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Cavium (NASDAQ:CAVM)

Q2 2013 Earnings Call

July 31, 2013 5:00 pm ET

Executives

Angel Atondo - Marketing Manager

Syed B. Ali - Founder, Chairman, Chief Executive Officer and President

Arthur D. Chadwick - Chief Financial Officer, Principal Accounting Officer, Vice President of Finance & Administration and Secretary

Analysts

Blayne Curtis - Barclays Capital, Research Division

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Sundeep Bajikar - Jefferies LLC, Research Division

Quinn Bolton - Needham & Company, LLC, Research Division

Harlan Sur - JP Morgan Chase & Co, Research Division

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Brian T. Modoff - Deutsche Bank AG, Research Division

Ruben Roy - Mizuho Securities USA Inc., Research Division

Sanjay Chaurasia - Nomura Securities Co. Ltd., Research Division

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Cavium, Inc. Second Quarter 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, July 31, 2013. And I would now like to turn the conference over to Angel Atondo, Senior Marketing Communications Manager. Please go ahead.

Angel Atondo

Thank you. Good afternoon, everyone, and welcome to Cavium's Second Quarter 2013 Financial Results Conference Call. Leading the call today are Mr. Syed Ali, President and CEO of the company; and Art Chadwick, Vice President and Chief Financial Officer.

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

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

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

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

Additionally, the information we provide on this call regarding sales by market does involve certain management judgment as to which market each sale is assigned, and you should consider that when analyzing such information.

I will now turn the call over to Syed Ali. Syed?

Syed B. Ali

Thanks, Angel, and thanks to everyone for joining us today. In brief, Cavium's second quarter revenue was $74.2 million, up 6.7% sequentially from Q1. Non-GAAP gross margins came in at 65.8%. Non-GAAP net income was $12.6 million or $0.23 per share. Our GAAP net loss for the quarter was $4.3 million or $0.08 per share.

Q2 was an excellent quarter on all major metrics that we track, including: top line growth, gross margins, operating margins, cash flow and design wins. We had our fifth quarter in a row of strong sequential growth, driving 6.7% sequential and 34% year-over-year growth. In Q2, growth was driven by chip sales into our core service provider Enterprise and Data Center markets. Sales into the broadband and consumer markets were down slightly.

In Q2, we have strong sales into the service provider market, with strength in both wireless and wired infrastructure. The wireless infrastructure markets were particularly strong this quarter, with strength in 3G and 4G equipment.

The wired infrastructure was also strong, with growth coming from EDGE routers, cable infrastructure and transport equipment. On the Enterprise side, we saw strength in the security and Data Center markets.

In Q2, our top customer was, once again, Cisco Systems, which came in at 18% of sales and was flat sequentially. Art will provide more details on the Q2 financial results and Q3 guidance shortly.

I would now like to provide an update on Q2 design wins. Last quarter in our core Enterprise, Data Center and service provider markets, we had the highest design win rate based upon expected annual revenue in our history. Design wins were broad-based across the Enterprise, Data Center, wireless and wired infrastructure markets. Design wins covered the entire range of products, including our flagship OCTEON line, NITROX, NEURON, Fusion to the latest LiquidIO controllers at a wide range of both Tier-1 and Tier 2 customers. New design wins covered a wide range of applications, such as wired and wireless infrastructure, Enterprise Routers and switches, Data Center equipment, small cells and security appliances.

I would also like to highlight that our design win engagement pipeline continues to be extremely robust and is also at record levels. The design win success reflects our vital product offering and highlight what we believe is our increasingly competitive position in the market.

Now I would like to move on and give an update on our newly announced products. During the quarter, we announced a number of new products. We introduced super low-power duo, quad and quad core members of the new 28-nanometer OCTEON III MIPS64 multi-core processor family. These processors integrate up to 4 MIPS64 cores, with full hardware virtualization, deep packet inspection, packet processing, security and QoS capabilities, along with very sophisticated power management in a highly integrated system-on-a-chip, which we believe will set a new bar in performance per watt. The new 70XX and 71XX processors are entry-level members of the OCTEON III family, which will provide the industry's widest line of multi-core processors supporting up to 48 cores at core frequencies of up to 2.5 gigahertz, with full software compatibility across the product line. The 70XX and 71XX will address the growing need of a high-performance Control Plane, application processing and intelligent networking in both Enterprise class and broadband applications. With full hardware virtualization, developers can create new applications that are firewalled from each other, so hardware telecom protocols and newer media and social applications can coexist in the same system with live in-service upgrades.

The 28-nanometer OCTEON III product line is the first time we have targeted and built a highly optimized solution in terms of features, power and cost for this end market. In previous generations, we had optimized primarily for mid- and high-range applications. This target end market will significantly increase our serviceable market, which has to date been primarily addressed by incumbent suppliers.

We now have a very significant customer pipeline for this family of product across a wide range of applications.

In Q2, we also introduced LiquidIO, a new family of 10-gigabit Ethernet server adapters that enables data centers to rapidly deploy high-performance SDN applications for both installed and new infrastructure, while clearly improving server utilization, response times and network agility. These new adapters are designed for deployment by cloud service providers, enterprise and private data centers worldwide. Server virtualization technology has enabled multiple virtual machines per server, providing significant benefits to enterprises worldwide. However, the complete benefits of server virtualization cannot be realized without the associated network virtualization. Software-defined networks, or SDN technology, enables flexible virtualization of the network. LiquidIO provides a programmable solution and offloads SDN and network processing from the main server CPU, improving performance, and reducing latency. Customers can choose between single and dual 10-gigabit Ethernet ports, and deploy them in standard servers through compliant half-height PCI Express form-factor adapters. The out-of-the-box Software Development Kit, SDK, allows software, allows customer and partners to develop high performance SDN applications, with packet processing, tunneling, QoS, security and metering at line rates, while freeing up cycles on the main server CPU. So since it's an add-on solution for standard servers, time to revenue is faster than the traditional embedded market. In fact, we are starting production shipments of this product to a Tier-1 customer in Q3. Customer traction on this product has been excellent and we are in evaluation at multiple Tier-1 customers worldwide.

Additionally, in Q2, we delivered a multi-mode 3G/4G reference design for small cells, which widens our serviceable market for our small cell product family. We also announced TurboSTOR, a complete production-ready software solution which runs on both the Vista and carrier-grade Linux, and is optimized for Network Attached Storage design running on Cavium's processors. TurboSTOR power systems provide exceptional data transfer performance, fully encrypted drives and support a wide range of client operating systems like Windows, Linux, iOS and Android. The solution includes Cavium processors, Vista OS and complete application software, and highlights our continuing strategy of delivering complete solutions to market. TurboSTOR is in deployment on Cavium processors in Tier-1 NAS systems today.

In the recent quarter, we also highlighted our products and solutions at a number of trade shows and conferences, including Interop in May, and Computex in June. We also continued to build out our partner ecosystem for our products, with announcements with partners like [indiscernible] for SDN, Amazon Networks and Cosmos for DPI.

Now I'd like to move on and give a quick update on Project Thunder. We continue to expect -- to execute very well on our silicon and software developments. We have made significant feature enhancements to our SDK, for features such as virtualization. The SDK has been delivered to a number of ecosystem partners and Tier-1 customers, who are using it for OS and application software development. Customer traction has been excellent for our Thunder family of products, and they see a high level of differentiation in capabilities and features compared to the competition. We already are working very closely with a few Tier-1 customers who are planning to develop Thunder-based systems, and have allocated R&D resources on their end towards this effort.

Now I would like to move on and give a brief outlook on our served end markets for Q3. For Q3, we expect to see the overall macro environment similar to the first half of 2013. However, we expect continued trends on newer product cycles to help us deliver another sequential growth quarter for us in Q3. We expect our core Enterprise and Data Center and service provider markets to be the driver for growth, with strength in infrastructure and customer-specific ramps in the Enterprise and Data Center markets. We expect our broadband and consumer business to be flat to up in Q3. Overall, we are very encouraged by the accelerating Mega Trends in our served markets.

The growth of mobile smartphone and tablet platforms, and the increasing adoption of 3G/4G as a last-mile delivery medium, will continue to drive the need for significant upgrades to the wireless infrastructure from small cells to base stations to the mobile core. The growing trend of ubiquitous network connectivity from the Enterprise to the home, to the Internet of Things, will put strains in the network infrastructure by driving substantial annual increases in the volume of data that needs to be processed, with line rates increasing from 10 GB to 40 GB and onto 100 GB.

The third Mega Trend we see is the rapid ramp of the cloud infrastructure, driven by CPU virtualization and network virtualization to derive off SDN technology. This is driving the need for highly-networked, power- and cost-efficient and extremely dense Data Center processors will deliver dramatically improved performance per watt.

And finally, security is becoming an over arching critical requirement across all the major Mega Trends, and driving the need for low-compromise, intelligent Layer 2 to Layer 7 security, while maintaining the increasing line rates from 10 GB to 40 GB to 100 GB. All these major Mega Trends map very well to Cavium's technology, IP portfolio and core competencies, which should help drive growth over the coming years.

On that note, I would now like to turn the call over to Art Chadwick, who will provide a detailed discussion of Q2 financial results and guidance for Q3. And after that, we'll be happy take your questions. Art?

Arthur D. Chadwick

Great. Thanks, Syed, and thanks to all of you for joining us today. I'll first go through Q2 fiscal highlights and then, provide guidance for the third quarter of 2013. As Syed mentioned, Q2 was another excellent quarter for us. We had strong sequential revenue growth with expanding non-GAAP growth and operating margins, strong non-GAAP EPS growth and very positive cash flow. Revenue in the second quarter was $74.2 million, up 7% sequentially and up 34% year-over-year. This was an all-time record revenue per quarter for the company.

Sales into the Enterprise and service provider markets were $63.0 million or 85% of total sales, up 8% sequentially. Sales into broadband and consumer were $11.2 million or 15% of sales, down 1% sequentially. Cisco was our only customer with sales greater than 10%. Sales to Cisco were $13.2 million or 18% of sales, essentially flat with last quarter.

Non-GAAP gross margins were 65.8%, a record high for the company. This was a 40 basis points sequential gross margin expansion over Q1, due to product cost reductions and favorable product mix. Now over the last few quarters, we've taken a number of actions to reduce R&D and marketing investments in some of our lower-return consumer products and noncore software and services business, in order to redeploy those resources and focus on our core Enterprise, Data Center and service provider markets.

Restructuring actions that we have taken includes discontinuance of a range of consumer products, including ECONA, and the discontinuance of additional consumer products this year for applications such as video conferencing and surveillance.

We have discontinued the MontaVista auto business and other noncore consumer software and services business.

We have consolidated our R&D software development centers in India from 4 centers into 2, and we closed our Taiwan R&D consumer product design center. And I'd like to point out that we have continued to post strong sequential revenue growth in spite of the headwind caused by our exits from those consumer businesses.

In Q2, we took a $3.9 million onetime inventory charge for discontinued consumer products, and a $1.25 million charge to cover potential, final contractual obligations related to our discontinued MontaVista auto business.

Our restructuring actions have reduced operating expenses, which we have back-filled with new headcount in our core engineering groups. As a result, total non-GAAP Q2 operating expenses were $35.0 million, just a 2% sequential increase over Q1. Non-GAAP R&D expenses were $23.8 million, and non-GAAP SG&A expenses were $11.2 million.

Non-GAAP Q2 operating income was $13.9 million, an increase from $11.1 million in Q1 due to the higher sales, expanded gross margin and operating expense leverage. This was a 25% sequential increase in non-GAAP operating income.

Operating margins were 18.7%, which was a 270 sequential basis point increase over Q1.

Income tax expense for the quarter was $677,000 or approximately 5% of non-GAAP income. The net GAAP loss for the quarter was $4.3 million or $0.08 per share. The non-GAAP net income was $12.6 million or $0.23 per share, up from $10.2 million or $0.19 per share in Q1. Non-GAAP result excludes $16.9 million in non-GAAP adjustments, which includes stock-based compensation expenses, amortization of acquired intangible asset, the discontinued consumer inventory charge, the charge related to our discontinued MontaVista Auto Business and other expenses as detailed in our reconciliation between our GAAP and non-GAAP results as reported in the press release.

We ended the quarter with $97.6 million in cash and equivalents, an increase of $11.1 million during the quarter. Net cash, well, provided by operating activity during the quarter, was $11.8 million.

Inventory at the end of the quarter was $39.6 million, a $1.8 million decrease from Q1. And accounts receivables were $44.7 million, which equates to DSOs of 55 days, up from 47 days in Q1.

I would now like to provide some more specific guidance for the third quarter of 2013. We expect continued sequential revenue growth in Q3. Sales in the third quarter should increase to between $77.5 million and $80 million, which at the midpoint, would drive sequential revenue growth of approximately 6%.

Non-GAAP gross margins are expected to be between 65.5% and 65.8%. Non-GAAP operating expenses are expected to increase between 2% and 4% sequentially, which at the midpoint, would be approximately $36.1 million.

Interest and other nonoperating expenses will be approximately $600,000. Q3 income taxes are expected to be between 3% and 5% of non-GAAP income, and taxes in 2014 are expected to be between 8% and 10% of non-GAAP income.

The Q3 non-GAAP share count is expected to be approximately 55 million shares. Non-GAAP Q3 income will exclude approximately $9 million in stock-based compensation expense and $3 million in amortization of acquired intangible assets and other items. So given those assumptions, we expect non-GAAP EPS to be between $0.26 per share and $0.27 per share in Q3.

And on that note, I'd like to hand the call back to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Blayne Curtis.

Blayne Curtis - Barclays Capital, Research Division

Syed, if you can just talk about -- I think you mentioned, in the back half of the year, you expected the overall demand to be kind of like the first. Is that implying that you expect more of a tempered environment and then, you seem to be obviously having some company-specific ramps. Can you talk about, if service providers were the strongest in Q2, is that where you're seeing the growth into Q3? If you could just give us some color as to what's the driver for the net growth into September.

Syed B. Ali

So Blayne, my comments on the Q3 environment relates to Q3 and not to Q4. So it is for one specific quarter only, and not for the back half in general. So having said that, overall, I think you've seen from many of our peers that the macro has not really dramatically been improved over the past few quarters. However, we do have several product ramps, both in the infrastructure side, like I talked in the prepared comments, in the wired and wireless side, and also in the Enterprise and Data Center side. So our product cycles are driving good sequential growth on a quarter-by-quarter basis. And obviously, if the macro improves, and as some of the larger infrastructure builds start coming online, that should help increase those growth rates further.

Blayne Curtis - Barclays Capital, Research Division

And then, it looks like Cisco was flat in the quarter. You were able to grow despite that. If you could just -- some thoughts on -- I know you have a ramp there. Is that still proceeding and kind of just your thoughts on the structure of that business for you?

Syed B. Ali

Yes, Blayne. Cisco, we are in hubs. So essentially, they have their own cadences of pull from the hub. So if you look at Q1, we had I think something like a double-digit sequential growth. This quarter was flat. But overall, in any given quarter, based upon what the production builds of the various platforms are, it can vary up and down. But definitely, because of the newer products design wins going into production, we'll definitely see growth for Cisco over the next few quarters.

Blayne Curtis - Barclays Capital, Research Division

Finally, if you could just talk about NEURON that you, in the last call, talked about getting the design win. How is that proceeding and are you still thinking about revenue late next year?

Syed B. Ali

Regarding NEURON, yes. We have had now a few design wins for that particular product and they are spread out over a few companies now. So overall, we expect our first revenues from this particular product line in Canada, back half of '14.

Operator

Our next question comes from the line of Anil Doradla.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

A couple of questions. Syed, can you talk about visibility? I mean, how does business looks like and if you could parse it by geography, that would be helpful. Then, I have a follow-up.

Syed B. Ali

We think that starting from the beginning of the year, visibility has improved. And we are finding our customers are willing to give us, at least, longer-term outlooks than they were before. So overall, it is, for our end customers and the product cycles we are in that are driving growth, a much higher visibility environment.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

And recently, Broadcom on their other earnings call were pretty bullish about their 20-core 8 bit [ph] processor, which they are talking about getting some design wins and getting good traction. Not sure whether you could specifically talk of any competitor, but can you share with us what's going on in the competitive landscape?

Syed B. Ali

Like I mentioned in the prepared comments, Anil, our design win rates were the highest in our history last quarter, we have a phenomenal pipeline of products, and again, we attribute this to a couple of things. One thing, obviously, is we have more products in our bag to win designs, number one. But number two, we feel that we are becoming increasingly competitive in this market, instead of kind of going the other way. So we are very confident about our products, their capabilities, their features, their competitiveness. So having said that, obviously, we are in a very competitive environment and we compete with some of the biggest companies out there. But as we've shown over the past few years, that we have been able to compete to not only stand our ground, but to increase our market share in our core markets. So we feel pretty confident about our abilities.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Great. And quickly on China, you know China seems to be worsening. With respect to your design wins and your traction, can you put it in a context of Cavium and its business?

Syed B. Ali

Overall, China at the end of last year was pretty challenging, but again, this is more product-specific for Cavium. We have seen an improvement in China from the beginning of this year moving on to Q3. And again, it is more dependent or more a statement on the product cycles we have than a statement on the macro in China as a whole.

Operator

Our next question comes from the line of Sundeep Bajikar.

Sundeep Bajikar - Jefferies LLC, Research Division

Question about SDN. So your largest competitor, Intel, is clearly getting more aggressive in this software design networking space. From your standpoint, what is the easiest way for us to differentiate Cavium's capabilities from the virtualization story that Intel is telling?

Syed B. Ali

No, I think, for cloud data centers for a certain class of networking equipment, both core virtualization and network visualization is definitely one of the major Mega Trends. And as you can see through the portfolio of products that we have brought to market now over the past year or so that we have a pretty nice IP portfolio and core competency in these areas. So essentially, we believe that we have the pieces required, number one. Number two, that we understand the deployment models for this pretty nicely. And third, as you see our products rolling out over the next whatever, 6 to 9 months, I think this core competency and this IP capability will be brought out very succinctly.

Sundeep Bajikar - Jefferies LLC, Research Division

Okay, great. And if I could follow up on the software side of things, is there a framework that you can share for us to think about the importance of software capabilities in terms of the value that your customers place on the software solution? Perhaps, in terms of the overall price that they pay for a router or even Dell server.

Syed B. Ali

Yes, software is probably the single most, not probably, it is the single most important piece of any solution. And the value that is attached to it is pretty substantially high. Reading some of the research reports today, the development of the hardware takes roughly about 20-plus percent of the total R&D development cost, whereas, software is 80% of the cost. One of the things that Cavium has done very well and has differentiated pretty nicely from many of the competitors is ground software capability, everything from kind of operating systems to drivers to application software. And also, we put together a very, very nice set of tools and a very robust ecosystem to go along with it. So this is a very differentiated capability and frankly, we think that this is one of the reasons why we are starting to see increased design win rates across our addressed markets.

Sundeep Bajikar - Jefferies LLC, Research Division

Great. The last one for me on the same line. Is it good to say that Cavium's already capturing a substantial portion of the network virtualization market through the network adapters that you have already deployed even before LiquidIO?

Syed B. Ali

No, I wouldn't say network virtualization, but obviously, we have a share in the networking market. Network virtualization is a brand-new functionality, if you will, and it is starting to get deployed. And the first, kind of, targeted product for that is the LiquidIO. But capabilities and features that are required for network virtualization will be seen in products that we bring to market over the coming quarters.

Operator

Our next question comes from the line of Quinn Bolton.

Quinn Bolton - Needham & Company, LLC, Research Division

Syed, now that you've got some customers dedicating resources to Project Thunder, are you in a position where you may be able to share some types of applications that you're seeing Project Thunder being used in?

Syed B. Ali

Yes, I can do that, but the applications typically are more classical, I would say, Data Center and cloud type applications. That is all the initial customers that -- are working with us on. I wouldn't like to go into specifics for competitive reasons, but the customer traction, as I've said in the prepared comments, has been very, very excellent. And as we bring this product to market, we believe that this will be a very highly differentiated and a very compelling product for the addressed markets.

Quinn Bolton - Needham & Company, LLC, Research Division

And just a follow-up on that, are the applications you're seeing Thunder being designed that, that can be a range of price points and volumes that you can target with the product family?

Syed B. Ali

That is correct. Project Thunder is not a point solution. Project Thunder is a family of products with a focus on different sections, if you will, of the cloud market. So there will be a range of price points, a range of performance points and a range of feature points across the family. So it's a very extensive family. It's not a single one-chip point solution.

Quinn Bolton - Needham & Company, LLC, Research Division

Great. And then, just lastly, looking at the China wireless infrastructure market to the extent that, that TD-LTE infrastructure starts to build late this year, into next year. Can you remind us what kind of content you have in TD-LTE base stations that could be used in that buildout?

Syed B. Ali

Cavium's OCTEON processors have been designed into everything from kind of base stations to kind of EPC part of the equation. So regarding that specific China Mobile deployment that you talked about, it has been publicly announced now that, I think, there are 6 or 7 vendors who have quoted on this. We haven't seen any press on what the percentage allocations of the deployment is, and what the schedule of deployments on the chosen vendors are. So having said that, we do have a customer who has talked about this particular deployment and has put some incremental backlog for us for Q4. So there's still a lot of unknowns in terms of who will get what, and obviously, all of them are not going to be deployed at the same time starting from Day 1. So as this plays out, I think over the next few months, our visibility will improve. Regarding our content, our content varies all over the place based upon the specific vendor and the specific platform, obviously, it varies quite a lot. So EPCs, it's higher; base stations, it's lower. In some base stations, we have more expandability capabilities. So the average amount of dollars could be higher. So it's a complete range of ASPs that we expect from wireless infrastructure products.

Operator

Our next question comes from the line of Harlan Sur.

Harlan Sur - JP Morgan Chase & Co, Research Division

I think somebody had a previous question on visibility. Clearly, seems as if book-to-bill was greater than 1 or above 1, actually, in Q2. I know it's early, but can you just talk at a high level about order rates, thus far, here in Q3? Has the order momentum continued to remain constructive here in July? Has backlog continued to grow? And any color on particular segments you're seeing order strength or weakness?

Syed B. Ali

As I've said in my prepared comments, we have a number of top product cycles that I've got driving growth for us. And the book-to-bill was definitely over 1. Otherwise, it would be a little bit difficult to drive sequential growth in a quarter-by-quarter basis. And again, I think one of the points that I have been making in earnings calls, and in investor conferences over the past year is, we have a very nicely diversified our customer base across end markets, across small, medium and large customers, across new and old customers. So overall, when you have a bigger customer base, that tends to help improve visibility, number one. And number two, if any given -- if any given customer is a little bit weak in the quarter, there are some other customers that are stronger in the quarter that can take up the slack. So it not only drives better visibility, it also drives stability in backlog for us.

Harlan Sur - JP Morgan Chase & Co, Research Division

Yes. Absolutely. And speaking of diversification, the team has done a great job of diversifying the customer base. Looking out over the next 1 to 2 quarters, obviously, outside of Cisco, do you expect any of your other customers will grow to become 10% or more of your revenues? And will this customer or customers be more service provider or Enterprise-focused, do you think?

Syed B. Ali

The short answer to that, Harlan, is yes. We do have customers now who are in the kind of the 5% to 10% range. And I would say, 75% of them are probably in the service provider space and there's one other customer in the Enterprises space who are kind of getting up into the higher single-digits right now.

Harlan Sur - JP Morgan Chase & Co, Research Division

Got it. And then, my last question, with the rollout of OCTEON III, the team is sort of taking somewhat of a new strategy here, right, which kind of increases your market opportunity. You're obviously going to roll out your high-end 48-core product, but you're also going to roll out some small core comp products targeted for low-end applications. And I think as you mentioned, this has really not been a focus area for Cavium, like dual core, 4-core segment of the market. However, it is a sizable market opportunity, I think, and time-to-market for these customers is relatively faster. So what are going to be the key differentiators for these low-end products relative to the incumbents in this segments? How would you size the market opportunity for these low-core comp processors? And Syed, when do you expect to start to sample these products to your customer base?

Syed B. Ali

Yes, as I've said in the prepared remarks, this is the first time in the 28-nanometer generation that we have really optimized the product for the kind of the 2-core, 4-core, Control Plane and other similar type of applications that I talked about in my prepared comments. So this market is a fairly significant market. There are incumbents out there who sell over $0.5 billion worth of product into the space. So this is a pretty large market. In previous times, we had really optimized the products for mid- and high-range, and we did have a kind of 4-core product, obviously, but it wasn't the most efficient for that lower end. So with the OCTEON III, what we have done is we've kind of chosen the 2 bookmarks, we've optimized the 48-core, obviously, for the highest performance possible, and then, we optimized the low-end for the best performance per watt and the best power consumption and very, very attractive cost structure and price points. So having done these 2, then, we'll come in and address the mid-range. So another kind of comment that I'd like to give out is our 68XX OCTEON II product, our 32-core product, it’s still the -- a CoreMark champ, if you will. CoreMark is one of the key benchmarks that are associated with the networking and communications despite a lot of competitors' 28-nanometer products coming to market. So when you look at that, when we bring out our 28-nanometer product, we're very competitive with our OCTEON II and the 28, once we are in the same playing field, which is happening as we are speaking, we believe that our competitiveness will increase much more dramatically.

Operator

Our next question comes from the line of Kevin Cassidy.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Along those lines, I was just wondering what -- as far as your volume of products that are shipping today, what process node are they on versus the 28-nanometer? And when do you expect any crossover?

Syed B. Ali

Kevin, the design cycles and the product cycles of our products are very, very long. So actually, more than 2/3 of our production, I think, 60%, 70% of our production, still, is in lagging EDGE nodes. And then, the 65-nanometer product is roughly 20% to 25% of it. So there's a long train to go for our -- even our OCTEON II design wins to ramp into full production.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Great, that's what I thought. And if we go back to the 3G/4G discussion, is your content increasing as you go to 4G versus 3G?

Syed B. Ali

In the designs that we are in, for example, definitely, the amount of horsepower needed is higher on the 4G systems than on 3G. There's no doubt about that. So the content is higher for 4G compared to 3G.

Operator

Our next question comes from the line of Brian Modoff.

Brian T. Modoff - Deutsche Bank AG, Research Division

A question for you, Syed, on demand trends you're seeing in the second half. If you could give us any granularity or color in terms of specific product platforms and market segments, use cases heading into the back half?

Syed B. Ali

I have alluded to them in the prepared comments, but just to kind of go over it in maybe a little bit more detail, definitely on the Enterprise side, we have things like switches, Enterprise routers and the like there. On the Data Center, we have obviously, the cellular balancers, products from companies like F5 and Citrix, for example. And also, some of the -- our first LiquidIO adapter customer. And then, in the infrastructure, on the wireless side, obviously, 3G/4G across a wide range of geographies. And even on the wired side, where -- in the previous generation, we really didn't have much of an organization and with the OCTEON II, we really drove our penetration into the wired infrastructure, things like EDGE routers, cable head-ends, transport equipment and the like. So again, there's not just one piece. You have either customer-specific growth or market-specific growth that is driving our sequential growth.

Brian T. Modoff - Deutsche Bank AG, Research Division

And a quick follow up, Syed, for the benefit of everyone. On the Fusion chip, 3G and 4G small cells your parts and when would you ramp into 3G small cells and into 4G small cells? Would it be heading into the December quarter or is it really next calendar year?

Syed B. Ali

I think the first deployment this year has been primarily 4G if you kind of take a look at -- if you take a look at who's really deployed it in any volume, has been 4G-only. I think you'll start seeing some mixed mode, probably, by the second half of next year. But 4G will continue in the existing geographies and from new geographies over the next few quarters.

Operator

Our next question comes from the line of Ruben Roy.

Ruben Roy - Mizuho Securities USA Inc., Research Division

Art, I just had a question for you on OpEx. I'm wondering, as you take some of these not restructuring but these efforts and put them into place, is this sort of a level of OpEx as a percentage of revenue that you're comfortable with or how are you looking at that if you look out into 2014? Are there significant tape-outs coming at some point or other initiatives that you're going to take?

Arthur D. Chadwick

Sure, good question. So let me start with the tape-outs. We actually -- and as we've talked about before, capitalized our mass cost, amortized them pretty quickly over a 12-month period, and that goes through cost of sales. So tape-outs never hit OpEx. But to answer your OpEx question, as I mentioned, we've done, I think, a very good job of redeploying a lot of our R&D dollars that were in some of these lower-return consumer products towards our core engineering. We've actually hired a lot of folks to work on our core products: OCTEON III, our Thunder, our NEURON, our Fusion products, without a very significant increase in overall OpEx. It went up 2% sequentially from Q1 to Q2. If you go back a few quarters, we've been keeping it to the very low-digit increase. I think going forward, the way to think about it is, our plan is to manage OpEx growth to about half of our top line growth. So for example in Q3, the midpoint of our top line growth was 6% and the midpoint of our OpEx growth was 3%, because I guided OpEx up 2%. So I think that's a good way to think about it, certainly, for the next number of quarters.

Syed B. Ali

And again, Ruben, I think if you take a look at the history over the last few years, we have done that and better in most quarters in terms of OpEx growth as a percentage of the top line growth. I think the only difference there is, in Q1 of any given year, you have the focal increases, which tend to put that a little bit out of whack. But for Q2, Q3, Q4 of every year, we've been able to do 50% or even 30% on a quarter-by-quarter basis compared to the top line.

Arthur D. Chadwick

Yes, and I'll add to that just a little bit. Q1 is the one quarter where, even though you didn't see it this last quarter because we had our restructuring efforts, in future Q1s, it's likely -- and in the next Q1 is likely that OpEx to go up, probably, a couple of million dollars, again, because we've got beginning-of-the-year employee raises that go into effect, beginning-of-the-year taxes that go into effect. So of all quarters, Q1 is the one where you have probably a higher step-up than any other quarter, and I wanted to make that clear just when people are modeling Q1 of 2014.

Syed B. Ali

I think another comment though is, I think, again when you take a look at year-over-year OpEx, we should be under that 50% bogey number.

Ruben Roy - Mizuho Securities USA Inc., Research Division

Okay. That's really helpful, guys. And Syed, quickly on the OCTEON III, you mentioned entry-level as the products coming out now. When I look at some of your competitors, they come to market with 28-nanometer technology that they are, at least, indicating is at the high end of the market. Can you just maybe talk about your thinking on sort of the way you expect these 28-nanometers to flow into the market, starting at entry-level and moving up from there? What is your sense of timing? Is the market not really ready for what you need to offer at the high level because your OCTEON II can do some of that stuff today? Or how are you thinking about the way the roadmap evolves for OCTEON III?

Syed B. Ali

Yes, at the high end again, our 68XX does very well compared to our 32-core 68XX that we've been shipping for a while now. It does very well compared to a lot of the more advanced processors, at more advanced nodes that have come to market. So eventually, you will see kind of a range of products coming out, and each new product will come out every few months. So that over the next kind 6, 7, 8 months, the whole product line will be complete.

Operator

Our next question comes from the line of Sanjay Chaurasia.

Sanjay Chaurasia - Nomura Securities Co. Ltd., Research Division

I have a question on the base station market. One of your competitors recently indicated that they see their share going from 15% to 40% over the next few years. I was just wondering if you could provide any update here as regards to your positioning in this market, and if anything has changed here?

Syed B. Ali

Sanjay, if you take a look at it, we -- I think the customers that we kind of shipping to are known. So I think with that, you can estimate what our percentage share of the market is. So our customer -- I mean, there will be competitors who will claim this or that, but at the end of the day, I think what really matters is what you are shipping today and how long these designs will remain in production. So we feel very confident, and again, the wireless infrastructure, if you look at it over the past year, has been a very strong growth driver for us, and we expect that to remain for the next year or 2 years at least.

Sanjay Chaurasia - Nomura Securities Co. Ltd., Research Division

Okay. And as a follow up, Cisco recently acquired this company, security company, Sunfire (sic) [Sourcefire]. Just wondering if you have any thoughts around that and how this could play out for you.

Syed B. Ali

I think Sourcefire is the name I think that you're looking for. But yes, so Sourcefire is the company that kind of really invented Snort, and put that out into the open source community, and develops kind of best-of-breed IPS, IDS type of products. So essentially, this will be a product that will be added on into Cisco's portfolio. And we don't see any dramatic changes coming up due to this.

Operator

[Operator Instructions] And I'm showing no further questions at this time. Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation. And if you would like to listen to a replay of today's call, you may do so by dialing (303) 590-3030 or 1 (800) 406-7325, with access code 4628662. Thank you for your participation. You may now disconnect.

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