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PLX Technology, Inc. (NASDAQ:PLXT)

Q4 2013 Earnings Conference Call

January 27, 2014, 17:00 PM ET

Executives

David K. Raun - President and CEO

Art Whipple - CFO

Analysts

Krishna Shankar - ROTH Capital Partners

Ian Ing - MKM Partners

Operator

Good day, ladies and gentlemen. Welcome to the Q4 2013 PLX Technology Earnings Conference Call. My name is Whitney and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Art Whipple, Chief Financial Officer. Please proceed, sir.

Art Whipple

Good afternoon. Thank you for joining us today. I will start this session with a review of our fourth quarter and full year financial performance; and David Raun, our CEO, will provide more information on our business and recent events.

As we begin, I'd like to point out that certain statements made in the course of this call regarding our expectations and associated projections will be forward-looking statements. These statements will include comments relating to the introduction and adoption of new products, financial guidance, the development of next-generation technologies, the Internet Machines litigation and other areas, and will be made in both our prepared remarks and the subsequent Q&A session.

Our forward-looking statements deal with future events and are subject to risks and uncertainties, and our actual results could differ materially from our current expectations. Some of the factors that could cause such differences are described in our press release dated January 27, 2014, and in our various SEC filings, including our report on Form 10-K for the year ended December 31, 2012, and our reports on Form 10-Q for the quarters ended March 31, June 30 and September 30, 2013.

Let's discuss the results of operations. Net revenues for the fourth quarter were $25.7 million, unchanged from $25.7 million last quarter. PCI Express revenues increased 2.1% to $18.6 million, and represented 72% of revenues. Connectivity revenues declined by 5.5% to $7.1 million.

Our GAAP gross margin was 54.8% in the fourth quarter. This number includes an accrual for royalties associated with the Internet Machines litigation. Without the Internet Machines accrual, the non-GAAP gross margin was 55.6%. PCI Express gross margins were consistent with the prior quarter, while connectivity margins declined moderately from the third quarter. We expect connectivity margins to return to previous levels in Q1.

Excluding stock comp, R&D and SG&A spending both came in at $6.2 million. SG&A costs were slightly higher in this quarter, reflecting increased costs associated with the proxy contest. R&D spending was lower than we had expected when we provided our business outlook in October. Continued cost controls drove higher use of litigation accruals and lower cost associated with consultants and other third parties.

GAAP profit came in at $1 million for the fourth quarter compared with $100.2 million [ph] last year. PCI Express revenues increased by 13.2% from $66.8 million tom $75.6 million and represented 72% of revenues. Connectivity revenues declined by 13.6% to $28.9 million.

Our GAAP and non-GAAP gross margins were 56.6% and 57.0%, respectively, for the full year. Our non-GAAP spending for the year was $47.6 million compared with a $52 million estimate we provided at the beginning of 2013. Revenue growth combined with reduced operating expenses and the divestiture refi business produced a GAAP profit of $7.2 million for 2013 compared with a $32.6 million loss in 2012. This is the highest annual profit of the company's history.

In addition to the GAAP results, we present non-GAAP measures in our press release that we believe are helpful to investors. Excluding such items as litigation accruals, discontinued operations, acquisition and restructuring costs, amortization of intangibles and stock comp, we have been profitable for the last three years. Our non-GAAP continuing net income for the fourth quarter was $1.9 million and $11.5 million for the full year.

On the balance sheet, cash and investments increased by $2.4 million in the fourth quarter to $20.4 million, even as we reduced bank debt by $1 million. This improvement on our cash position was a result of cash generated by operations and the collection of the $2 million escrow account associated with the Entropic transaction that closed in 2012.

Inventory increased slightly to $10.3 million from $10.1 million. Accounts receivable was $12.8 million compared with $12 million last quarter. DSOs stood at 46 days for the current quarter. Collections remain excellent.

Now, David Raun will provide further comments on the business.

David K. Raun

Thank you, Art. Good afternoon, everybody. 2013 was a year of transition for the company where we believe significant progress was made. We went from heavy losses in 2012 and decreasing revenues to four consecutive quarters of profitability in 2013, setting a new profitability record as well as growing the top line revenue for the first time in several years.

With tight control on expenses and exclusive focus on our market-leading PCI Express product line, PLX improved its balance sheet on a number of fronts. We increased cash and investments by 22%, decreased bank debt by 38% and increased shareholder equity by 24%.

In terms of revenue, PCIe growth in 2013 was 13%. The first half grew 17% year-over-year slowing to 9% in the second half as we experienced end-market softness, primarily in the enterprise storage space, as well as delays of Gen 3 production ramps in several market segments.

We don't believe that the decrease in our growth rate in the second half was caused by competitive pressure or design losses. In fact, our competitive lead continues to increase and we realized record design wins in the year, especially strong in the second half.

Turning to the fourth quarter, PCI Express products saw growth of 2% sequentially and 14% over Q4 2012. Demand in enterprise storage, our largest PCI end customer, was lower sequentially. Based on comments from our customers, we believe this is temporary and partially tied to the lower government and corporate IT spending.

Networking was about flat. We saw sequential growth in servers based on initial production ramps and preproduction build of new Gen 3 systems. In the PC in the consumer space, our smallest market, we saw nice growth as new Gen 3 programs entered production. The embedded segment also saw increased demand led by security and industrial automation companies.

In terms of design win activity, we saw another strong quarter with broad-based wins across our Gen 2 and Gen 3 device portfolio, particularly our high lane count Gen 3 switches. Enterprise storage, our largest market, continued to see heavy design win activity for our Gen 3 switches in mid to high end platforms, as well as PCI Express solid state drives. This market segment tends to use the larger devices with higher prices and better margins compared to other markets.

In networking, PLX switches continue to be the standard for the control plane at all market leaders, with a mix of new Gen 2 and Gen 3 designs. Multiple high-end server customers designed in our largest 96-lane Gen 3 device in Q4. In the embedded market, we saw a mix of bridges as well as Gen 2 and Gen 3 switches designed in the printers, security, surveillance systems and industrial control applications.

We now have 18 PCI Express Gen 3 switch products in production, complementing a full portfolio of Gen 2 switches. PLX is the market leader in PCI Express and our design win success indicates our continued market share growth. With such strong design activity, the key issue for us as with our investors is when will the design wins translate into revenue.

While we are seeing some additional Gen 3 designs beginning to ramp, the bulk of the opportunity still lies ahead of us. And although it is difficult for us to predict exact timing of the ramp of these designs, we have experienced these technology transition cycles before and we look at historical trends as a guide.

For example, in 2009 we saw a trend with Gen 2 much like what we're seeing today with Gen 3. Customers were actively designing in our products but the initial ramp was slow. However, between 2010 and 2012, PCI Express revenues more than doubled. This strong growth was the result of key Gen 2 programs going into production.

Today, the potential revenue value of our design wins is more than three times what they were previously and this is in a less competitive marketplace. Therefore, we're excited about the potential of our PCI Express business and believe that during 2014, we will see many more Gen 3 platforms ramp into production driving company growth.

Similar to what we saw with Gen 2, we believe our growth over the next several years should average close to the historic 25% per year level and double as it did with Gen 2. In 2014, our estimate is that PCIe will grow somewhere between 15% and 25%.

Turning to our ExpressFabric solution. During the fourth quarter we continued to work closely with customers and partners whom we expect will be early adopters of the technology. ExpressFabric is a disruptive technology within the data center and cloud because it can eliminate the traditional array of costly and power-hungry fabric controllers and switches currently found within many server and storage racks.

The ExpressFabric solution is about one-half the cost and one-half the power of alternative fabric schemes. We have a growing list of companies interested in taking advantage of this technology to deploy in their own data center or provide as part of their own enterprise solutions to the market. We believe success with the early adopters will result in many of these additional interested parties moving forward with solutions as well, expanding our opportunity significantly.

This disruptive solution leverages PLX's PCI Express switch technology, system fabric experience and market leading customer base to expand the opportunity for the company over the coming years. We expect these products to sample in the third quarter and impact revenue somewhat in 2015 followed by stronger strong in 2016.

Throughout 2013 I mentioned that we were especially focused on OpEx control. In parallel to this continued focus, the company is also working on margin improvement. Although we have some short-term issues, mix issues and additional activity in the lower margin PC in consumer space creating pressure, we have implemented multiple programs to improve gross margins over time. These improvements will come with cost reductions, a greater mix of large Gen 3 switches, growth in the storage space, improved yields and increased value associated with our products in general.

To sum it up, we are excited about our growth prospects for the coming year and in the years ahead. Gen 2 sales continue to be healthy and we believe that the weakness we have seen in the storage market will correct itself in the coming quarters. Further, we expect to see many more PCIe Gen 3 designs going into production in the coming year which will be a key driver for our growth.

Connectivity products will continue to be a headwind for PLX as they are expected to continue to decline at approximately the same rate as 2013, but with each year become a smaller and smaller part of our business. PLX is becoming more and more a pure play PCI Express company driven by leading edge technologies. The combination of higher PCI Express revenues offset by smaller and smaller contributions by connectivity will allow PLX's top line revenue to grow at a greater rate each year.

With growth in our revenues coupled with improving margins over time and continued tight express control, we believe that we will continue to deliver enhanced profitability and shareholder value.

With that, let me pass it back to Art to discuss Q1.

Art Whipple

Thank you, Dave. We expect revenues to be approximately $24 million to $27 million in the first quarter of 2014. The wider revenue range this quarter reflects several unusual items that we faced this quarter. One of our larger customers is moving to a vendor-managed inventory process and will work down their own inventory before taking draws from PMI [ph].

Additionally, one of our assembly contractors has had their wafer bumping line shut down by the Taiwanese authorities limiting upside capacity for a few of our products. Also, estimates for our storage customers remain below our expectations and Lunar New Year is always a factor in first quarter business. However, bookings so far this quarter have been strong for both Q1 and Q2 delivery.

Non-GAAP gross margins are expected to be approximately 56% with GAAP margins at approximately 55%. The GAAP number includes an accrual for the royalties associated with the Internet Machines litigation. These gross margin accruals will be reversed later in the year if PLX wins the appeal in Washington.

Our non-GAAP OpEx spending is expected to be approximately $52 million in 2014. The quarterly spending will be lumpy. Our first quarter is generally a little higher due to beginning of year expenses including employer payroll taxes. We are also factoring in a 40-nanometer tape-out in the first quarter. This tape-out will occur either late in Q1 or early in Q2. But for purposes of forecasting we have it in our Q1 spending plan. We are expecting GAAP operating expense of about $14.0 million, including the tape-out about $600,000 of stock comp and other GAAP items in the first quarter.

Let me now open up the lines for questions related to the business.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Krishna Shankar with ROTH Capital. Please proceed.

Krishna Shankar - ROTH Capital Partners

David and Art, congratulations on a good 2013 results. Regarding PCI Express, within PCI Express, can you give us the split between storage, networking and servers? And can you just give a little more color on – you said you're seeing strong bookings. Are you seeing things pickup in the storage market also which was weak in Q4?

Art Whipple

So, our splits on the different market segments haven't changed dramatically, they've just moved around a little bit. Storage remains the biggest part by far followed by networking and then embedded, server and PC markets. We are seeing bookings in all market segments including storage.

Krishna Shankar - ROTH Capital Partners

Okay. And then as you look at – last year, I guess you grew your PCI Express business about 13%. Given your design wins and more PCI Express Gen 3 moving into production, would you hope to have revenue growth greater than that this year or can you give us some sense for what revenue growth will be in PCI Express this year?

David K. Raun

Yes, two comments. As I commented in the script, we believe based on the design wins we have, history and knowing the production ramps, we think if you – over a number of years we're probably looking at an average 25% growth rate and doubling the revenue. For this year what the number we put in here is 15% to 25% and I think we get more comfortable with that range on the high side as we see things develop through this quarter.

Krishna Shankar - ROTH Capital Partners

Okay. And then on the PCI ExpressFabric, can you give us some of the milestones you've achieved there? And it seems like – I think you were earlier talking about maybe sampling early this year. I guess now you're saying sampling later this year. Can you talk about the timeline and what milestones you still need to achieve?

David K. Raun

Yes. I mean this is the program that has had some delays. The product was just more complex and got stuck in a few areas. But one of the things we're driving towards is some called [ph] Gen 3s. We have now accomplished that and that creates more of a confined clock to the trend we tape out. So, as we discussed today, we believe it tapes out at the end of this quarter but possible it could drift into early next quarter. We've put the first samples in customer's hand (indiscernible) Q3 to give a little padding. Then these will be going to customers that are working very closely with us and are ready for them.

Krishna Shankar - ROTH Capital Partners

Okay. And these customers are in servers, networking, storage; can you give us some color on the nature of customers you're working with, with the ExpressFabric?

David K. Raun

We're working with enterprise guys, the main guys in all the other areas you just mentioned plus cloud providers that build that kind of equipment also.

Krishna Shankar - ROTH Capital Partners

Okay. Thank you.

Operator

Our next question comes from the line of Ian Ing with MKM Partners. Please proceed.

Ian Ing - MKM Partners

[Technical Difficulty]

David K. Raun

Your message was pretty rambled here, I don't know exactly why. What I did hear is something about trends with competition, but that was about all I heard.

Ian Ing - MKM Partners

Yes, I'm just wondering, you have a fabric solution based on PCI Express. I'm just wondering how you can displace some of the incumbents' fabric solutions, Gigabit Ethernet or InfiniBand?

David K. Raun

Yes, so the customers that are actively doing that which are market leaders, these are for platforms that may have originally planned to use Ethernet and to a lesser degree InfiniBand. And then they coexist with those in the larger system. So they see the PCI Express as a superior interconnect within the rack to save cost and power, but they still are able to maintain the larger network and take advantage of all the applications in software already developed for those other two IO.

Ian Ing - MKM Partners

Understand. And then you sell a lot of your parts through a distribution channel, but do you have a sense of – is the end customer, is it typically the branded OEMs and things like storage, or are you targeting sort of the white-box Taiwan ODMs that serve the cloud customers? Do you have a sense of that mix there?

David K. Raun

We draft and serve them all. We spend a considerable amount of time with all the big brand name guys but also the white-box suppliers.

Operator

There are no further questions in the queue at this time. I'll now like to turn the call over to Mr. David Raun, President and CEO for closing.

David K. Raun

Okay. Thank you. During 2013 we achieved many of the milestones we set out to tackle including solid improvements to the balance sheet and profitability. In 2014 we expect to see greater revenue growth, driven by production ramp of the new Gen 3 programs and market improvement. Additionally, our continued focus on cost control, margin expansion and cash generation will give us the opportunity to deliver further financial improvement building upon our progress in 2013. Thank you for your time.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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