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PMC-Sierra, Inc. (NASDAQ:PMCS)

Q2 2010 Earnings Conference Call

July 22, 2010 5:30 PM ET

Executives

David Climie – VP, Marketing Communications & IR

Mike Zellner – CFO

Greg Lang – President and CEO

Analysts

Harlan Sur – JPMorgan

Kevin Cassidy – Stifel Nicolaus

Ruben Roy – Pacific Crest Securities

James Schneider – Goldman Sachs

Mark Lipacis – Morgan Stanley

Sandy Harrison – Signal Hill

Eric Ghernati – Bank of America/Merrill Lynch

Operator

Good day and welcome to the Q2 2010 earnings release and conference call. Today's conference is being recorded. Today is Thursday, July 22, 2010. It is now my pleasure to introduce Mr. David Climie. Please go ahead, Mr. Climie.

David Climie

Thank you. Good afternoon, everyone, and thank you for attending our investor conference call. With us on the call today is Greg Lang, President and CEO and Mike Zellner, Vice President and CFO. Please note that our second quarter 2010 earnings release was disseminated today via Business Wire, after market close, and a copy of the release can be downloaded from our website.

Before we begin I would like to point out that during the course of this conference call, we'll be making forward-looking statements that involve a number of risks and uncertainties. These risks and uncertainties include, but are not limited to, product demand, inventory levels, pricing, exchange rates, taxation rates and other risk factors that are detailed in the company's Securities and Exchange Commission filings. Actual results may differ materially from the company's projections.

For further information about these risks and uncertainties, please read the company's SEC filings, including our forms 10-K and 10-Q. If you're asking a question during the Q&A session of today's call, we request that you limit yourself to one question; if you'd like to ask a second question, please re-queue with the operator.

Thank you. I'll now turn the call over to Mike Zellner.

Mike Zellner

Thanks, Dave. I'll review our second quarter 2010 results and financial position and then turn it over to Greg to discuss our business activity in detail.

PMC-Sierra had a strong second quarter generating our fifth consecutive quarter of revenue growth. Revenue in Q2 was $160.7 million and reflected an increase of $7.9 million or 5.2% over Q1. On June 8th, we closed our purchase of Adaptec's channel storage business. Revenue contributed by the channel business for Q2 stub period was in line on pro rate basis with the fourth quarter revenue estimate of $12 million to $13 million indicated in our previous investor conference call.

Our turns business, I mean those orders booked and shipped within the same quarter was 14% in Q2 compared to with 17% in Q1. In Q2, we had one customer that represented greater than 10% of our revenue calculated on a 12-month rolling basis, namely HP.

Gross margin in second quarter was 69%, which was 90 basis points higher than Q1's 68.1%. This improvement was driven mainly by product mix partially offset by inventory related integration cost from our acquisition of Adaptec's channel storage business last month.

On a non-GAAP basis, operating expenses increased by $2.7 million from $59.3 million in Q1 to $62 million in Q2. This was in line with our outlook on expenses provided on our previous quarterly conference call. The increase relates mainly to planned hiring and investments in R&D as well as annual merit increases, stub period operating expenses included for the acquisition and foreign exchange on our foreign operation.

In Q2 our non-GAAP operating margin reached 30%, which is at the high end of our targeted operating margin range of 25% to 30%. The non-GAAP tax provision was slightly lower in the second quarter at $1.7 million compared to $2 million in Q1.

Non-GAAP net income for Q2 was $47.6 million or $0.20 per share on a diluted basis, representing a $4.1 million or 9% increase over $43.5 million generated in Q1. On a year-over-year basis, non-GAAP net income increased by $17.9 million or 60% from the $29.7 million generated in Q2 of 2009.

Q2 GAAP diluted net income per share was $0.13 versus $0.12 in Q1. The comparable GAAP measures for each of gross margin, operating expenses, operating income, provision for income taxes and net income are reconciled to the related non-GAAP amounts in our reconciliation of GAAP to non-GAAP measures included in our press release issued today.

The primarily reconciling items of Q2 are as follows; $6.8 million in amortization of purchased intangible assets, $5.7 million in stock-based compensation expense, $800,000 of non-cash interest expense, $1.5 million of acquisition related costs and $2.7 million of income tax related adjustments as described in our press release.

Turning to the balance sheet, we ended the quarter with over $500 million of cash and cash equivalents, short-term investments and investment securities. Our cash position at quarter end net of the $68.3 million face value of our convertible note was $433 million, an increase of $15.2 million from Q1. The net increase relates primarily to the $47.7 million of non-GAAP net income in the quarter and $2.2 million of cash from employee related stock issuances offset by $34.2 million paid for the acquisition and $3.3 million of IP and capital expenditures.

In Q2, cash flow generated from operations was a strong $51.9 million, our highest in nearly a decade. Accounts receivable increased $19.6 million to $79.8 million including the acquired channel storage business. Excluding the effect of the acquisition, we have 39 days sales outstanding based on a quarterly sales volume. This was slightly higher in terms of days than we had in the prior quarter but remains a very healthy collection to profile.

Our net inventory at the end of Q2 was $34.9 million, an increase of $2 million in the prior quarter primarily due to our acquisition. Net inventory turns improved to 6.5 times compared with 6 times in Q1. Channel inventory remains healthy with increases in the turns at our distributors in the second quarter. In addition lead times from the foundries have steadied.

With that I will turn it over to Greg for his briefing.

Greg Lang

Thanks, Mike. As Mike noted, we generated a $161 million of revenue in the second quarter this year, which was 5% higher than Q1. This increase was driven by growth in our Storage and Fiber to the Home business as well as $2 million from the addition of Adaptec's channel business. On the earnings front, we generated approximately $49 million of non-GAAP operating income in Q2, which was up $4 million from or 9% higher than the prior quarter. We also achieved 30% non-GAAP operating margin in the second quarter, which is at the top of our stated target range.

In June, we closed the purchase of Adaptec's channel storage business, I'm very pleased with the integration progress to date. We have hired on 96 people from the former Adaptec company, about half of their prior work force and the team has been up and running from day one. This purchase has a strong fit with PMC's existing storage business, greatly accelerates our move into the channel and allows us to increase our efforts to expand the 6 gig SAS RAID product line for the channel customer base, and customer response has been excellent.

So now let's talk about the second quarter by end market segment. In enterprise storage, we once again experienced good sequential growth in Q2 given the positive enterprise and corporate IT spending environment. Activity in fiber channel was down a bit due to some inventory digestion while our SAS devices at both 3 gig and 6 gig continued to grow. In the external storage system market segment, our top tier customers are ramping up their new 6 gig SAS platforms. We expect this to continue into the second half of this year and into next year as our SAS design wins from last year or two are now starting to go into full production.

In the server market, our 6 gig RAID-on-Chip business increased sequentially again given the strong performance and success of HP's Proliant server line. We also made a couple of substantial product announcements this quarter, continuing to set the pace for SAS solutions in server and storage systems.

We announced our first RAID adapter called maxRAID, which runs on our 6 gig SAS RAID controller together with the industry's first multithreaded RAID stack software optimized for high performance data intensive application. This new card and RAID stack deliver breakthrough performance of 300,000 IOPS in a single controller for solid state drive subsystems. And in addition, it's the industry's first RAID adapter to enable hybrid storage using solid state drives as well as hard disks on the same RAID card, which allows IT managers more flexibility and manageability in their configurations. The maxRAID adapter was developed in the joint development agreement with IBM and we are now shipping the solution into IBM's high end eX5 SSD enabled servers and it's also being offered as a customer option for other configurations. The maxRAID will contribute to our revenue in Q3 and more meaningfully in the Q4 timeframe. We are actively testing our new maxRAID adapters with other Tier 1 OEMs that could generate additional revenue in late 2010.

The second announcement was for our second generation SAS2 RAID-On-Chip product line called the SRCv, which includes the industry's first 24 port 6 gig SAS controller as well as a higher performance 8 port controller. The SRCv is another industry leading device based on PMC's innovative, multi-core architecture that more than doubles the throughput performance over existing solutions and consumes 30% less power than any comparable solution.

In the wide area network infrastructure market segment, which includes both our wireline and wireless infrastructure products, activity was flattish in Q2 as we experienced good sequential growth in North America offset by Europe, Korea and China being a little lighter on the wireline side. Our wireless infrastructure business improved during the second quarter supported by China Mobile moving from Phase III to Phase IV of its TD-SCDMA network build-out.

In the aggregation and metro transport market segments, we saw a bit of softness as we worked through some inventory. We remain optimistic about this segment as we are in the very early days of moving to converged OTN network architecture with carriers starting (inaudible) appointments later this year in North America and China.

PMC is very well positioned here enabling both transport and router platforms with highly integrated multi service, multi aggregation devices like our HiFi and Meta products at 10 and 20 gig. This is one of the toughest challenges for carriers today, efficiently packing and unpacking the high speed traffic at the edge of their converged IP and TDM networks. We expect this to be a growth driver in 2011 and 2012 timeframe.

In broadband access, our Fiber to the Home business improved in the second quarter as NTT in Japan now has plans to further extend the reach of its fiber access network in the more regional areas. So they are targeting to add over $2 million new subscribers again this year. In China, we believe the second half will show strength, China Telecom, China Unicom and China Mobile all planning healthy deployments in the second half.

In Q2, we introduced the industry's first pluggable GPON ONT dongle that connects residential gateways to high speed PON networks via a small form factor pluggable port. This eliminates the requirement for a standalone separate ONT box, which is often referred to as a two-box solution and it enables carriers to quickly and cost effectively introduce fiber based services with a single device. We have had very good interest from a large number of carriers and OEMs on this solution.

In microprocessors, our business was down in Q2 as we had forecasted. Customers are working through inventory after a strong first quarter. However, we are encouraged to see this market segment return to health and anticipate growth in Q3.

So now let's look to the third quarter outlook. Based on our backlog in bookings today, we currently anticipate PMC-Sierra revenue growth of 5% to 10% in the third quarter of 2010 or revenue in the range of $169 million to $177 million. We anticipate this growth to be primarily from storage, Fiber to the Home, microprocessors and of course, the addition of a full quarter of channel revenue from Adaptec. Our WAN infrastructure business is expected to be down in Q3 as customers continue to work through some inventory. We believe we will get to normalized customer inventory levels by Q4 of this year.

So in summary, the fundamentals of our business are very solid. Our financials remain very healthy as we have successfully established a stronger business model for the company and our balance sheet is in great shape. In addition, we believe our end market segments are healthy and growing. The enterprise server and storage markets have grown beyond pre-recession peaks and carrier networks across the globe are being stretched.

The underlying demand drivers are as strong as ever. The digitization of everything continues, books, music, map, medical images and video, and the penetration of media capable devices, smartphones and tablets has just started and it's still well below 10% of the handset market. As this new class of devices grows, the traffic on the network will grow dramatically.

In emerging video distribution services such as Hulu, Netflix, Amazon and Apple TV are starting to take route and the players are starting to align to remove the final barriers such as the ultra video industry consortium announced this week. Solving the rights management and distribution issues around premium content is one of the last key barriers to unleash streaming and downloaded high quality video content over the network.

The cloud services needed to host these and many other applications are also growing rapidly. IDC projects cloud computing spending will grow at 27% a year through 2014 and the server platform GM at Dell says his cloud business has seen triple digit growth year-over-year. So more content, fatter content, more devices that can support it and more services that can offer it. Data is exploding and so is the traffic it generates on the network. Networks must be rearchitectured and the data must be stored and protected. We believe we are just starting the first phase of a 5 to 10 year Internet infrastructure build-out to support these fundamental drivers.

With our product line up, new product investments and excellent traction with Tier 1 equipment providers, PMC is in a great position to benefit from this Internet infrastructure build-out for several years to come.

So with that, I will now hand the call back over to Mike for more detail on our outlook for the third quarter.

Mike Zellner

Thanks, Greg. I will now provide more information about our Q3 outlook. Considering current levels of demand and our expectation of booking rate through the balance of the quarter, we estimate that potential revenue for PMC-Sierra for Q3 is in the range of $169 million to $177 million as Greg mentioned. Just shipped and shippable backlog at the beginning of Q3 was approximately $139 million and as of today it is approximately $160 million including the acquired channel storage business indicating that we need approximately 20% turn from the beginning of the quarter and 8% turn from this date to get to the midpoint of our revenue outlook for Q3.

With the addition of the reseller channel business, our turns profile has changed from prior periods. If we exclude Adaptec's channel business, we estimate turns required from today's business to be approximately 5% consistent with the low turns experienced in each of the last two quarters.

On a non-GAAP operating basis, we expect our overall gross margin percentage in Q3 to be approximately 58% plus or minus 50 basis points. The quarter-over-quarter difference is primarily due to product mix as well as the integration of the channel storage business for a full quarter.

Non-GAAP operating expenses in Q3 are expected to be in the range of $66 million to $67 million, increasing from $62 million in Q2. This increase is predominantly the result of having a whole quarter of operating expenses for the channel storage business that we acquired last month.

On a general note, depending on the number and timing of tapeouts, which do vary from period to period, our expenses could be affected by $2 million in any given quarter. We expect non-GAAP net other income to be in the half million range, which is primarily net interest income from our cash position offset by servicing or outstanding convertible notes. We expect the non-GAAP tax provision in Q3 to be $1.5 million to $2.5 million. As a reminder, tax expense can be impacted by a number variables associated with our FIN 48 liability, including but not limited to a change in foreign income and product mix.

Regarding share count, we ended Q2 with a diluted share count of $234.9 million. In Q3, our diluted share count is expected to be approximately $236 million. For the upcoming quarter, we plan for the following significant GAAP to non-GAAP reconciling items. First, amortization of purchased accounting costs associated with past business acquisitions, stock option expense as required under FAS 123R, FX gains or losses on our net foreign tax liabilities. The income tax effect of the above adjustments and other tax items as specified on our reconciliation of GAAP to non-GAAP measures indicated in our press release issued today.

Additional non-reoccurring items associated with restructuring our costs, positive or negative are always possible.

With that we'd like to open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Harlan Sur of JPMorgan.

Harlan Sur – JPMorgan

As you mentioned, I did see the announcement of your second generation RAID controller last week. The question here is is this targeted for the ROM-ly (ph) generation of servers to more of a back half 2011, 2012 type of rollout by your customers? If so, I would assume that given some of the endorsements that we saw for this product by your customers that they will be adopting your solutions at least to 2012? Is that the way to think about it?

Greg Lang

That's probably a fair approximation. I think there is a good you can see products rolling out before ROM-ly (ph) rolls out, but in terms of kind of material revenue, meaning for big revenue, it's probably – it coincides with the ROM-ly (ph) generation. I think that's a fair assessment.

Harlan Sur – JPMorgan

On the Fiber to the Home, obviously the momentum continues to kind of pick up here, especially in China as you mentioned in your opening remarks. It seems like there is at least three or four other semiconductor competitors in the PON market, all of them are claiming good design win momentum in China. I think I have a good handle on this but if you could just help us clarify your sort of specific engagements with the equipment suppliers and service providers in China for the PON build-out.

Greg Lang

I don't think that there is a simple answer to the question, only because there is multiple different pieces in the market, there is EPON, there is GPON, there is the client side, there is the OLT side. On the client side, there is multi dwelling units, there is single family units, there is gray areas in between. So it's a fairly (ph) well fragmented market.

Our engagements in that spaces, we have been, I think in the 45% to 55% range in market share in China in particular for the last year or so and expect to kind of hold in there, and that really ranges across the business with the big guys that you would expect, ROM-ly (ph), ETE and to a lesser extent, Fiber to the Home in terms of the local providers here. We also have quite a bit of activity with some of the lesser known names that are considered the "ODMs" who are kind of smaller shops that do some of the CPEs equipment for the bigger customers.

So there really is kind of a multiple levels, multiple segments, multiple customers, so announcing a design win in one corner may not mean much because there is a (inaudible) to go after.

Harlan Sur – JPMorgan

And just a comment on the service providers that you think you got a little bit more overexposure to in China?

Greg Lang

Yes, and the carrier that's been the most active today and has the most subscribers – and that's where we have the most – so we have had very good traction there, that's China Telecom, kind of get things started early, more recently this year in particular China Unicom has started, although they have started slower than they would like and than we would like to see. We think we have comparable traction there.

The third one and probably the third in terms of size going forward, they don't really have a wireline business that they are building from is China Mobile, they are kind of coming from the mobile space. They are focused on GPON, and GPON is a place where we entered the market later than EPON; EPON, we had a really very good lead. So if you wanted to characterize the three, we would probably have the strongest positions at China Telecom and China Unicom, and lesser in China Mobile simply because we have had lesser traction on GPON than as compared to the EPON space. Obviously, EPON, we started in Japan and have a very, very strong footprint there as well as in Korea, and in EPON in China, we are also very strong. GPON, we are working on getting our penetration up there.

Operator

Your next question comes from Kevin Cassidy of Stifel Nicolaus.

Kevin Cassidy – Stifel Nicolaus

On the backlog coming into the quarter, it seems good. I think you said you think it's stabilizing like this and I just wanted see, going into fourth quarter do you see that the same or are lead times changing at all?

Greg Lang

That's a good question because I think that's an important part of the message today, which is we definitely have seen over the last six weeks or so, things start to stabilize. Fewer expedites, fewer panic buttons by our customers, some leveling out of some of the, I will call it hyper-expectations that people had, which I think is a good thing because I think it's a sign that people are more comfortable with the product that's coming in, the product they have in the shelves.

We have even seen and I commented on a couple of these areas, we are even seeing customers start to kind of readjust their inventory levels internally. It's happening in a pretty orderly fashion. I mean our business is still growing even despite some of these kind of little corrections that are going on.

So to me this is a very healthy time in the environment and it feels like it's going to be a very manageable period. I would like to see that continue. I think people are getting more comfortable at this plan, even though there is still tightness. So I think that our business will, over the course of the back half of this year continue to reflect the strong end markets that we are serving.

I am not sure if I answered the question. I kind took liberty and broadened it a bit, but did I get to the –

Kevin Cassidy – Stifel Nicolaus

Yes, absolutely, that was great, thank you. Maybe just if we go to the balance sheet, any plans for cash? What are your thought processes there?

Greg Lang

So, obviously very strong balance sheet, and we constantly review our capital structure and the level of cash that we had in what's core and what's, if you will can be utilized for other purposes. So nothing to specifically announce, but I can assure you that we are looking at this closely.

Operator

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

Ruben Roy – Pacific Crest Securities

Greg, I was hoping you can go through the pieces of the core business again in terms of guidance, you went through it a little quickly. If I assume that Adaptec puts in the revenues you guys had talked about back on the conference call a couple months ago, it looks like the core business is tracking flat to slightly down, which I guess is seasonal but I was just wondering if you can kind of get into the moving parts a little bit more. Thanks.

Greg Lang

Sure, sure. If you look at the core business, it's flattish to slightly up, so you are close. And underneath that we are seeing the storage business grow quarter to quarter, we will see the microprocessor business grow quarter to quarter and we will see the Fiber to the Home business grow quarter to quarter. So three of the main four segments or businesses that we look at are growing.

The fourth one is the offset to that, which is in the kind of the wireline metro business where we are seeing some inventory burn-off this quarter, in particular it's happening in China, it's probably the biggest single place. So that is kind of the overall mix of things, really, we are seeing good growth in each of the segments and I will call it an inventory burn-off in the other.

Ruben Roy – Pacific Crest Securities

On the storage side, is that mostly driven by the systems that you mentioned? I know you had a good quarter with HP in Q2 but are you seeing any pause with HP as they kind of ramp the LMEX (ph).

Greg Lang

The business on the server side is doing well and we are also seeing continued growth on the storage sides, where SAS designs in the last couple of years continued to grow. We think the nature of that business is less of the hockey stick type of growth and more of kind of a gradual transition.

So we think that SAS2 transition in the storage system space will continue for through 2011. So that's continuing pretty much as we have thought it would over the past year.

Ruben Roy – Pacific Crest Securities

Last call you had mentioned that we should potentially expect some revenues from your work with IBM to show up in Q3? Is that still on track?

Mike Zellner

Yes, and I think I mentioned that it would be modest small numbers in Q3 because we are just getting started, and Q4, I expect to get into $2 million range for the back half of the year basically.

Operator

Your next question is from James Schneider of Goldman Sachs.

James Schneider – Goldman Sachs

Greg, I was wondering if you could start off and give us a little more detail on the WAN or wireline business. I think it's pretty consistent what you're seeing with what some of your peers have been seeing in terms of some inventory build-offs. You mentioned China. I was wondering if you could maybe break it down for us and any particular pieces of that business, is it just backhaul, is it other parts of metro? What are the other trends you're seeing from a geographic standpoint?

Greg Lang

Let's start with the China piece in particular. The inventory that's being burn-off is more on the metro and aggregation side of things as opposed to backhaul. We saw actually a little bit of an uptick last quarter in the wireless side. So that is part of your question there.

The other part of your question was really about other geographies. We are seeing good healthy strength out of North America right now and actually I think AT&T came out with some announcements today, which – they are still planning on pretty nice amount of growth in their CapEx spending again heavily focused on the wireless space. And then beyond that, we are definitely seeing vendors, carriers getting geared up for this OTN transition starting with some trials late in the year and moving into good growth in 2011, good growth for us anyways as they start deploying this new packet based network that's going to help address some of the traffic problems they are having today.

James Schneider – Goldman Sachs

You mentioned storage, microprocessor and Fiber to the Home all being up in Q3. Can you give us a sense of which of those might be up the most?

Greg Lang

On a percentage basis, probably not so relevant. They are all up, they are all up a bit, none of them are up double or triple digits, they are all up a nice clip and then a little offset comes from the wireline side.

James Schneider – Goldman Sachs

Just to clarify, on the inventory on the WAN side, when you say that's going to be worked through by Q4, do you think it will be worked through before Q4 allowing you to grow in the fourth quarter or not really until the first quarter?

Greg Lang

Yes, that's a good question and that is the big question. We think that it will probably happen sometime in Q4. So I would like to see in particular for example, China, they kind of picked back up a bit in Q4. That's my current expectation but it's a little early to call that one at this point, looks like we can get there based on the rate at things are being burned through. So we hope that's the case.

Interesting to know, we are on the subject that we did have a bit of a burn-off last quarter in fiber channel, but fiber channel is growing this quarter. So that's a good sign that we have kind of worked through some of the inventory there. Same thing on the printer side where we burned off some excess inventory.

So we kind of piece by piece working through some of that and at the same still showing topline growth each quarter, which is the right, at least the profile we would like to keep.

Operator

Your next question comes from Mark Lipacis of Morgan Stanley.

Mark Lipacis – Morgan Stanley

On the enterprise side, I think this is the second quarter in a row where you have had some pretty good strength. To what extent do you characterize that as being just the end markets being healthy, people wanting to start to spend again versus you guys having a good product cycle in this 6 gig SAS area?

Greg Lang

We have actually had probably five quarters of good growth on the enterprise. So it's just not really the last couple of quarters and it's been a combination of two things I think. One is, and I think you have seen this from other companies' book or other companies may supply into the equipment guys but also the equipment OEMs are doing quite well. But on the server side, I think we have been both IBM and HP bounce back to above pre-recession level. So the business there is very healthy, very strong. People are buying and building new infrastructure, I think it's related to the same traffic challenges that I mentioned earlier for the carriers, people need to put in this infrastructure to be able to run their businesses and keep things rolling.

On the storage side, we have seen EMC, NetApp, and I think if you look underneath some details in HP, a lot of the storage guys are at or above or at least at their pre recession levels as well. So we have seen a really healthy recovery in this enterprise side of the business and that's benefited us across the board.

Now the other dynamic, which you mentioned is the transition to 6 gig SAS, which has been kind of an added uplift for us as well because as move those systems to 6 gig, we are getting some extra benefit on top of it. So it's been really a combination of all of the above over the past year, strengthening the underlying markets as well as our market position strengthening in that same period of time.

Mark Lipacis – Morgan Stanley

Last question, when you hear most semiconductor companies talk, so far this earnings season, last several quarters, most of them – they're not seeing any inventory whatsoever and for the most part the supply chain seems to be extremely lean. But you guys seem to have seen some burn-off and a pickup again.

Two questions on this. One, when you talk about the inventories, are you talking about inventories of your chips or inventories of your customer products? Second question would be why do you think you guys are able to see this? Do you have visibility deeper into the supply chain do you think than maybe some of the other semiconductor companies out there? Or maybe it's just the nature of the fact that your customer's order patterns are a little bit different? Any kind of color on that would be helpful.

Greg Lang

Good question. First, just let me clarify the first thing. When I am referring to the inventory burn-off, primarily I am referring to the components that are sitting at some of our customers' shops. Now you can of course see inventory show up in system form in the channel. But most of what I referred to today was our own components sitting at inside of one of our customers that they need to use before they buy more.

To the answer the bigger question though, the tightness for the products that, all of us in semiconductors have been selling, has really been driven by, in part the capacity on a particular foundry and a particular process now. So foundry A might have plenty of capacity at 40 nanometer but we tied on 0.35 micron and then foundry B might be a different mix.

So, there isn't going to be I think a single answer to the question. I think it's really going to come down to where is the tightness and how much – and sometimes individual product lines have been affected by the capacity constraints. I can say that – well, I will give you a datapoint. Last quarter we met 98.8% of some very aggressive commit dates to our customers, which is good even in normal times but really, really good given the environment.

So we have been able to keep our customers in pretty good shape with our parts, given the way that we have managed our supply line, which gives them comfort and confidence that they are not going to be short at, which allows them to take a more normal/rational approach to how they are buying parts from us.

Now if we were in a different situation where we were constantly constrained over the last six months, my bet is we wouldn't see a change in behavior because they would still be concerned about getting supply.

So it really is almost a process by process type of question. We happen to be in a situation where the foundry and the process that we are using are in pretty good shape. I think we managed it really well and so we are seeing kind of, I would call it a relatively early adjustment back to normal.

If you look at our inventory turns, they are in very healthy shape at 6.5 times, which our goal or target is 6. So we are pretty much right where we like to be and then disti channel, our turns actually increased last quarter.

So overall we think the supply line is pretty healthy and balancing itself out in a very orderly way.

Operator

Your next question comes from Sandy Harrison of Signal Hill.

Sandy Harrison – Signal Hill

Just some quick questions surrounding like the maxRAID. If you look at selling more of a system solution, how is the sales channel adjusting to that sale and what are some of the challenges that you've incorporated with this new sale?

Greg Lang

That's a good question. We have a big part of the rational for bringing on the team from Adaptec was really bringing their sales team that knows how to sell into that channel and understands the dynamics and has the relationships, etcetera. So the way we have dealt with it thus far is we have brought on people who are experts at it and had decades of experience in doing it.

So we basically bought the team that knew how to do this. So that was a big part of the value proposition there. Now the positive part of it, one of the positive outcomes from that is we get much closer touch to the end customer base and the datacenter customers that are actually deploying the technology. So it's going to give us some extra insight as we are developing products and technology in the roadmap going forward, just having that extra touch and seeing what people are really doing with their products, I think would be very beneficial for us.

Sandy Harrison – Signal Hill

Along those lines, when do you expect to see some of the newer products to come out of the acquisition and putting together the parts that you guys have developed to introduce these newer products? Is that 3 months, 6 months, 12 months, how quickly do you think you could see some of that come out of there?

Greg Lang

Our current goal right now is to get kind of (inaudible) based on PMC, so looking in the Q1 timeframe, Q1 of 2011.

Sandy Harrison – Signal Hill

If you cross what the Chinese government and talking about spending for not only increasing broadband subscribers but also wireless subscribers and you match up what they thought they would spend this year with what they've spent already, it suggests there's a pretty strong second half ramp on their part. Is that consistent with what you guys are seeing and hearing? Is there some concerns to be had that maybe they were pumping up the numbers a little bit in the popular press? What are sort of your thoughts on that whole big picture?

Greg Lang

It seems to me that on the wireless front, they are pretty much on track with what they said they would do the things, seem to align and that's based on what we see, what we hear from others, etcetera. It seems like we are on track. Fiber to the Home, I would argue is a hair behind where they said and I would probably say that's probably China Unicom getting a little slower start than what they would have liked to when they made their announcements late last year.

So that's my general assessment. Wireless seems to be on track; Fiber to the Home, a little bit behind, should and both I think should bode well for a healthy second half.

Sandy Harrison – Signal Hill

As you look at some of the new markets you've gotten into and the storage, taking the maxRAID and now getting that out with your new sales channel or going after it in a little bit different way than you historically have, are you finding any other markets out there adjacent to what you are doing or complementary to what you are doing that you are finding potentially attractive to enter or looking at going after?

Greg Lang

Sure. I mean we are always looking at the opportunities to grow, we have several new programs, products in development, some of which are follow-ons to what we already do, some of which are extensions, entering (ph) into the new markets. There is not a new one that we have announced at the moment. Having said that, we have a lot of room to grow. For example in the storage market by itself, it's roughly a billion dollar market opportunity and we are probably half of what our potential is in that space. So lot of room to grow there.

In the telecom arena, we have talked a lot about the growth in front of us and the opportunities in front of us in the OTN space. And really we have been just talking about kind of 10 and 20 gig solutions, but 40 and 100 gig solutions will be coming right after that and probably faster than we expect to given all the traffic growth that happening right now. And in wireless, there is a tremendous amount of activity there for all the same reasons.

So I think in our core business there is a whole lot growth in the execution on our part to realize that growth and that will continue to be job one. And in time, you will see us actually wrench on some other areas as well but nothing to announce today.

Operator

Your next question comes from Eric Ghernati.

Eric Ghernati – Bank of America/Merrill Lynch

Mike, just looking at the OpEx profile heading to the fourth quarter, would you expect that to change with the Adaptec, was there any puts and takes that we should be thinking about, and similarly on the gross margins?

Mike Zellner

So, obviously Q3 gets this on, a run rate that includes them in for a full quarter, that is the Adaptec piece. So there are some areas that we are modestly increasing our investment on the R&D side, and we are not guiding into Q4, so I am not giving any specifics on it, but there could be some kind of minor additional investments that way, but certainly nothing significant. Our belief is that the level that we are at in Q3 really is kind of our new baseline, now that we have pulled Adaptec into that.

Greg Lang

The only addition to that would be big tapeout might swing that (inaudible) quarter to quarter but that's kind of normal course and speed.

Mike Zellner

Right, and then again in terms of gross margins, every now and then we do have a little bit of movement because of normal product mix, some other things that Greg was talking about with our wireline business etcetera. But we are kind of at the level that we think we will run at for a while, in fact once we did, our products that we are selling through our channel division ported to PMC Silicon, they should actually improve a bit from there. Of course, that's as Greg mentioned not until kind of the first quarter next year but nonetheless that should help the profile of the products that we are selling through the channel once it's on PMC Silicon.

Eric Ghernati – Bank of America/Merrill Lynch

Greg, with respect to your fiber channel storage business, how should we think about the growth profile going into Q4? It's normally pretty strong. You have guided for only modest growth in Q3. How should we think about that for Q4?

Greg Lang

Yes, Q4 last year was our strongest quarter of the year, the year before was the strongest quarter of the year. We are relatively newbies into the storage space over the last five years, but it does seem that Q4 is a good strong seasonal quarter. So we would look for another quarter of growth in Q4 as well. I mean this quarter is going to be our best ever in that business and we expect to grow from there. So I think the underpinning drivers are still really the same. It's the SAS2 transition on the system side, strong growth from HP, some additional revenue that we should experience on the IBM side and the 8 gig fiber channel transition as well.

So things are lining up well in the storage business.

Operator

(Operator Instructions) We have a follow-up question from Harlan Sur of JPMorgan.

Harlan Sur – JPMorgan

You have got the RAID adapter solution out there as you mentioned. IBM is using it on its 4 and 2 socket eX5 systems. So you have got the high end system out there or the high end solution out there. I think the team's strategy is to start to trickle down, sort of pare back solutions for the high volume server markets. When should we see those RAID adapter solutions being announced?

Greg Lang

That's a good question. I think one of the things that Adaptec also brings to us is some more capability on the board side and I think over the course of the next couple of quarters, our ability to deliver a broad range of products in that space will grow. And in that period of time, I would like to think we will be able to earn some more of IBM's business as well.

So in terms of impacting revenue, I would expect it to be out in the first part of 2011. But you are right, our goal is not to stop where we have kind of just got in the door, but to continue – I like to think of it as a waterfall rather than a trickle down, but waterfall down into the balance of the IBM product line. But that's something that we are actively working on as we speak.

Harlan Sur – JPMorgan

Obviously, as it relates to customers outside of IBM, obviously, they have the same solution that IBM is currently ramping into production today. Can you just give us a sense of sort of the feedback and if there in qualifications, early indications of how the qualifications are going with some of these other customers?

Greg Lang

I would like not to jump the gun on kind of pre-announcing anything, but we definitely are working with the other major guys both through the big ones via direct channels and some of the next level down through some indirect channels. But lot of these folks are interested in having two suppliers and right now they are really locked into one, and we see good opportunities to kind of break into a number of accounts, both other Tier 1 accounts as well as Tier 2s and channels account for that matter.

Operator

Gentlemen, there are no further questions from the phone line. I will turn the conference back to you.

David Climie

Thank you, operator. Thank you for attending our conference call today and we will be scheduling our third quarter 2010 conference call for the third week of October. At that time, we will be reviewing quarterly results and providing an outlook for our fourth quarter. So thank you for attending and that ends today's call.

Operator

Thank you. Ladies and gentlemen, this does conclude the conference call for today. We thank you for participating. You may now disconnect your lines and have a great day.

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