over the last two years, that IDT’s more successful product launches were in the non-Cisco area. It was an area that they had not given enough focus to let’s say five years ago. However, when they saw how much we are growing there, they started to focus on it. So, over the last couple of years, they’ve done pretty well there. So, I would echo what Mike said, that they’re pretty early in the non-Cisco ramp, and that’s where the growth will be in the IDT business.

Allan Mishan -Brigantine Advisors

Okay. So, if I look at that 8 million that they did in that quarter, about 70% would be Cisco, and let’s say more than half the business is gen 2? Are those both fair?

Mike Tate

Yes.

Allan Mishan -Brigantine Advisors

Okay, perfect. And how many IDT employees came over to work for you?

Mike Tate

Less than 10.

Allan Mishan -Brigantine Advisors

Less than 10. Okay, great. Then, NETLite had a pretty big Q1 if I remember. How did that do in Q2? Did it grow again or did it come off a bit?

Mike Tate

One of the major customer ramps that we had with Huawei in Q1 took a little pause. It’s typical when these products launch, they kind of fill up the channel and then take a break. So, Q2 was a little flattish from that, but we do see it growing nicely in Q3 and Q4. We’re trying to hit a million [per quarter] in the back half of the year.

Operator

Your next question comes from Matt Robinson - Wedbush.

Matt Robinson - Wedbush

Thanks for taking my question. With the OpEx commentary for the September quarter, how much of that should we associate with IDT, and incrementally, it might be a cost reduction initiatives and the like?

Mike Tate

Yes. The cost reductions for IDT are mostly going to be focused on product costs. We didn’t really take on too many heads with the IDT transaction. So, incrementally, not much in incremental operating expenses are coming over to IDT.

Ron Jankov

We’re going to be building up some new test equipment, and especially test equipment and field equipment to increase the yields, and we will put that into OpEx.

Matt Robinson - Wedbush

You made some comments on the NLS2008, is that product going to be a catalyst for Layer 4 through 7 network processers on the line cards?

Ron Jankov

Absolutely. This thing is a quantum leap in performance where I can truly do up to 100 Gig wire speed Layer 7 processing. It’s extremely unique. That’s a circuit-based solution, which is an order of magnitude faster over the next closest thing. So, it will enable essential wire-speed Layer 7 on data planes which has just not been possible until this chip.

Matt Robinson - Wedbush

So, therefore, you think pull the higher layer processers on the line cards in addition to the lower layer processers, it might already be there?

Ron Jankov

Absolutely. This reminds me of what happened in 2004, with Layer 4 processing when our initial quad pipeline KDTs made it possible to do 10 to 40 Gig wire-speed Layer 4, then lots and lots more equipment started doing Layer 4 at wire-speed. This is the same thing that we are just getting started on in Layer 7.

Matt Robinson - Wedbush

Just for housekeeping, Mike, can you give me a CapEx and then NetLogic headcount in the quarter, and I guess to summarize that OpEx number that you gave for guidance, would you consider that to be at least relative to the run rate that you’ve shown it, all be coming from RMI basically?

Mike Tate

For the OpEx, the NetLogic proper spending is continuing to grow at typical, reasonable levels, but we are incurring more and more tape-outs as we move down the 40 nanometers. The cash flow from ops was $11 million and our CapEx continues to be nominal. We did have a capital lease during the quarter which will show up in our cash flows as a capital item. It was about $3 million, but it was mostly in the form of [Inaudible] licenses.

Matt Robinson - Wedbush

Head count?

Mike Tate

NetLogic is running a little over 250.

Operator

Your next question comes from Kevin Cassidy - Thomas Weisel Partners.

Kevin Cassidy - Thomas Weisel Partners

Thanks for taking my question. When you were talking about the 10 Gigabit Ethernet upgrade, is it spending increasing or are you saying that there is technology breakthroughs that are making this possible?

Ron Jankov

Well, I think it’s both. I think clearly the data centers maybe as the first mover, but also enterprise equipment and even Telco equipment following quickly on its heels. The bandwidth requirements are going through the roof and basically, the transition to 10 Gigabit Ethernet has to take place to enable that increased bandwidth; it’s just a 1 PHYs or huge bottleneck on the whole system right now. This is just very, very new in this transition.

I think it’s the fact that with vendors like ourselves are able to deliver the products with such efficiency right now but also on the optic side, 10 Gigabit optics, modules are much lower in price than they were this time last year, for example, so that’s going to spur the increase of 10 Gig as well. So, I think technological advances in the manufacturing as well as the requirement for increased bandwidth.

Kevin Cassidy - Thomas Weisel Partners

Even though there is tight budget, that they are seeing a return on investment, so that’s why it’s some of the spending.

Ron Jankov

Yes, I agree and also it’s a competitive necessity because your competitors are definitely going to do 10 gigs, so you better do it as well.

Kevin Cassidy - Thomas Weisel Partners

Also you’ve mentioned ZTE and Ericsson just ramping. Do you see them as becoming a 10% customer or is the other growth going to keep them still below 10%?

Ron Jankov

Well, it’s going to be a foot race, so would have been easy before, but both companies, well in ZTE in particular is a large RMI customer as well, so that will help. I think there is great opportunities at Ericsson which is currently uses all free scale right now. There is big opportunities to displace single core processing with multi-core.

Clearly there’s a potential, I’d say that without the acquisition, Ericsson almost certainly was going to be one but with the acquisition, RMI and us together will need to get design wins to displace their free scale at Ericsson.

Operator

Your next question comes from Sukhi Nagesh - Deutsche Bank.

Sukhi Nagesh - Deutsche Bank

Thanks for taking my question. Hey Mike, quick question here on the IDTI business. You said it was running at quarterly run rate of around 8 million, yet you’re guiding about 4.2 million for about two and a half months worth of sales. By my math, I think it seems like you should be guiding somewhere in the 6.5 to 6.7 million. Any reason why the delta between what the quarterly run rate is and what you’re guiding?

Mike Tate

Sure. One of the pieces is in purchase accounting, any inventory that’s sitting after distributors on the close date is something that we wouldn’t be able to recognize. So we only recognize asset that we put into the channel, post close so the run rates are a little lower because of that.

Also it is a partial quarter and finally, whenever you have a change of hands like that, there’s typically some of the customers want to get a little extra stock on the shelves before the change or just make sure there’s no interruption, so it’s kind of a combination of all three.

Ron Jankov

Add to that, with Cisco as you know is a July ending quarter and it’s around July 20th is the last time you can make a shipment into Cisco to still turn revenue for them for that quarter. The first half of July, end of June, first half of July is always the strongest period for Cisco and as IDTI is by far their biggest customer pulled a lot of their Q3 demands in the beginning of July.

Sukhi Nagesh - Deutsche Bank

Got it, thank you and then on the share count Mike, 27.2 million on a non-GAAP basis?

Mike Tate

Right.

Sukhi Nagesh - Deutsche Bank

If I recall correctly, when you guys announced the deal with RMI, you said it would be somewhere around eight to nine million extra diluted share accounts, will that increase for the December quarter?

Mike Tate

Yes, so the Q3 is one-third of what we’re estimating because for the EPS shares you only count what’s outstanding during the period while they’re outstanding. We’re anticipating an August 31st, close date, so this year it will be only outstanding for the month of September and then for the fourth quarter, that’s actually another two-thirds of that amount.

Sukhi Nagesh - Deutsche Bank

One last question for you, Ron. If you just look at your enterprise business, at this point in time you’ve acquired ITI, you have a pretty sizable market share there at Cisco. How would you look on a year-over-year basis as your enterprise business. Do you expect it to be flat this year? Down slightly? Up? How would you characterize it from your advantage point?

Ron Jankov

As far as year-to-year comparison, I don’t want to get into that because I haven’t done the analysis including the IDT results or whatever. Generally speaking of course, the first half of 2008 was very strong enterprise so year-to-year comparison is hard to do. That being said, we see a lot of positive trends in enterprise, 10 Gigabit, of course, it drives our Fi business, but it also means more bandwidth drives a higher value knowledge based processor as well, so that’s a positive trend for us.

Also what we are seeing is as I mentioned Brocade on the call, they’re using a lot higher content of knowledge based processors increasing the amount of layer four processing done. I think that’s a trend we’re likely to see.

Another thing that is going to happen in enterprise is the Federal Government came out a few days ago and reaffirmed that I think it’s around mid-2010, all boxes shipped to federal agencies will be required to be IDT-6 capable that means that they are going to have to use our latest and greatest knowledge based processors which are more valuable and more of them. There’s a lot of positive trends in enterprise right now.

Operator

Your next question comes from Dan Morris - Oppenheimer & Co.

Dan Morris - Oppenheimer & Co.

First question, Mike. On the backlog coverage I believe you said it was over 100%. Was that for the NetLogic core or do that also it could be IDT and RMI contributions?

Mike Tate

That’s for NetLogic profit. So again we’re more than fully covered. For IDT, it closed on July 17th. So at that time, customers effectively had to bring down their backlog with IDT and then resubmit orders to NetLogic. So that’s kind of underway right now, but we’re not counting on too much in turns in that business as well.

Dan Morris - Oppenheimer & Co.

I assume that you would be able to move IDT business so much of your business model where you can front load the quarter. With RMI, would you be able to do the same and are the lead times a little bit different? I mean how comfortable are you with the visibility of the RMI business since it’s towards the end of the quarter?

Mike Tate

Yeah the RMI business will have a little bit more turns to it. But again, a lot of the end customers are the same customers that RMI will be sourced into. So we’ll have a lot of dynamics where I think in short order, it will start to look more like the NetLogic business model getting back on coverage.

Dan Morris - Oppenheimer & Co.

If I could just ask a slightly different angle on the OpEx question. I think the acquisition call you said that 2010 incremental OpEx would be about 53 million. Is that the right number now that you’ve had a chance to look around a little bit?

Mike Tate

Yeah. Incrementally to NetLogic it’s about $53 million.

Operator

Your next question comes from Gary Mobley - Noble Financial Group.

Gary Mobley - Noble Financial Group

It was certainly nice to see the gross margin improve sequentially in the second quarter but it seems counterintuitive given the increased mix of Cisco. Is that just a function of the carrier portion of Cisco’s business having that much higher gross margins than enterprise side?

Ron Jankov

Yes, that’s definitely part of it. I think the largest area of growth for us at Cisco is in the wireline and wireless boxes, the routers that sit in the backhaul behind that. So, that is a higher gross margin business. So that’s part of it. As well as the non-Cisco business also grew well in the quarter.

Gary Mobley - Noble Financial Group

With respect to your 40-nanometer products at TSMC, what kind of yields are you getting in those products? And have you come in to the some of the same issues that some others have had at 40-nanometer?

Ron Jankov

Well, there’s one good about communication is that’s a long design cycles. So, we have to be very aggressive to deliver samples to customers earlier on the cycle, for example [gain a] 40-nanometer product right now, the same where we’ve got in 55-nanometer product nearly two years ago.

Then our customers take about two years to design products around our products, get them all the software-written and get them qualified by their end-customers et cetera. So, even though it’s very important for us to sample 40-nanometer right now, we don’t need to be shipping it in high volume for probably another 18 months or so. So I’m comfortable.

The graphics guys are building tens of thousands of wafers per month these days. So they’re going to knock all the kinks out of that production line long before we need high volume of it. So I really don’t have a concern there.

As a good example is what we are going through with 55 right now. Two years ago, when the graphics guy started shipping that stuff for the first time, they struggled the same way they are struggling now, but our 55-nanometer yields are great and above our expectations right now and very solid and that’s what we’re ramping now.

Operator

Your next question comes from Arnab Chanda - Roth Capital.

Arnab Chanda - Roth Capital

A couple questions either from Mike or from Ron. First of all, maybe for Ron. There has been a couple of product announcements. If you could maybe update us a little bit on what your NETL 7 products, how does that compare with LSI and maybe now Cavium I guess is announcer product? If you could talk a little bit about what sort of TAM do you think that is over a couple of years and what their strategy is in terms of new customers or engagements? Thank you.

Ron Jankov

Well, we have a very broad product line now. We have got the two single chips we announced about this time last year, which are targeted at the SMB marketplace and I think those are quite unique. In that their single chip don’t require external memory, very, very low power and a very, very small package. So it’s easy to kind of fit that into an environment where Layer 7 was never considered before. So, that is a very unique product.

We are currently shipping our volume production on 10 and 20 Gig solutions as well that are based on different versions of those chips. So that’s kind of targeted security of plans market. The latest product we just came announce this wire speed chip that can go up to 100 gig, that again is extremely unique because it’s targeted at the data plane, not just like a security appliance but a regular switcher or router to handle all the traffic at Layer 7. So it’s a very, very broad spectrum.

So we’re able to go after essentially every segment of the market. So, in terms of how that compares competitively. Our solutions are custom chips with full mass tape offs and all those kind of things. What we’re seeing from the competition is an FPGA-based designs which again can’t achieve the same performance, power, and cost profiles that our more mature solutions can command.

I’ll turn to the TAM, that’s always a tough question. It’s clearly going to be big, it’s really hard to say and it depends. I think it depends somewhat on us to not to be arrogant, but if we can drive the cost performance and footprint of Layer 7 down to be very affordable and usable, it’s going to proliferate to many, many more switches and routers. So, we are working hard to make sure that TAM is as big as possible, but it’s certainly going to be few hundred million dollars several years down the road.

Arnab Chanda - Roth Capital

Okay. Great, Ron. Maybe a question for the accounting expert here, Mike, I was trying to look through the 8-K, and again, I’m no accounting expert. It seemed like the gross margins for the IDT business have been sort of all over the place. It was almost 60% ‘08; maybe it was kind of just about 50 in ‘07 and almost 40 in ‘09.

Could you explain that a little bit? Is there something I’m missing there, inventory et cetera, and how you expect to sort of migrate that business to where you’d like it to be?

Mike Tate

Sure. We don’t have exact visibility to what was causing the variations in the historical gross margins. We do know what the product costs are today, and then what the ASPs are to the customers.

So, we feel good where the margins are going from this point on. In the 8-K financials, it’s also is a full GAAP financials, so there are areas of burden such as mask depreciation and intangible amortization and stock-based compensation that could also be explaining the variations.

Arnab Chanda - Roth Capital

Okay. Then, if you could talk a little bit about, I mean, sort of a big equation here with a lot of variables. You’ve got your own business which obviously seems like it’s actually going higher in gross margins, especially given the mix for Q3, and then you’ve got IDT probably a little bit lower, and then RMI has two businesses where maybe the mix is also improving. What is the sort of medium-term as well as long-term as in like 2010 and then beyond, where the margins could be? If you could talk a little bit about that and sort of how you get there? Thank you.

Mike Tate

There is definitely some positive trends in the existing NetLogic business, and also inside the multi-core, multi-threaded processors that RMI are offering today. However, there’s just a lot of different end markets and opportunities to go after, so we still believe you should look at NetLogic at a 65% long-term gross margin business, and that’s the way we’re operating the company to achieve in this year, next year and the following year.

Ron Jankov

I would second that. I would say that to me, the 2010 projections that are out there, all the businesses would tend to have a gross margin bias towards a higher number, but we want to keep the flexibility as Mike mentioned. There’s some high volume opportunities that we’re not exposed to yet, that aren’t factored into those projections for 2010 that we might want to go after, and still be able to keep our 65 points gross margin rather than quoting something higher and limiting our flexibility to go after some of these opportunities.

Arnab Chanda - Roth Capital

You’re obviously not responsible for other people’s businesses, but it seems like RMI has two different businesses, and one is more lower margin versus the high performance part that, maybe the high end of that competes with Cavium. Obviously, the gross line for Cavium are substantially lower although they do count their gross margins somewhat differently.

It almost seems like the RMI has really good gross margins, and that 65 number is fairly high. Not a bad thing, but just very good compared to what’s going on out there. To get there, I would assume you’d have to improve dramatically IDT margins too. So, give us maybe a little more insight as to whether I’m missing something here. Thank you.

Ron Jankov

By the way, RMI accounts the same way Cavium does, so that’s apples-to-apples, and that will improve when we move into our way of accounting for things. So, they look that good even with the same way of accounting advertising math

To me the big delta is, if you look at in particular XLR processor with its 1.5 gigahertz core, its 32 threads, it is by far the highest performing part for packet processing in a multi-core environment. It’s also exposed to some of the highest growth, and we’ll call it, they are so performance sensitive, they’re a less price sensitive markets, like wireless infrastructure, like wireline infrastructure, Layer 7 content processing, and very high-end storage.

These customers need the best performance no matter what, and prices is a little bit secondary. I think that RMI’s exposure is much greater. I think they’re the clear leader in terms of revenue and clearly profit in the high end of the multi-core segment. So, I really that’s the difference, and that’s always the segment that’s willing to pay the most.

I think also RMI is a very low power cores. The single core processors actually do quite well in terms of gross margin, because they’re not targeting the lowest margin segments. They’re targeting unique applications where very, very low power and very, very high video performance are required, and those applications do command pretty good gross margins as well.

You mentioned IDT, and I would like to follow-up on something Mike mentioned. We see a lot of opportunities for cost improvement in the IDT products. We kind of weren’t paying attention to them that much over the last 12 months, and so I think there’s a lot we can do there. So, we are pretty bullish, it will take three to six months for that to start to kick in, but we definitely have a solid action plan for those products.

Arnab Chanda - Roth Capital

Then last question, there are so many things going on with the newer businesses that it may be a little bit confusing for me. It seems like the IT business actually has been in terms of revenue is also in declining, I would guess that was the share again that you guys were seeing but are you acquiring it at a point where you think that that’s sort of stable or you are not? You’re getting the positive benefit and not a declining revenue stream?

Ron Jankov

First of all that was mainly taken by Renaissance not us, that Cisco business, but we are starting to take business from Renaissance now with the NetLogic products. Of course, just like everybody else particularly at Cisco, Q4 and Q1 were horrible quarters and a lot of inventory reduction and not buying to demand and everything. So, clearly the IDT business we’re picking it up at a good time.

Again, as we mentioned on the call, I think the best growth opportunities there are with the non-Cisco business. A lot of that stuff hasn’t ramped yet, so we are going to concentrate on making that happen.

Operator

Your next question comes from David Wu - GC Research.

David Wu - Global Crown Capital

Good afternoon. Ron, can you help us with a few things. We had a conference call yesterday afternoon about RMI, but I just want to ask two things about RMI. Number one is when you do the due diligence before you come together with RMI, how did your top couple of customers react to a potential, multi-source or multi-core processor arrangement out there? That was the first question and then I also have a follow-up.

Ron Jankov

Okay. I am very pleasantly surprised by the reaction across the Board from customers, both to RMI’s technology, I’ll call it all three things, RMI’s technology, the fact that the combined company and the strength it brings, as well as their need to dramatically increase our use of multi-core processors. I personal underestimated just how much of a trend towards multi-core is happening right as we speak right now. That’s very, very exciting.

I think that the excitedness of the customers towards the RMI technology and their commitment to it and how much time and money they’ve invested into programming with the quad-thread technology to maximize, to eek out that last bit of performance they’ve invested tens of millions of dollars in writing code specifically to the RMI quad-thread technology. We had underestimated again, just how much committed the customers really were.

Everything, I would say from a customer commitment and customer excitement level it’s above expectations and the equal amount of excitements from people who don’t use RMI yet but who are NetLogic customers and most obvious example of their largest customer where they feel that now we have the capability to access this high performance course, whereas they did not before, because essentially Cisco was barred from using private companies.

David Wu - Global Crown Capital

I guess the last design win RMI had at Cisco was 2001. How soon could you get them into getting design wins into that big monstrous for the multi-division account?

Ron Jankov

Well, I don’t want to predict that quite yet, but you can bet it’s going to be priority number one for us.

David Wu - Global Crown Capital

The other point I wonder is in terms of programming multi-core processing hasn’t been easiest thing to program. Is there any improvement in third party software that allows your customers of RMI, let’s say to program efficiently and therefore allow more people to use multi-core? You said there’s [segregated] need to go to multi-core. So I assume that programming has been improved.

Ron Jankov

I would say that actually, the third party stuff is getting better and it will be important in the long run to reach especially the second tier of accounts, but what we found out is the biggest amount of software that’s been written, its actually been written by the customers themselves. Lets say, Juniper on JUNOS, Huawei on their OS, ZTE on their OS and so really the breakthrough its happened at the customer-by-customer level and these customers are building up the multi-core expertise in house.

I was out of [Inaudible] a few weeks ago and I visited their demo facility of a whole floor of one of their buildings, shows off their latest and greatest equipment. They were touting the fact that their routers were better than the competition because they were using multi-core processors. This was all written in Chinese, I had to get a translation for it. But they’re touting that their expertise…

David Wu - Global Crown Capital

You should allow me to come with you next time, Ron, I’ll do that right there.

Ron Jankov

The fact that they’re touting their expertise in multi-core, that means a lot and most of that code, probably 80% of it is written around RMI processors.

David Wu - Global Crown Capital

Okay. I assume 40-nanometer being a common process thing would allow you to share costs and reduce both engineering and cost of goods sold, right?

Ron Jankov

Absolutely. It also allows us to leverage the IP from the different groups into different chips, that’s an example, the 40-nanometer KBP will be taping out, will utilize the 10 Gig PHY technology that’s in the marketplace today and we see similar synergies with RMI, of course.

Operator

Your next question comes from Auguste Richard - Piper Jaffray.

Auguste Richard - Piper Jaffray

Thanks for taking my question. Mike, there’s a lot of pieces moving. What is going to be the long-term operating model of the company and when do you think you’re going to get there?

Mike Tate

Sure. So, on the gross margin line, it’s still the same at 65% and we think we’ll be operating very close to that once all deals are fully closed and have a full quarter under their belt. On the operating margin our target is 25%, so that would imply 28% R&D and 12% SG&A. We’ll have a little bit of a low point here in Q4, not much and then we think each quarter we should see improvement to that as we leverage up to the 25% over time.

Auguste Richard - Piper Jaffray

Is that like a two year type of goal?

Mike Tate

The goal is definitely to achieve it within 2011.

Auguste Richard - Piper Jaffray

Okay, got it. Then just given, you can’t recognize the revenue of what’s on the DishTV shelves. It takes one, two quarters to clear and is that mostly weighted towards Q4? And then just a little tag ends in Q1, just how do you see that clearing out for you?

Mike Tate

We think it will mostly clear up in September, just a nominal impact in Q4.

Auguste Richard - Piper Jaffray

Nominal being few million dollars, is that reasonable?

Mike Tate

I mean, less than a million dollars.

Operator

Your next question comes from Alex Gauna - JMP Securities.

Alex Gauna - JMP Securities

Most of my questions have been asked, but if I would ask on the comments you made about NETLite picking up again in the second half of the year, any specific color on that? Is that China coming back online or are there new drivers in play there?

Ron Jankov

It is both. China, both ZTE and Huawei are building NETLite boxes both for the enterprise as well as for [chip on] access. We see other both enterprise and chip on access stuff coming up in Europe and the U.S. in the second half. So it’s pretty broad based.

Alex Gauna - JMP Securities

Then the question was asked on your 40-nanometer efforts with TSM, can you remind us how big your diode, your leading-edge diode, how many transistors were talking about and what that means with the complexity of your efforts?

Ron Jankov

Our big KBP is tend to be up to a billion transistors. Our diodes are anywhere from 50 to 300 square millimeters depending on where it is.

Alex Gauna - JMP Securities

So that does, in fact, make you a pretty important strategic partner for them, correct, in terms of working with for their partners and all...

Mike Tate

Well, Absolutely. I think that’s one reason they invested into us very early on. I think its also as you noticed, we did a strategic announcement with them a few weeks ago and that strategic announcement was signed off all the way up to Morris Chang’s level.

Alex Gauna - JMP Securities

You talked a little bit about the IDT revenues be a little bit more enterprise centric. What’s your feeling right now with a little deeper out exceeding the year, maybe into 2010 when we start to get budget refresh cycles out there. How do you feel about enterprise exposure right now?

Mike Tate

The IDT business will trend towards less enterprise as the non-Cisco business they won is mainly in telco. But again, I mentioned because of the Federal Government moving to [IDT 6], and the increased content driven by 10 gig; I feel pretty good that the enterprise business will grow next year.

Alex Gauna - JMP Securities

Okay. Last one, you touched on the 10 Gig here. Is your PHY technology particularly attached to any of the other controllers or switch technologies out there or is it pretty broad based in terms of your design wins?

Ron Jankov

It’s pretty broad based, and the biggest number of designs is always connecting directly to the customer ASICs and also FBGAs. We are very tight with both FBGA guides.

Operator

Your next question comes from Cody Acree - Stifel Nicolaus.

Cody Acree - Stifel Nicolaus

I got just a little late, could your refresh my memory to the Cisco numbers.

Mike Tate

They were 34% of revenue or $11.1 million.

Cody Acree - Stifel Nicolaus

34%, 11 million. Then, with the acquisitions and the competitive environment, where do you think you stand lastly here with RMI, with IDTI? We have very few players left out there. So, what would you expect to be left I guess to really put a competitive threat?

Ron Jankov

I think in the case of multi-core processing, this is brand new market, and as the TAM in that market gets huge, I would expect there to be others looking at it, and our existing competitors to continue to offer more and more products in area.

I think that will be a competitive area, but I feel strongly that RMI has the best technology, and in fact that they’ve had their quad-thread technology in the market for a couple of years, and those designs are just starting to ramp meaning that software is just now being completed.

We have a big advantage there, but it certainly will continue to be competitive. In the knowledge-based processor market, renaissance is still there, particularly at Cisco. We’re encouraged by the distraction they’re seeing with their merger with NEC, but we still expect them to be a strong competitor.

Cody Acree - Stifel Nicolaus

Any bias towards acquisitions now that you have IDTI and RMI?

Ron Jankov

We are going to digest the current two for a while here. So, I’d say we’re not particularly active in that area right now.

Operator

There are no further questions. I will now turn the call back over to Mr. Ron Jankov for any closing remarks.

Ronald Jankov

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

Operator

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

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