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Executives

Angel Atondo - Marketing Communications Manager

Syed Ali - President and CEO

Art Chadwick -VP and CFO

Analysts

Sanjay Devgan - Morgan Stanley

Tim Luke - Barclays Capital

Quinn Bolton - Needham and Company

Hans Mosesmann - Raymond James

Arnab Chanda - Roth Capital

Dan Morris - Oppenheimer

Kevin Cassidy - Thomas Weisel Partners

Sandy Harrison - Signal Hill

Anil Doradla - William Blair

Gary Mobley - Noble Financial Group

Christian Schwab - Craig Hallum Capital Group

Alex Gauna - JMP Securities

Colin Denman - D.A. Davidson

Allan Mishan - Brigantine Advisors

Cavium Networks, Inc (CAVM) Q3 2009 Earnings Call October 27, 2009 5:00 PM ET

Operator

Welcome to the Cavium Networks Q3 Earnings Call. (Operator instructions)

I would now like to turn the conference over to our host, Angel Atondo, Marketing Communications Manager.

Angel Atondo

Good afternoon, everyone. Welcome to Cavium Networks' third quarter 2009 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 purpose of the Safe Harbor Provisions under the Private Securities Litigation Reform Act.

These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our most recent Form 10-K and Form 10-Q filed with the SEC, in particular to the section entitled Risk 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 obligations to update these forward-looking statements.

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

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

I will now turn over the call to Cavium's Syed Ali.

Syed Ali

Thanks, Angel. And thanks to everyone for joining us today. In brief, Cavium's third quarter revenue was $25.9 million, which represents a 14% sequential increase, and a 6% year-over-year growth. Non-GAAP gross margins grew 370 basis points quarter-over-quarter, and came in at 55.7%, which resulted in a non-GAAP net income of approximately $0.8 million or $0.02 per share.

Our GAAP loss for the quarter was $4.2 million or $0.10 per share. During the quarter, we also generated a healthy cash flow. Art will provide more details on the Q3 financial results and Q4 guidance shortly.

I will now move on to give you a breakdown of our Q3 revenues, along with the general update on the demand environment. I will discuss design wins and new customer and partner relationships.

Q3 was our second quarter in a row this year of strong double-digit sequential topline growth. In our last conference call, we had mentioned that unlike our growth in the first half of calendar year 2009, which was primarily driven by sales into the broadband and consumer segment that we expected our growth in the second half of calendar year 2009 to be driven strongly by sales into the enterprise and datacenter segments.

This is now happening in a way which is even more robust than our expectations. This quarter, the enterprise and datacenter segment was up from 43% of sales in Q2 of 2009, to 51% of total revenues and grew 34% quarter-over-quarter. Growth in this segment was driven by several new product ramps and to a smaller extent a continuing recovery in the run rate business.

The securities segment, which was very soft in the first half, also had a strong rebound in the third quarter. The remaining segments, including consumer broadband, access service provider, and software and services segment combined for 49% of sales, and declined 2% quarter-over-quarter.

The broadband and consumer segment was the second largest segment and came in at 36% of revenues, and declined 6% quarter-over-quarter. Our top customer in Q3 was once again Cisco Systems, which came in at 26% of sales and grew 61% quarter-over-quarter. The other two 10% customers were Actiontec for Verizon, and Sumitomo Electric for NTT, which were 11% and 10% respectively, both of which were down due to softness in fiber to the home deployments in Q3.

Other customers who had excellent sequential growth include, Citrix, Juniper, F5, Huawei and SonicWall, all of which are starting new product cycles that use our processors.

Now, I would like to move on and talk about the business and booking trends that we have seen in Q3. Q3 was a record bookings quarter again. Book-to-bill was once again well in excess of one. Additionally, the booking trends were very linear right through the quarter.

In Q4 we expect revenues will continue to be driven by new product ramps, as well as a continued in the run rate business. We expect continued strength in the enterprise and datacenter segment, driven by increasing sales to our top enterprise customers including Cisco, Juniper, Citrix, F5 and Brocade.

The access and service-provider segment should also now start seeing healthy growth, driven by Tier 1 customers rolling out new Edge and Access routers and switches, and wireless infrastructure, such as Huawei, Alcatel-Lucent, and Nokia-Siemens, along with a range of ATCA, AMC system manufacturers, such as RadiSys, Kontron, GE and Emerson.

I would also like to point out that in this ATCA AMC space, which has finally started to ramp, we have built an extremely strong position amongst pretty much all the major suppliers as the processor of choice for Layer 3 to Layer 7 data and security applications.

In the broadband and consumer segment, we expect our revenues in the fiber to the home segment to be soft again in this quarter, and we have factored that into our Q4 guidance. On the flip side, we expect nice growth from our PureVu line of video processors, which for the first time should contribute over $1 million in revenue for the quarter.

Additionally, our ARM based ECONA processor line is also showing excellent growth, albeit off a small revenue base as the first design wins of the existing products post the Star Semiconductor acquisition go to production.

Now, I would like to add a quick comment about our PureVu line of video processors. Our solutions have started to ship into video conferencing, embedded applications, and wireless high definition delivery boxes for Asian Tier 2, Tier 3 customers. We expect to see a nice revenue ramp in these applications starting this quarter.

In addition, we are in various stages of evaluation at major Tier 1 CE device manufacturers for TV, set-top box, notebook, and standalone dongle applications. The feedback that we have received so far on video quality and reliability has been very positive.

We will also be announcing a highly integrated and cost reduced solution for this specific application this quarter, which will meet all the feature, footprint, cost and power needs of these very high volume applications. We believe that this solution will significantly accelerate the wireless display market. Many of the major Tier 1 CE vendors that are evaluating our current solution have worked closely with us, and have played a significant role in defining and fine tuning this product so that it fits in very efficiently with their architecture.

Now, I would like to move and give an update on design wins in Q3. During the quarter, we further increased the total number of quarterly design wins at an extensive set of Tier 1 OEMs. Our relatively new ECONA and PureVu lines also contributed a meaningful portion to new wins this quarter.

Design wins are spread across all four target segments, and across low to high price and performance points. New design wins were approximately evenly distributed across enterprise, datacenter, service provider, and broadband consumer segments. We closed multiple new design wins at a number of our Tier 1 customers, including Cisco, Alcatel-Lucent, Huawei, Ericsson, ZTE, BigBand, Aruba, Ciena, Ixia, RadiSys, Kontron, GE, Sumitomo, Avision and (inaudible).

In the enterprise and datacenter segment we won new designs in SME routers, security and XML appliances, WAN optimization gateways, test and measurement equipment, enterprise access points, DNS gateways and military systems.

In the access and service provider segments we won significant new designs in utility routers, services cards, Edge QAM, service provider line card control plane, ATCA, AMC, and NIC cards, and cellular aggregation systems.

In the broadband and consumer segment we won new designs in fiber to the home broadband, and SMB routers and switches, and for (inaudible) wireless HD delivery at smaller Tier 2, Tier 3 customers.

Our recently announced products are gaining significant traction in the market. Our flagship OCTEON II line is seeing tremendous amounts of interest in all our target markets and has started getting significant design wins. Our overall pipeline of potential new design wins spans all of our product lines and remains extremely strong.

Now moving on and talking about the new products that we announced in the past quarter. In September, we introduced the ECONA CNS3XXX family of highly integrated system-on-a-chip processors. These processors feature up to two ARM11 CPU cores, at up to 700 megahertz, a rich set of over 10 hardware accelerators, several of which are leveraged from our OCTEON and NITROX lines, and a range of I/Os for seamless voice, video and data connectivity.

Sophisticated power management techniques enables super lows power operation, starting at less than 1 watt. The ECONA CNS3XXX family is targeted for applications in the digital home, including fiber to the home broadband gateways, CE devices, NAS appliances, media and print servers, IP cameras, and wireless access points.

Then current with our ECONA product introduction we announced that one of our major customers, Sumitomo has selected ECONA processors for use in their next generation fiber to the home gateway to achieve lower bill of materials cost, significantly lower power consumption and increased CPU headroom. The new ECONA processors increased our addressable stamp significantly, while at the same time delivering an optimized cost structure for us, which will help improve our gross margins in the broadband segment.

During the quarter, we also sampled the NITROX Deep Packet Inspection Layer 7 content processors, and completed evaluations at some major Tier 1 OEMs worldwide. The NITROX DPI processors offer 4 gigabits to 20 gigabits of deterministic performance, with low latency and support for an unlimited number of pattern rule-sets and flows.

Initial results from the OEM evaluations have validated that the NITROX DPI processors are significantly superior to existing solutions in several critical metrics, such as deterministic and high performance regardless of number of flows and patterns being examined, as well as the compactness of the pattern memory required.

We also continue to make excellent progress towards delivering our next generation OCTEON II and PureVu products to market. We also had several relationship announcements during the quarter.

At the time of our CNS3XXX processor system-on-a-chip announcement several key ecosystem partners highlighted support for ECONA, this include Tuxera with its next generation drivers for storage applications, TeamF1's comprehensive turnkey SMB VPN/Firewall gateway and Wi-Fi Access Point Software on ECONA processors for digital home applications, D2 Technologies with their voice over IP solutions. Entropic's third-generation MoCA 1.1 compliant solution, which when fed with our ECONA processors delivers feature-rich, high- performance, next generation fiber to the home gateways, with greatly reduced cost and power.

Wind River software platform optimized for the ECONA processor line, this will target connected broadband home and small office customer premises equipment that deliver dynamic IP centric services and support high definition video and audio, Internet telephony, remote configuration, monitoring and home automation.

We also announced a number of customer and ecosystem partner relationships using our OCTEON, NITROX, PureVU products.

SoftAtHome's turnkey solution for high-performance gateways was announced in the quarter, as well as, Aricent's LTE evolved Packet Core Solutions for OCTEON II products. GE Fanuc's OCTEON based AMC and NIC form-factor solutions for military and aerospace customers. Enea's unique mulit-core, real time operating system for OCTEON, for designers of 3G and 4G wireless infrastructure.

Xyratex's OCTEON plus Intelligent I/O controller for an industry standard storage bay reference platform. Hitachi's deployment of NITROX PX Security Adapters in their server product line. MontaVista's carrier grade OS solutions for next generation LTE and WiMAX 4G wireless networks.

And finally Broadcast Sports, Inc. deployment of Cavium's PureVu processors to enable corporate view at premier NASCAR, Indy 500, and other racing events nationwide.

To summarize, Q3 was indeed an extremely strong quarter on all metrics. Topline growth, gross margin expansion, design wins, and we also generated a positive non-GAAP net income. The leverage in our model will drive our superior topline growth to result in a nice expansion in our operating margins in the coming quarters.

We have a strong pipeline of new products coming to market over Q4 and Q1 2010, including the low power ARM based ECONA processors, the OCTEON II line and our next generation PureVu products. We believe that we are extremely well positioned as a company to deliver excellent topline and bottom line growth over the coming quarters.

On that note, I would now like to turn the call over to Art Chadwick, who will provide a detailed discussion on the Q3 financial results and guidance for Q4, and after that, we'll be happy to take your questions.

Art Chadwick

I'll first go through Q3 financial highlights and then provide some guidance for the fourth quarter. So as Syed mentioned, all key business metrics this quarter were very positive. We had record orders, a very strong book to bill ratio, 14% sequential sales growth, record quarterly revenue, positive cash flow, gross margin expansion, as well as a strong improvement to the bottom line, and in addition, we have record design wins across multiple Tier 1 customers and market segments.

Revenue in the third quarter was $25.9 million, which as Syed mentioned, was a 14% sequential increase over the second quarter, and 6% higher than the same quarter last year. Sales into the enterprise and datacenter markets accounted for 51% of total sales, and that was up from 43% in Q2, driven by strong sales into the Enterprise market including strong sales to Cisco.

Sales into the broadband and consumer market were 36% of total sales, down from 43% in Q2, due primarily to lower sales to Actiontec for Verizon and Sumitomo for NTT. Remaining 13% of sales went in to the access and service provider market and into software and services.

Cisco was again our largest customer this quarter, with sales increasing 61% sequentially. Sales to Cisco were $6.7 million or 26% of sales, up from 18% last quarter. Sales to Actiontec were $2.8 million or 11% of sales, down from 19% last quarter, and sales to Sumitomo were $2.5 million or 10% of sales, down from 13% last quarter. Sales to our top five customers accounted for 55% of total sales, compared to 56% last quarter.

As you know, in our press release, we announced both GAAP and non-GAAP results, and we ask that you please refer to our press release for the detailed reconciliation between GAAP and non-GAAP results.

We had good gross margin expansion this quarter. Non-GAAP gross margins were 55.7%, which was a 370 basis point improvement over Two quarter, due to a more favorable product mix, improved overhead absorption, as well as continued reductions in wafer assembly and test costs.

Non-GAAP operating expenses were $13.5 million. This was 5% higher than last quarter due primarily to increased R&D spending. Non-GAAP R&D expenses in Q3 were $8.3 million, up from $7.9 million last quarter. Non-GAAP SG&A expenses were $5.1 million, up from $4.9 million last quarter. We ended the quarter with 334 employees, an increase of 16 during the quarter. Non-GAAP operating income was $1 million, which was a substantial improvement over the $0.9 million loss last quarter.

The improved operating income was due to the higher sales, higher gross margins, and operating expenses that increased at less than half the rate of our sales growth. Net interest and other income was a net expense of $50,000 due to almost non-existent money market interest rates, and income tax expense was $167,000 for the quarter.

The GAAP loss for the quarter was $4.2 million, which is compared to $6.2 million in Q2. The non-GAAP net income was $0.8 million or $0.02 per share, and this was a $0.04 per share improvement over last quarter. The non-GAAP net income excludes $4.9 million in stock-based compensation, and acquisition-related expenses.

We had positive cash flow this quarter, and increased our cash balance by $4 million. We ended the quarter with more than $70 million in cash and equivalents, and no bank debt. The positive cash flow this quarter came from positive cash earnings, as well as a decrease in accounts receivable.

Accounts receivable were $11.7 million, down from $15.3 million last quarter, and DSOs in Q3 were 41 days, which was dramatically lower than DSOs of 60 days in Q2. This was due to good customer collections, as well as linear shipments during the quarter. However, DSOs of 41 days is unusually low, and we do expect them to increase somewhat in Q4.

Inventory at the end of the quarter was $18.3 million, an 11% increase over Q2, which is relatively consistent with the 14% sequential increase in sales.

I would now like to provide some guidance and how we see the fourth quarter. First of all, we are starting Q4 with record high backlog and excellent visibility and our turns requirement is lower than ever.

In Q4, we are expecting strong sequential sales growth, continued gross margin expansion, and improving operating margins as we take advantage of the leverage in our financial model. We currently expect that sales in Q4 will be between $29 million and $30 million, which would be a sequential growth rate of between 12% and 16% over Q3.

At the midpoint of this range, sales would be 33% higher than they were in the same quarter last year. The increased sales are expected to come primarily from higher sales into the enterprise and data-center market, including increased sales to Cisco, Juniper, Citrix, F5, Brocade and others.

This guidance also assumes that sales into the broadband and consumer market, specifically sales to Actiontec for Verizon, and Sumitomo for NTT will be down sequentially. We expect continued gross margin expansion due to continued improved product mix, continued material cost reductions and continued improvement in manufacturing overhead absorption.

Non-GAAP gross margins in Q4 are expected to be between 57% and 58%, which would be a 130 to 230 basis point sequential improvement over gross margins in Q3.

Non-GAAP operating expenses in Q4 are expected to increase somewhere between 5% and 7% sequentially, which would put non-GAAP OpEx at somewhere between $14.2 million, and $14.4 million. The increased spending is all focused on new product development.

Net interest and other income will essentially be zero in Q4 due to the extremely low interest income we're currently earning on money market funds. Income tax expense is expected to be approximately $250,000 in the fourth quarter.

In 2010 and longer term, we believe that our worldwide blended tax rate will be somewhere between 15% and 20% of non-GAAP income. So based on those assumptions, we expect that Q4, non-GAAP net income will be somewhere between $0.05 a share and $0.06 per share.

Our Q4 GAAP loss will also include approximately $4 million in stock, and acquisition based composition expense, and approximately $1 million in amortized, acquired, intangible assets. We expect that our non-GAAP share count will be approximately 46 million shares.

So in summary, our leading indicators are all very positive, and we are starting Q4 with record backlog and strong sales momentum. We expect to see good gross margin, and operating margin expansion in Q4 and beyond. We have recently introduced a number of significant new products across all four of our major product families, all of which are being very well received by our customers.

The increasing design win traction across multiple customers and markets continues to support our long-term growth plans. In addition, we have a solid balance sheet and no debt, which continues to give us a competitive advantage in the current market environment.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Sanjay Devgan with Morgan Stanley.

Sanjay Devgan - Morgan Stanley

Art and Syed, thanks so much for the call, and great job on the quarter. Just a couple of questions. I guess first off, I think on the last call you talked about the strength of the design-win pipeline, and I think you are running at about $25 million or something north of $25 million a quarter in terms of design-win dollars. I was wondering if you can tell us in Q3 were you kind of running at that same rate?

Syed Ali

Typically, I mean we've not really talked about absolute numbers in terms of design win dollars per quarter, but if you take a look at it over the past year to two years, that number on a quarterly basis has approximately doubled.

Sanjay Devgan - Morgan Stanley

Then Syed, I guess more kind of a question, as we talk about the multi-core market, I was wondering if you can remind us, as a percentage of your OCTEON processor sales I believe you said that north of 50%, and correct me if I'm wrong, came from multi-core. I was wondering, going forward the trend, how do you see that market evolving for, and when I say multi-core, I mean above four to eight cores, how do you see that market trending?

Can you talk about the competitive landscape? Any comments relating to some of these startups, like Tilera et cetera would be greatly appreciated?

Syed Ali

You are correct in the comment that you made, that more than 50% of our revenues come from four-core and above and actually more than 90% of our revenues in the OCTEON line come from two-core and above. So single-core designs are becoming indeed a rare breed.

We are seeing that even in lower-end applications, which used to use single core and dual core are very quickly moving to four-core and even eight-core devices. In fact, even in control plane applications, which used to be traditionally a single core market, we are getting designs now with four-core, eight-core, and even 12-core products for control plane applications. So, this is indeed a very, very nice trend that will increase the design win rates and attractiveness of Cavium's products.

Regarding the competitive landscape, it pretty much remains the same as it has been. The primary competitors include, Freescale is probably the single biggest competitor across our products, and Intel, NetLogic, RMI are there and then in the lower end obviously you have companies such as Marvell, Broadcom, AMCC, BMCC and alike.

Operator

Our next question comes from the line of Tim Luke with Barclays Capital.

Tim Luke - Barclays Capital

With your strong margin guidance, could you give us some flavor about how you are thinking about that going forward in terms of gross margins, what are some of the keys things to watch for 2010, and what do you think some of the parameters are for where you think that may go to? Syed, just on the revenue side, having guided up 12 to 16, as you begin to embark on 2010, do you think that you'll see some moderation in the rates of growth in the March period seasonally or what sort of things should we be thinking about? Thanks.

Art Chadwick

So, Tim, thanks for the question. So in terms of gross margins, you are right, we had very strong gross margin expansion in the quarter and the things that drove our gross margin expansion in Q3 is going to continue to drive it in Q4 and into 2010, and those things are basically improved product mix, continued material cost reductions, that's reductions in our wafer cost, assembly cost, and costs to test our products, and lastly, continued improvement in our manufacturing overhead absorption.

So, all those things helped in Q3. They are all going to help drive better margins in Q4 and the same going into 2010. So, our longer term model has always been that our gross margins would be somewhere in the low 60s, and we still believe that's an appropriate long-term kind of gross margin expectation. So, we're not quite there yet, but we're on a pretty strong curve getting there. In terms of the sales growth, I think Syed will comment on that.

Syed Ali

Yes, I think regarding the sales growth, Tim, we still expect 2010 to continue to have excellent sequential growth over the year, and the primary reason is that if you take a look at our design wins, earlier on in Cavium's life history, the type of design wins we got were the much smaller design wins with smaller annual revenues per year per design win. As we went into '06 and '07, and by the way, these smaller design wins are the ones in production today. As we moved into '06, '07 and '08, we really started to win the main platforms which are much, much higher revenue per design win. The first of these platforms are just starting to go to production in the second half of '09. So, we feel very confident and very positive that we still should see very, very nice growth trends moving over 2010.

Tim Luke - Barclays Capital

Female: I may also Syed, could you just touch on may be the timelines in terms of the milestones for PureVu, and when you may be looking for visibility on whether the Tier 1 players may start to embrace the offering?

Syed Ali

I think from an overall viewpoint, the timeline remains pretty much the same as I talked about last quarter. We've got initial design wins. We are starting to ramp into revenue. As I said in the last conference call, Q4 will be the first quarter where we will have meaningful revenues generated from this product line, and this itself will keep growing very nicely through the first half of '10. In terms of Tier 1, I believe that from an overall viewpoint timing wise or schedule wise, late this year, early next year by Q1, we should start getting some pretty good visibility on Tier 1 adoption.

Tim Luke - Barclays Capital

Lastly, if I may, it appeared as you moved through the quarter that your order growth rates continued to strengthen. How have you seen the order or the order rates as you have moved into October?

Syed Ali

The order rates, like I said in my prepared comments, were pretty linear with some improvement if you will in September. October rates are pretty much the average of the last three months. So, it's very, very similar rate, no dramatic change up or down.

Operator

Our next question comes from the line of Quinn Bolton with Needham and Company. Please go ahead.

Quinn Bolton - Needham and Company

Syed, could you give us an update on the total design win or the total value of your design win pipeline? I think, in the past, you've said that's $400 million or greater. It sounds like you've had another couple quarters of strong design wins, so I was wondering if there's an update to that total design win value.

Syed Ali

I think from an overall viewpoint you can say that we would be obviously north of $400 million, but somewhere in kind of the $500 million range in terms of total design-win dollars.

Art Chadwick

Just to be clear to anyone else that's listening, that means when all of the design wins that we have won go in to production, that would generate annual revenue of approximately $500 million give or take.

Syed Ali

Yes. This is not lifetime revenue that some of the companies have started to quote.

Quinn Bolton - Needham and Company

The second question, just you've seen sort of a softening in the consumer broadband, particularly Actiontec and Sumitomo in the second half of 2009, any sense you have in terms of visibility as we come into 2010 whether that business recovers or do you expect, whether it's due to share loss or just lower net subscriber adds that that business remains soft into the first half of next year.

Syed Ali

As you may have seen in Verizon's call and also Entropic's call that the fiber-to-the-home subs were down substantially in Third quarter, and obviously, we are seeing the offshoot on that in Q3 and modeling for Q4. We believe, though, that from what we've seen and heard from our vendors, that, approximate target is in kind of the 1 million subs per year, average, plus or minus, some number on a quarter-by-quarter basis. So, from where we are modeling Q4 for fiber-to-the-home broadband revenue, I believe there is only one way, and that is up in Q1. So, we believe it'll get back in to more the historical levels in approximately the quarter one timeframe.

Quinn Bolton - Needham and Company

Just a follow on that, any comments you can make about NTT West beginning to deploy the home gateways?

Syed Ali

The NTT West has started to deploy the gateways, but it's in much smaller pilot line-type areas, and the reason is, from what we understand, that to increase the number of subs the head end infrastructure needs to be in place, and that is the reason why NTT West is behind NTT East in subscriber of signups right now. So, we should start seeing NTT West also start increasing nicely in first half of '10, and be a much more significant portion of the revenues of the fiber to the home business in Japan moving off into second half of '10.

Quinn Bolton - Needham & Co.

Syed, I know you gotten a question on the competitive landscape, and you mentioned Freescale, but I was wondering if you've started to see their eight-core, core IT product, more in the market now? It sounds like that device is starting to get some design wins. So just curious if you see Freescale becoming a little bit more competitive in the higher end multi-core segment of the communication processor market?

Syed Ali

Quinn, I don't see, any again, dramatic difference over the past three to six months in terms of any particular competitor being more or less competitive. They have always been there, and if these are single and dual core products or even the four-core and eight-core products if you notice were announced I think a year or two years ago. So, their presence has already been there in the market for a while.

Also, I think the important thing to note is that this is Freescale's first generation of multi-core product, and, the first generation of anything requires a fair amount of work, and there's a fair amount of opportunity to optimize. We are on our third generation, so, there are a lot of lessons we learnt in our first generation to make our second generation better and then a lot lessons in our second generation to make the third generation better. So this is a process, and I don't believe that any one specific event is going to dramatically change the competitive nature for us or for the other guys.

Operator

Our next question comes from the line of Hans Mosesmann with Raymond James.

Hans Mosesmann - Raymond James

A lot of my questions have been answered. Congratulations. Just a further commentary if you can regarding the competitive dynamic, there is something called Tilera that announced a product that has 100 cores. I Just wanted Syed, if you can give us a sense of what does that mean? After a while there are so many cores. Are these real cores or how can you make all of these cores work in tandem and in an efficient way? If you can give us some commentary there that will be great? Thanks.

Syed Ali

First of all I think I would like to point out that announcing something versus delivering something, there's a big gap in between. I think what they are talking about is kind of end of '10, so that's the first point I wanted to clarify. The second point is you can answer the question, when there are a lot of cores, obviously, you have to have all of the tools and the support infrastructure to take care of that. Also I think the important fact that needs to be addressed is, that in any non-standard instruction set architecture, if you are not X86 MIPS or power PC, having a different ISA is a fairly big handicap in that particular market.

Operator

Our next question comes from the line of Arnab Chanda with Roth Capital.

Arnab Chanda - Roth Capital

Couple of questions for Syed and a couple for Art. First of all, Art, if you can talk a little bit about gross margins. It seems like your mix is obviously improving in the second half of the year, but then maybe your consumer broadband business comes back, and you've got PureVu, and then ECONA, I am guessing, is improving the gross margins in the consumer broadband. So, you talked about your long-term gross margin in low-60s. Between here and there, what sort of trajectory do you think it takes and sort of how long? If you give us a sense, that will be great.

Art Chadwick

I think if you looked at what we did going from Q2 to Q3, and now our guidance Q3 to Q4, that's a good trajectory. We expect to continue that into 2010. As you mentioned, if the broadband and consumer business comes back strong in 2010, that is a slight negative to the mix, but the counter to that is, we'll have our new ECONA line that we'll be shipping. Those will supplant a lot of what we ship into that market today at much better gross margins for us. So again, I think in summary, we expect our gross margins to continue to improve into 2010. We still think our long-term model is about right, even when you add hopefully some significant PureVu and ECONA sales in the future.

Syed Ali

Just add a comment that Arnab, if you look at my prepared comments, one of the things I've talked about is the enterprise datacenter, obviously starting to ramp significantly, but right behind that, we have several higher value designs in the access and service provider market also starting to ramp, both in the wide and wireless access infrastructure. Both these have a very, very good gross margins. Additionally, the PureVu line of products runs that higher than corporate target gross margins. So that helps too. So, when you take all of these moving parts, we still see a nice increase as we move up overtime and get to our model.

Arnab Chanda - Roth Capital

Just to follow-up on ECONA, at this point, I know in the long-term it should obviously help your TAM, but at this point, based on the design wins you have, is it basically just replacing your higher cost, kind of low end of your product or do you expect that to add to your TAM next year?

Syed Ali

A Very large majority I would say, 80% plus is in brand new sockets. The current design wins as you know we've announced the design win with Sumitomo; that is a replacement. However, a very large majority are brand new sockets that we were not able to address due to either, cost, power or functionality in our current products. This is a significant TAM expansion for us.

Arnab Chanda - Roth Capital

So it seems like you are getting your high volume design wins in both enterprise as well as actual service provider ramping, you are getting ECONA which is all new, and then PureVu is new. However, of course, last year coming off sort of depressed base, if you put qualitatively that together, do you think your growth rates will actually accelerate through 2010 or kind of stay at sort of the range that you see here? Obviously exact numbers are tough but just generally speaking.

Syed Ali

If you take a look at year-over-year obviously the 2009 overall top line revenues has declined in the Q4 of 2008 and Q1 of 2009. So, generally, we think that moving forward, again, as our higher design win dollars designs to go to production that we should continue to see pretty good growth rates on a quarter-by-quarter basis.

Art Chadwick

Again, just to reiterate our guidance for Q4, Q3 was a record revenue quarter for us. We're sitting here now guiding 12 to 16% up from Q3 to Q4 and I think that's a good indication of kind of the strength of this design win momentum and how our new products are doing out there, and that's not on a depressed base, that's off of a record quarter.

Operator

Our next question comes from the line of Dan Morris with Oppenheimer. Please go ahead.

Dan Morris - Oppenheimer

Just with regards to our guidance there. I know obviously the backlog was pretty good, but are we still within the historical ranges for turns requirements, which I think you've said is 30% to 50%?

Art Chadwick

No actually in my comments I made a comment that the turns requirement going into Q4 is the lowest ever.

Dan Morris - Oppenheimer

Okay. So we're outside that range now. Great. Well, maybe you could address what the lead times are across your segments. I assume that broadband and consumer has perhaps lower shorter lead times?

Syed Ali

Lead times for a wide range of customers kind of differs, but the largest Tier 1 customers, it's pretty much between eight to ten weeks. Some of the smaller guys come and go and they look for lead times in the six to eight weeks time frame. So, generally overall, the lead times have improved over the past quarter or two.

Dan Morris - Oppenheimer

It doesn't really differ across category?

Syed Ali

Not really across categories, yes.

Dan Morris - Oppenheimer

Okay. Great. Then, lastly, Cisco obviously had a nice jump this quarter. It's over half of your enterprise sales there, as enterprise continues to grow, would you expect that the non-Cisco or the Cisco side of thing, which would you expect to drive more of that growth?

Syed Ali

We think that both the Cisco and the non-Cisco segments in enterprise and data-center will grow. In my prepared comments I talked about companies like Huawei, Juniper, Citrix, F5, Brocade and Nokia Siemens. These are starting to contribute fairly decent amounts to our quarter and that should increase over 2010. So, I believe that we will see growth in both areas. At the very, very high level, if you take a look at our history, Cisco has been somewhere between 20% to 30% of sales, and not looking at any one specific quarter, we expect to kind of average in that particular area over the next several quarters.

Operator

Our next question comes from the line of Kevin Cassidy with Thomas Weisel Partners. . Please go ahead.

Kevin Cassidy - Thomas Weisel Partners

When we are looking at the growth for next quarter, how much of that is coming from run rate business and how much from new designs?

Syed Ali

I would say about one third from run rate business and two thirds from new products ramping to production. So, actually, there are still elements or there are many elements of our run rate business that have not yet come up to the peaks that were established in Q2 and Q3 of 2008.

Kevin Cassidy - Thomas Weisel Partners

Right. That's what I was wondering, how much of the existing designs are coming back.

Syed Ali

Some segments are still down 10% to 20% compared to that number, and for those we are seeing kind of a modest nice slow recovery, and hopefully over time, they will at least get back to their historical rates. However, a major portion of our revenues are coming from brand new product ramps, in brand new market segments, in brand new sockets that we have never addressed in the previous generation.

Kevin Cassidy - Thomas Weisel Partners

I see. What is the product mix between NITROX and OCTEON?

Syed Ali

OCTEON is the single largest number. I don't have the exact number, but it's a in the 60% to 70% range. If I had to guess; somewhere in that range.

Operator

Our next question comes from the line of Sandy Harrison with Signal Hill. Please go ahead.

Sandy Harrison - Signal Hill

Syed on prior question, you got into a discussion of just two different technologies, your ECONA line, which is based upon ARM and the potential for it to replace some of your other MIPS-based products. This is often embedded around that ARM had its place, MIPS had its place, and Power PC has it places. And now it appears as though the lines are blurring and were even seeing in new results, as you've evolve from just being a MIPS player. Could you sort of give us an update on, who is going where and at the end of the day, which technologies you think are going to have the lion share or is it going to be a third MIPS, a third ARM, and a third Power PC?

Syed Ali

Sandy, when you take a look at our product lines. We do have two product lines, the MIPS line and the ARM line. What we have seen is the lines are not really blurring. ARM is very, very well established in digital home, broadband, mobile type platforms. They have a lot of software associated with them in those particular platforms and they are continuously building momentum in that area.

Regarding the enterprise, datacenter and service provider, it's primarily a MIPS, Power PC and bit of X86, that have the lion's share of the revenue there. Obviously, there will be some point like a broadband gateway which maybe at the front line, if you will, between these two architectures which could go either way, depending upon, who has the better product. Overall, at this particular point in time, we see very, very clear benefits and end markets for each one of these architectures. We are probably one of the very few players that is aggressively addressing both of these segments.

Sandy Harrison - Signal Hill

You threw a lot at us in your prepared remarks about opportunities and market segments and so forth. What would be helpful for me at least, would be if you could maybe characterize the top three things that are going to drive, pretty clear in sort of Q4, but in 2010, sort of the top three opportunities or markets that you see sort of driving your growth and how it is that we could keep an eye on that and understand what the end markets are doing?

Syed Ali

In terms of our OCTEON line, obviously, the single biggest opportunities from a revenue viewpoint are enterprise routers. This is a very, very large segment and today we have extremely low market share, but we do have Cisco, Juniper, and Huawei, three players who probably between them control 85%, 90% of the market going to production with our products. So that is definitely a very strong growth trend out there.

The second large growth trend we have is in the wireless infrastructure in terms of everything from WiMAX, to 3G base stations, to radio network controllers, to GSM backhaul, and here companies like Huawei, Samsung, ZTE, some of these big players will start ramping. Of course, in our PureVu line, I have talked about where our current products are being shipped, but the opportunities there in the CE space are fairly large.

Operator

Our next question comes from the line of Anil Doradla with Williams Blair and Company. Please go ahead.

Anil Doradla - William Blair

Just kind of a larger picture question. If you look as we go in to higher-core products, eight, to 16, to 32. Can you share with us, what are the different sub-functions that are subsumed into the main processor, and which of the sub-functions in your opinion are most threatened by this emergence of these high-core multi-core processors?

Syed Ali

If you look at the entire component landscape, if you will, on say a high-end blade in the networking or communications area, there generally is CPU, there is generally a data processing, there is security processing, there is SPGAs to kind of glue the components together, and maybe even some hardwired ASIC to do application specific functions.

Now, when you take a look at these three or four different classes of products, the flexibility varies dramatically. So for example the ASIC is not flexible at all, and the CPU is the most flexible element there, because everything is reprogrammable. So if multi-core processors, as you increase the core count, and drive down the cost per megahertz, if you will, our high end OCTEON II 32-core will have 50-gigahertz of CPU processing power in there, which basically means, a lot of the functionality sitting in the board can now be taken away from the other types of the components that I have talked about whether it's ASICs or FPGAs, and put into the C software. Customers really like this, because when you take a look at C programming, there are probably a 100-X more designers who can program in C than who can do ASIC design or RTL design for an FPGA.

So, at the ideal point, if multi-core processors keep on driving this evolution, and are able to get into these types of systems, they will subsume more and more of the functions around. In fact, we do now see a wireless infrastructure box, which in the previous generation used to have all of these three type of components. In this particular generation, which will start coming out into the market in the second half of '10, there is no other component except a CPU and a switch. So, multiple of our CPUs are 12-core CPUs are used in the system along with the back plane 10 gigabytes switch, and this the only two types of components that are used. The programmable part being our CPU and the fix switch part coming from a standard switch supplier.

Anil Doradla - William Blair

So, Syed, this trend that's out there, is it getting in to the mainstream or is it still niche? If it's niche, when do you think this will get in to the mainstream?

Syed Ali

We are seeing a phenomenal uptick into this, and obviously, two to three years ago, this was a very specialized niche, but I would think in three to five years, a lot of the functionality will be done on the CPU versus any other component sitting around.

Anil Doradla - William Blair

So from your point-of-view, wouldn't that be accretive to your gross margins? I mean, would we start seeing your margin profile maybe in two years, three years, more like a software company?

Syed Ali

Not exactly. If you want to drive market growth, you still need to have costs that go down on a cost per megahertz bases regularly. So, overall, obviously, if more higher end core counts products are used. For example our 16-core products have gross margins in the excess of 70%. So, if more of those are used, and the trend is moving towards higher core count parts, that would obviously play in to our core competency and have some positive improvement on margins.

Art Chadwick

Obviously, the big benefit is increased sales.

Operator

Our next question comes from the line of Gary Mobley with Noble Financial Group. Please go ahead.

Gary Mobley - Noble Financial Group

Hi, guys, I had a couple of questions that hadn't been asked yet. Focusing specifically on the broadband access market, when would you expect the ECONA products to overcome the OCTEON products? Then for Art, I would like some further clarification on your tax rate for 2010. Could you mention a 15% to 20% non-GAAP tax rate for that timeframe?

Art Chadwick

We'll start with the tax rate. That is correct. In the past, we've have quoted 20%. At this point, we are comfortable with saying 15% to 20%, and that is 15% to 20% of our non-GAAP income. So, there is a difference between our non-GAAP income and our GAAP income. This is 15% to 20% of our non-GAAP income.

Syed Ali

Regarding your other question, Gary, the ECONA processors will go into Sumitomo's next generation fiber-to-the-home gateway that should be targeted for production in the second half of 2010.

Gary Mobley - Noble Financial Group

Okay. So, Actiontec is not fully committed to the ECONA product, they are still using Apian, is that right?

Syed Ali

The current BHR2 just went into production a couple of quarters ago. So, people like to run it at least year and a half to two years before tying to come out with the next generation. However, we believe that, in conjunction with Entropic, that our solution will actually be the absolute best solution in the market.

Operator

Our next question comes from the line of Christian Schwab with Craig Hallum Capital Group. Please go ahead.

Christian Schwab - Craig Hallum Capital Group

Regarding, sales into Sumitomo, do you guys see an impact from NTT qualifying a third source for that product, Hitachi?

Syed Ali

Not really. From our understanding, NEC and Sumitomo are the lion's share of that deployment with Hitachi being a small share. So, essentially, NEC uses their own A6 silicon, Sumitomo uses ours. So, there is a few percent impact on that at the most.

Christian Schwab - Craig Hallum Capital Group

You don't think that mix eventually goes a third, a third, a third.

Syed Ali

That is not our current understanding.

Operator

Our next question comes from the line of Alex Gauna with JMP Securities. Please go ahead.

Alex Gauna - JMP Securities

Thanks for taking my call. I was wondering with regard to the powerful Cisco ramp you are seeing how much of what we were expecting to come on from say the Catalyst 3000 or the ARS 1000, are both of those in now or are we still expecting further follow on platform ramps here in the Q4 timeframe and into Q1?

Syed Ali

Regarding Cisco, Alex, we have a range of platforms that are going to go to production almost on a quarterly basis for the next six to eight quarters. So, we've had a couple of the earlier ones that are just starting to go in to production, and by the way, these type of products take about, I would say, three quarters to four quarters to ramp to full run rate. So, there is still a lot of headroom for growth. However, if I look at my two highest volume design wins at Cisco, the first one has just started to go to production. So, there is a lot of headroom remaining with other Cisco designs.

Alex Gauna - JMP Securities

Then on the PureVu product, you were pretty clear Tier 2, Tier 3 opportunities starting to ramp right now. Are those coming back in to North America? Are they targeting Asian markets and what are some of the Tier 1 solutions that I am seeing emerge using right now? What is your opportunity or time line with an opportunity there?

Syed Ali

I didn't quite get the first part of your question, Alex.

Alex Gauna - JMP Securities

With the Tier 2, Tier 3, PureVu.

Syed Ali

PureVu you are talking about, okay.

Alex Gauna - JMP Securities

Are those coming back into North American channels, or are they also staying in Tier 2, Tier 3 markets, and then also what are the Tier 1 solutions that I'm starting to see emerge using out there and what is your opportunity or time line to opportunity on those?

Syed Ali

Regarding the vendors who are going to start delivering systems this quarter, these are Asian customers who are primarily targeting Asian and European retail sales channels and service provider channels. Regarding the U.S., we do have two or three vendors who are just starting development of that for the U.S. market, but that's in the early stages, and I would think that it would probably be, mid-'10, Q2 to mid-'10 by the time they come out. The Asians generally jumped on this faster and brought it to market much faster.

Regarding the overall opportunity, I think the opportunity for wireless distribution of HD content in the home is absolutely a phenomenal opportunity. The current solutions in the market primarily use some proprietary wireless with no compression, and they are there in some of the, early proof of concept equipment that has been out there over the past six months, but every one of our customers, basically believes that our solution, if it meets their video quality, reliability and cost, is the right solution to go to, because if you use standard-space compression, decompression, and standard' spaced Wi-Fi, there is nothing proprietary about it which allows different equipment embedding this technology to talk to each other seamlessly.

Operator

Our next question comes from the line of Aalok Shah with D.A. Davidson.

Colin Denman - D.A. Davidson

This is Colin Denman in for Aalok. Basically all my questions have been answered. I just was wondering would you guys be willing to disclose what the licensing revenue this quarter was?

Syed Ali

Our licensing revenue of?

Colin Denman - D.A. Davidson

In your Q, you usually break out small portion of licensing revenue for some software and I was wondering if you could break that out.

Art Chadwick

It was not large. We'll be filing our Q in a couple of days. We just don't have the exact number right in front of us, so I don't want to through a number out there, but it is not significant. Less than 5%.

Operator

Our final question comes from the line of Allan Mishan with Brigantine Advisors.

Allan Mishan - Brigantine Advisors

If I look at your broadband and consumer business outside of Actiontec and Sumitomo, it looks like it was actually up 60% quarter-on-quarter. I know it's a small amount of revenue, but can you just tell us what drove that increase? Was there some new program or what took place there?

Syed Ali

Allan that was a very astute observation I must say. In our past business just because Sumitomo and Actiontec numbers were very large, the other stuff kind of got lost in the mix and that number is going to become substantially higher as we move forward. Here I'm talking about companies like D-Link, NETGEAR, ZyXEL, a whole range of these types of companies that are bringing a range of products to market for security, network attached storage, wireless access points, and the like. So in that specific segment of the market, you are going to start seeing a pretty nice ramp as we move ahead

Allan Mishan - Brigantine Advisors

So that was not PureVu, that was other OCTEON and NITROX within that segment?

Syed Ali

In that area, again PureVu is definitely ramping, but other than PureVu even in our standard business, the type of NETGEAR, D-Link, ZyXEL type designs are also starting to contribute very nicely.

Allan Mishan - Brigantine Advisors

On a dollar basis sequentially was NITROX up more or was OCTEON up more versus Q2?

Syed Ali

I don't have that number in front of me, but overall, as a percentage viewpoint, I think NITROX was up higher than OCTEON. In terms of dollar view point, I really don't have that clear for number right now.

Art Chadwick

As Syed mentioned, security came back rather strongly in Q3?

Allan Mishan - Brigantine Advisors

Then last question, do you anticipate PureVu shipping into embedded in televisions in 2010 or will it all be equipment that gets used within the home that either a dongle or plugs in to the TV?

Syed Ali

The first way, are obviously the dongles for that you can retrofit your existing home with this technology. I actually have a pair of these dongles in my house from the first Tier 3 Asian manufacturer who produced these, and I must say these work pretty well. In the next generation, specifically if you look at my prepared comments, I talked about a very highly integrated single-chip solution that we'll be announcing this quarter. That is the one that will really get embedded directly in to the end equipment.

Allan Mishan - Brigantine Advisors

If I look at the revenue in 2010, you are probably talking about the video conferencing stuff, as well as the add-on equipment, and then maybe in 2011, it could be embedded in a TV for revenue?

Syed Ali

If you take a look at without specifically talking about which platform amongst the three or four platforms I talked about, other than the video conferencing, and the embedded application. We believe we'll start seeing some revenues in the second half of '10.

Operator

At this time I would like to turn the conference back to management for any closing comments.

Angel Atondo

Great, thank you, operator. Given that we have no more questions, we want to thank everybody for joining our call today, and have a great afternoon. Thank you.

Operator

Ladies and gentlemen, this does conclude the Cavium Networks Q3 2009 earnings conference call. If you would like to listen to a replay of today's conference, you may do so by dialing 1-800-406-7325 or for international participants, 303-590-3030, and entering the access code of 4169138. Those numbers again are 1-800-406-7325 and 303-590-3030 with the access code of 4169138.

Thank you for your participation. You may now disconnect.

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