Executives
David Climie – Vice President,Marketing Communications
Mike Zellner – Vice President andChief Financial Officer
Bob Bailey – Chairman and ChiefExecutive Officer
Analysts
Sandy Harrison – Signal Hill
Shawn Webster – J.P. Morgan
Allan Mishan – CIBC World Markets
Ruben Roy – Pacific CrestSecurities
Kathryn Buergert – A.G. Edwards
Seogju Lee – Goldman Sachs
Jeremy Bunting – Thomas WeiselPartners
Romit Shah – Lehman Brothers
PMC-Sierra, Inc. (PMCS) Q3 2007 Earnings Call October 18, 2007 4:30 PM ET
Operator
Good day and welcome toPMC-Sierra's Third Quarter 2007 Earnings Release and Conference Call. Today's conference call is being recorded. At this time, I would like to turn theconference over to Mr. David Climie, VP, Marketing Communications. Please go ahead, sir.
David Climie – Vice President, Marketing Communications
Thank you, operator. Good afternoon everyone and thank you forattending our investor conference call. Withus on the call today is Bob Bailey, Chairman and CEO and Mike Zellner, VicePresident and CFO. Please note that ourthird quarter 2007 earnings release was disseminated today via Business Wireafter market close, and a copy of the release can be downloaded from ourwebsite.
Before we begin, I would like topoint out that during the course of this conference call, we will be makingforward-looking statements that involve a number of risks and uncertainties. These risks and uncertainties include but arenot limited to product demand, inventory levels, exchange in taxation rates,and other risk factors detailed in the company's Securities and ExchangeCommission filings. Actual results maydiffer materially from the company's projections. For further information about these risks anduncertainties, please read the company's SEC filings including our Forms 10-Kand 10-Q.
If you are asking a questionduring the Q&A session of today's call, we request that you limit yourselfto one question at a time and then simply re-queue with the operator. Thank you and I'll turn the call over to MikeZellner.
Mike Zellner – Vice President and Chief Financial Officer
Thanks, Dave. I'll review our third quarter 2007 resultsand financial position and then turn it over to Bob to discuss our businessactivity in detail. Q3 was a strongquarter for PMC-Sierra. Our book-to-billwas greater than 1.1. Revenue for thequarter was $117.5 million, representing an increase of $12.8 million or12% versus Q2.
As a reminder, we began to deferinternational revenue in Q2 associated with our largest distributor, reflectingour global agreement with them. Excludingthis one-time impact in deferral in Q2, our quarter-over-quarter revenue growthin Q3 versus Q2 would have been 8%. Thisincrease in revenue was primarily the result of improved activity in ourwireline business.
Our turns business, meaning thoseorders booked and shipped within the quarter, was 33% of revenue in Q3 comparedwith 28% turns in Q2. In Q3, our twolargest customers, EMC and Cisco, each exceeded 10% of overall revenue for thequarter. No other customer accounted formore than 10% of revenue.
Quarter-over-quarter revenuegrowth was strongest in Asia with a vast majority ofthis growth coming from our largest OEM customer in China. By region, Asiacontinued to generate strong results in the quarter with the geographicbreakdown as follows: Asia67%, North America 20%, Europe10%, and other geographies 3.
On a non-GAAP basis, grossmargins in Q3 increased to 66.3% versus 64.5% in Q2. This was primarily due to stronger wirelinebusiness in the quarter, which has higher gross margins.
The company's operating expensesreflected continued savings as a result of the restructuring announced in Q1. On a non-GAAP basis, operating expenses weredown $8 million to $51.9 million in Q3 versus $59.9 million in Q2. Operating expenses continued to decreaseprimarily due to our focus on controlling costs from our previously mentionedrestructuring efforts combined with decreased photomask and wafer costs onfewer tapeouts in the quarter. We doexpect increased tapeouts in Q4.
Breaking down operating expenses,non-GAAP R&D was $31.8 million in Q3 versus $37.2 million in Q2 andnon-GAAP SG&A was $20.1 million in Q3 versus $22.7 million in Q2.
Non-GAAP operating income in Q3was $26 million or 22% of sales, which aligns with our targeted operatingmargin levels. Net interest income of $2.7million in Q3 was up slightly from Q2 due to our increased cash balance.
Our non-GAAP tax rate was 32% forthe quarter. This came in higher thanexpected primarily due to the ongoing impact of our FIN 48 liability. In addition, we generated increased income inrelatively higher tax jurisdictions due to product mix. Although it's difficult to predict aquarterly tax rate due to the impact of our FIN 48 position, we expect the taxrate will remain in the low 30s until we resolve the outstanding matters.
Non-GAAP profit after tax for Q3was $19.1 million, or $0.09 per share on a fully diluted basis. For detailed reconciliation between GAAP andnon-GAAP results, please see our press release issued today.
Q3 GAAP loss per share was $0.03. The primary reconciling items for Q3 are asfollows:
First, stock option expense orFAS 123R of $8.1 million, amortization of intangible assets $9.8 million, and significantFX movements in the quarter drove a net unrealized foreign exchange loss of $6.8million related to our foreign denominated FIN 48 liabilities.
Restructuring charge of $1.6million. Again in March of this year, weannounced a corporate restructuring of approximately 175 people or 14% of ourworkforce. The total costs and chargesassociated with this restructuring were estimated to be between $12 and $14million, of which $12.4 million has been expensed to date.
Turning to the balance sheet, we endedthe quarter with $328 million of cash and cash equivalents. Free cash and cash equivalents net of our $225million of convertible debt increased $29.7 million to $103 million, up fromthe net cash position of $73.3 million in the prior quarter.
The primary reasons for theincrease in the company's net cash position were as follows: Positive non-GAAP cash flow from operations inthe third quarter of $25.9 million and cash received from ESPP and stock optionexercises of $6.5 million.
Offsetting these increases wereoutflows of $2.7 million associated with capital expenditures and intangibleassets.
Accounts receivable increased $4.6million to $41.4 million, which equates to 32 days' sales outstanding based onour quarterly sales volumes. Our netinventory at the end of Q3 was $30.5 million, an increase of $2 million fromthe prior quarter. Net inventory turnson an annualized basis were 5.2, down slightly from the prior quarter's 5.3turns.
I'll now turn it over to Bob forhis briefing.
Bob Bailey – Chairman and Chief Executive Officer
Thanks, Mike. PMC's revenues in the third quarter climbed8% sequentially following revenue growth of 5% in the second quarter. Our Q3 revenues of $117.5 million exceededthe high end of the revenue outlook we'd estimated for the quarter, as ourturns activity was slightly better at 33%. The company's book-to-bill ratio at the end of the third quarter wasstrong at over 1.1.
In general, the markets thatPMC-Sierra serves continue to improve as we are still in the very early stagesof a triple-play deployment trend. Atthe same time, there are general access and transport network upgrades in thewide area network and storage system upgrades in the enterprise ongoing. We expect to see continued capital investmentin the access and metro transport networks of the service providers as well asimproved capital spending on enterprise storage systems as multimedia contentand applications become more mainstream. The downloadable economy driven by new web applications and the iPodgeneration is driving this new wave of capital investment. We also see certain of our telecom customers,where PMC has significant content, gain share, in turn increasing PMC-Sierra'smarket share. This is particularlyapparent in the transport segment. Thisis happening at the same time our efficiencies with respect to fixed costs haveimproved as a result of initiatives announced earlier in the year. As well, operating cash flow was robust. Inventories are at a healthy level within thesupply chain. Demand appears to bestrong as evidenced by healthy backlog going into the current quarter.
During the third quarter, ourtelecom business picked up rapidly in the August timeframe based on increasedAsian service provider contract activities and as a result, we experiencedstrong booking activities. Ourenterprise storage business improved again in Q3, while the fibre-to-the-homebusiness was slightly down, and our MIPS related microprocessor businessexperienced a modest seasonal decline in Q3 as expected.
We had a good quarter of designwin activity. In Q3, we believe theinventory levels will work down on the supply chain, and for most of ourcustomers we believe we are shipping into consumption levels. Unless there is an abrupt slowdown ofbookings, we expect continued growth into Q4 of this year. Overall, our visibility is good and we expectto grow sequentially, while at the same time we'll continue to focus on ouroverall expense structure.
We have done a good jobcompleting key development projects in Q3 while implementing the cost reductionprogram ahead of schedule. From ageographic perspective, Chinashowed continued improvement during the third quarter of this year,significantly outpacing North America and Europeas Mike reported earlier.
During Q3, we introduced a numberof new products including our highly integrated WiMAX radio frequency IC. This chip we call the WiZIRD is the firstchip with two transmission-out/two transmission-in MIMO capability supportingdownlink rates of 63 megabits per second and uplink rates of 28 megabitsper second.
The WiZIRD device is targeted at femtocellbase stations, customer premise equipment, mobile base station designs, andlaptop air cards, and its multi-band capability covers all licensed radiospectra worldwide. We announced apartnership with a private company to provide mobile WiMAX OEMs with acomprehensive solution. Our referencedesign combines the baseband MAC solution with our WiZIRD RF IC and requisitesoftware. We launched this product atWiMAX World USA at the end of September. We had more than 20 customer meetings there. Many of these meetings resulted in agreementsto evaluate our platform. We expect toclose several design wins in the coming months.
At this trade show and throughthese evaluations, we are having confirmed by the industry's leading wirelessOEMs that this is the highest performance WiMAX RF IC available today. We have already secured Asian design winsbased on the reference design that is currently available, so we are verypleased with the early stages of this program. We are very excited about WiMAX as a technology. We believe it will become mainstream wirelesstechnology that will complement our fibre-to-the-home program as the accesstechnology of the future at the expense of cable modems and DSL.
In enterprise storage, theongoing trend towards mid-range and low-end storage systems is driving stronggrowth in 4-Gig fibre channel disk array interconnect requirements andincreasing customer demand for PMC's cut-through loop switch and enclosuremanagement processor product family.
Industry checks are indicating apositive trend in storage IT spending for Q4 of '07, with sequential growthexpected for our Tachyon storage controllers as well as our disk interconnectproducts. Following the ongoingindustry-wide adoption of SAS and SATA technology, tier I storage OEMs arebeginning to introduce enterprise-class storage platforms based on 3-Gig SAS/SATAarchitectures using the SAS expander disk interconnect switches from PMC.
Notably, Network Appliance's FAS 2000platform and Dell's PowerVault MD3000 were recently introduced using PMC-Sierra'sSAS expanders, enclosure management processors, and system firmware. We continue to secure additional design winsinvolving 4-Gig fibre channel and 3-Gig SAS/SATA with our North American andAsian OEM customers. In the thirdquarter, once again our enterprise storage design win dollar content exceededthat of our telecom products.
In the wireline market, wecontinue to see increasing demand largely driven by deployment activities fromChinese OEMs. This activity isassociated with service provider requirements and large contracts for metro opticaltransport equipment. Many of the OEMplatforms being selected today for deployment contain PMC devices that weredesigned into those platforms between 2004 and 2006.
PMC's Chinabusiness is also benefiting from improved activity in low-end routers andwireless infrastructure as well as Chinese OEM wins in the internationalmarkets. We continue to see momentum onthe design win front with our CHESS metro optical product line where weachieved wins with Huawei and FiberHome in Chinaduring this past quarter.
Wireless base stations andbackhaul is also an area of strength as well as for design wins for several ofour products. Most of our telecom OEMcustomers placed orders with sufficient lead times during Q3, so backlog goinginto Q4 is strong. As a result, we areexpecting our turns business to be a little lower in Q4, and we are watchful ofthe typical feast-and-famine cycle of the telecom capital investment cycle. But for now, we are benefiting from thiscycle.
In fiber-to-the-home, we sawbusiness in Q3 slightly down due to it being a seasonally slower quarter. Japanese activity in the third quarter didincrease, however, with our three major OEMs improving. In addition, two of our Japanese OEMcustomers were awarded additional EPON ONU business using our parts with NTTtargeting at the video PON market, which is cable TV over PON. This will result in additional revenuecontributions in 2008. In Korea,Korea Telecom has slowed its initial fiber-to-the-home deployments. With regard to fiber-to-the-home in China,we continue to demonstrate interoperability with our leading edge end-to-endEPON solutions, and some field trials of EPON fiber-to-the-home are nowstarting. We have won approximately 15different designs in Chinawith our EPON ONU solutions, all addressing different provinces and deploymentschedules. We are expecting revenues inthe millions in 2008 in Chinain EPON.
In North Americaand Europe, we are engaged with equipment manufacturerson GPON solutions for end customers in those markets. We have a GPON ONT reference design, and we'llbe announcing additional GPON products featuring our GigaPASS architecture,which is deployed in the Asian EPON markets. Several evaluations are ongoing.
Now for the outlook. Based on our backlog and bookings to date aswell as expected levels of capital spending in the end markets that we serve,we expect PMC-Sierra's revenues in the second quarter of 2007 to be in the – I'msorry, the fourth quarter of 2007 to be in the range of $122 to $126 million ora sequential growth rate of 4% to 7%. Interms of anticipated business activity, we are expecting enterprise storage togrow in Q4 compared to the third quarter based on the growth in 4-Gig fibrechannel as well as some of our SAS products.
With regard to communications, weare expecting continued growth in Q4 largely driven by strength in Asiaand recovery in the North American markets. However, as mentioned, lower turns are expected in this area. Fiber-to-the-home is expected to increaseslightly and our macro processor business is expected to be shipping at asimilar rate in the fourth quarter as compared to the third.
I believe PMC is well positionedin the growth markets that we serve and that we are gaining market share inmany of those segments. In addition, weare now starting to benefit from the cost reduction initiatives that welaunched in Q1 of '07. Given our strongdesign wins so far this year and many of our new product initiatives such asour WiMAX RF IC and our server-based RAID controller product, I feel verypositive about PMC's performance.
Thank you. I will now hand the call back over to Mikefor more details on our outlook for the fourth quarter.
Mike Zellner – Vice President and Chief Financial Officer
Thanks Bob. I'll now provide more information about ourQ4 2007 outlook. Judged shipped andshippable backlog at the beginning of Q4 was approximately $98 million comparedto $78 million at the beginning of Q3. Asof today, judged backlog including shipped plus shippables is approximately $107million.
Based on this information,considering the current levels of demand and general uncertainty as to bookingrates throughout the quarter, we estimate that potential revenue for PMC-Sierrafor Q4 is in the range of $122 to $126 million.
On a non-GAAP operating basis, weexpect our overall gross margin percentage in Q4 to remain consistent with Q3. We expect non-GAAP Q4 operating expenses tobe approximately $1 to $2 million higher than Q3 levels primarily due toincreased tapeout activities. We expect non-GAAPnet other income to be approximately $2 million.
As previously noted, we expectthat tax rate will remain in the low 30s due to our FIN 48 liability. As a reminder, the effective tax rate can beimpacted by a number of variables associated with our FIN 48 liabilitiesincluding but not limited to a change in product mix and a potential full orpartial resolution of the underlying tax matters.
Finally, as we end Q3 with abasic share count of 217 million and a diluted share count of 219 million, ourbasic share count is expected to be between 217 and 219 million in Q4 and ourdiluted share count, which will likely be impacted by dilution associated withour convertible debenture is expected to be between 225 and 230 million.
For the fourth quarter of 2007,we plan for the following significant GAAP to non-GAAP reconciliation items. First, amortization of purchased accountingcosts associated with past business acquisitions, stock option expense asrequired under FAS 123R, FX gains or losses on our FIN 48 liability. Additionally non-reoccurring items always arepossible associated with other activity, positive or negative. Now, let me turn it back over to Bob for hisclosing comments.
Bob Bailey – Chairman and Chief Executive Officer
I would now like to provide somecommentary on the second press release that the company issued today regardingmy decision to retire as CEO of the company. As most of you probably now know, I have announced my intention toretire. As a result, the Board ofDirectors is in the process of launching a search for my successor. Both internal and external candidates will beconsidered. I will stay on in my currentrole as CEO until a successor is appointed and in place. I will continue to serve as Chairman of theBoard.
There is a search committee ofwhich I am a part. There will be nochanges in my work schedule, there will be no change in how we work. There is much work to do and I am as motivatedas ever to make sure that this work is accomplished as effectively as possible.
This was my decision. The combination of PMC-Sierra havingrelatively good momentum as well as my wanting to pursue some personalendeavors made this the right time to make my decision and to commence a searchand transition. The Board and I wantthis to be a transparent and orderly process, which is why we are announcing myintentions now. I am not seeking norinterested in any other job.
I have worked at PMC-Sierra since1993. The Board, the employees, and Ihelped our customers to build the first generation Internet. It is something we are all very proud of. But the thing I am most proud of is thecompetitiveness and technical prowess of the company despite having gonethrough the most dramatic down-turn in the semiconductor industry's history. PMC-Sierra is now thriving as evidenced byour profitable growth and healthy new product offerings. We know what we have to do. We have our fate in our own hands; in thisbusiness this is all you can ask for.
In early 2001, we booked negativebookings in Q1, not a book-to-bill below 1, negative meaning cancellationsexceeded new bookings. Our revenuesdropped 80% within four quarters. Inretrospect, there was approximately three years of excess inventory in thesupply chain at the time. We were goingthrough what Andy Grove called a strategic inflection point. The world was now different. PMC's business was vastly NorthAmerican-centric, telecom-centric, and had customers that were shrinking at analarming rate.
We had to change our top 10customers. We had to diversify ourproduct mix and markets served. We hadto dramatically reduce our fixed costs, and we had to change our culture. I don't want you to think for a minute thatwe think we are done. We have much workto do, but today we have two-thirds of our revenues in Asia. Our headcount is almost half of what it wasin 2000 even after two large acquisitions. We are 50/50 telecom and enterprise inrevenues and 7 out of the top 10 of our top customers are different since 2002while becoming solidly profitable.
In fact, we are at modelprofitability today. And I believePMC-Sierra's employees are of a more competitive culture. We have ingrained a culture of execution andaccountability that runs deep and is self-sustaining. I want to take this opportunity to thank theBoard of Directors and the long-term investors for having the patience to seethis metamorphosis through. I want toespecially thank the employees who have had to endure much uncertainty whileexecuting in a world-class manner. Ofall of our accomplishments, it's the professionalism and competence of ouremployees that makes me the most proud. SoI am not going anywhere soon. It isbusiness as usual. Now we can take someof your questions.
Question-and-Answer Session
Operator
Thank you, sir. Ladies and gentlemen, if you would like toask a question, please press "*" "1" on your touchtonephone. To withdraw your question, pleasepress the "#" sign. If you areusing a speaker phone, please lift the handset before entering your request. Please standby for the first question.
The first question comes fromSandy Harrison, Signal Hill. Please goahead.
Sandy Harrison – Signal Hill
Well, Bob, I just wanted to saythanks for the wild ride. It's been somefun times.
Bob Bailey – Chairman and Chief Executive Officer
Thank you, Sandy,and best of luck to you.
Sandy Harrison – Signal Hill
As far as talking about what youguys are looking at from a fiber-to-the-home perspective, you talked a littlebit about the fact that you've made some inroads into the cable area over in Japanand in the NTT world. Is this somethingthat you think you can continue with the momentum made in some of the otherareas such as Koreaand China? Isthis sort of a unique opportunity that you've got to the Japanese market? And specifically when you look at Chinabuilding out its infrastructure not only from a fibre-to-the-premise but alsobuilding out some of its digital cable for perhaps providing the service forthe Olympics, how does that sort of fit into the grand scheme of things forthis market segment?
Bob Bailey – Chairman and Chief Executive Officer
Well, Sandy,they have -- these different cable MSOs have different architectures. This one was very specific. It's more of an overlay because it's -- I don'tthink it's a retrofit. And it's a smallpiece, although, we'll take it. It'sadditive as I pointed out. But I willtell you that most of the cable operating companies including the ones in North America are looking at PON as a technology. They're trying to figure out how to use itbecause it's predictable if you want to run 100 high-definition channelssimultaneously that the coax plant runs out of gas, it doesn't have enoughbandwidth. And so these areopportunities that we are looking at and are pursuing, but they're less maturethan the one in Japan.
Sandy Harrison – Signal Hill
Got you. And then just a quick follow up and I'll passthe call. Gross margin, you saw that acouple quarters back when the com business -- telecom business slowed down yousaw the hit to the gross margins and you have seen that come back with a risein the contribution of telecom. Lookingin your crystal ball, do you think that these levels of gross margins aresustainable realizing we have sort of come back to them? Or do you think we'llhave some more truing up as fiber-to-the-home and some of the MIPS picks backup early next year?
Mike Zellner – Vice President and Chief Financial Officer
It's Mike. I mean, we are suggesting that our marginsshould stay in the 60% to 65% range and for sure, there are some pressures onthose. We obviously continue to doeverything we can to maintain our margins and pricing in those areas wherethere's a little more pressure on them. Butwe are predicting that it will stay the same. Certainly, the strength in wireline helps that, and there is no reasonto believe that that's going to drop off (inaudible) any time soon. So we think that we can kind of continue inthat range.
Sandy Harrison – Signal Hill
All right. Thanks guys. I'll go back in the queue.
Operator
The next question comes fromShawn Webster, J.P. Morgan. Please goahead.
Shawn Webster – J.P. Morgan
Yes. Good afternoon. Thanks for taking my questions. And, Bob, good luck with your search and goodluck in retirement.
Bob Bailey – Chairman and Chief Executive Officer
Thanks.
Shawn Webster – J.P. Morgan
The -- if I am calculating itright, it looks like turns is about 20%, 21% for Q4. Is that right?
Mike Zellner – Vice President and Chief Financial Officer
That's correct.
Shawn Webster – J.P. Morgan
Okay. So can you help us understand your mindset onwhy you are taking a little, or maybe a lot of judgment? What are you hearing, what are you seeing interms of linearity that's making you cautious?
Mike Zellner – Vice President and Chief Financial Officer
Yeah, I mean, lead times arecoming – are pulling back, and they are getting normal. I think that when we -- as I mentioned when Italked about the outlook, there is definitely some variability in the bookingsin the current quarter and we kind of see that. So we just thought it was appropriate to consider that and we did infact. Obviously the bookings, thebacklog is strong, as you have observed, but we think it's the right thing todo to kind of consider that.
Shawn Webster – J.P. Morgan
I see. And can you quantify or talk a little bitmore about lead times? What they did,where were they exiting Q2, where they are now, and where do you think they aregoing?
Bob Bailey – Chairman and Chief Executive Officer
Well, it's very specific totechnologies. But as an average leadtime, they were stretched out beyond the norm last quarter and as a result, wegot a lot more backlog, and now I think, I don't know if they are quite tonormal yet, but they are getting to normal levels, and that's why we expectlesser turns as a result.
Shawn Webster – J.P. Morgan
And is that because you were ableto bring supply online or what's the dynamic there?
Bob Bailey – Chairman and Chief Executive Officer
Yeah, it's – well, the – oursuppliers caught up with demand.
Shawn Webster – J.P. Morgan
Okay. And in terms of the com supply chain, yousaid things appears pretty lean, can you give any detail like how do you seethe wireless infrastructure supply chain, the traditional telecom andenterprise? And yeah, well, I guess, start with there.
Mike Zellner – Vice President and Chief Financial Officer
Well, we track our own -- we don'treport it, but we track our own trading partners' and distributors' inventoriesas well as our own of course, and we are at approximately model level right now,whereas when things were not going that well we were not at model level.
Shawn Webster – J.P. Morgan
I see. Is there any area in the supply chain thatlooks particularly lean, like telecom, enterprise, wireless?
Bob Bailey – Chairman and Chief Executive Officer
Not really.
Shawn Webster – J.P. Morgan
Okay. Things are normal?
Bob Bailey – Chairman and Chief Executive Officer
Yeah.
David Climie – Vice President, Marketing Communications
Shawn, it's Dave Climie, can we -- you have had two or threequestions, would you mind if you have one quick one, and then re-queue, and sowe can let others in on the call?
Shawn Webster – J.P. Morgan
Yeah. I've just one really quick final one then. What was your com business as a percent ofyour total sales, and what did it do sequentially?
Bob Bailey – Chairman and Chief Executive Officer
Yeah. We...
Mike Zellner – Vice President and Chief Financial Officer
Yeah.
Bob Bailey – Chairman and Chief Executive Officer
We don't really break it out tothat level of granularity, Shawn. Theseguys will go over that with you offline a little bit.
Shawn Webster – J.P. Morgan
Okay. Thank you.
Operator
The next question comes fromAllan Mishan, CIBC World Markets. Pleasego ahead.
Allan Mishan – CIBC World Markets
Hey, guys, and good luck to youBob in the future. I have a questionabout the MIPS business and the fiber-to-the-home. You mentioned that they were down slightly inthe quarter. Is that down excluding thedeferral impact, or were they actually down from the revenue that you booked inJune in those two businesses?
Bob Bailey – Chairman and Chief Executive Officer
It's really -- it's excluding the deferral. I mean, you can add to it...
Mike Zellner – Vice President and Chief Financial Officer
Yeah.
Bob Bailey – Chairman and Chief Executive Officer
But it's really excluding thedeferral impact.
Mike Zellner – Vice President and Chief Financial Officer
Right.
Allan Mishan – CIBC World Markets
So those businesses actuallycould have been up versus what you booked in Q2?
Bob Bailey – Chairman and Chief Executive Officer
No.
Mike Zellner – Vice President and Chief Financial Officer
No. What I am saying is we -- the comments were kind of considering the overall businesslevel going from Q2 to Q3. So in otherwords, if you consider that Q2's revenue would have been 1088, so when we talkabout the -- the kind of the business level quarter to quarter, we kind of considerthe fact that we had a deferral in Q2, and we adjust for it.
Allan Mishan – CIBC World Markets
Okay. Great. And two of the big European telecom OEMs had significant negativepre-announcements this quarter. Did youguys see a slowing in wireless business outside of Asia? Or are those guys still catching up fromwhen they were reducing inventory? Howdo you sew that up?
Bob Bailey – Chairman and Chief Executive Officer
Well, it's a pretty small pieceof our business, so we really weren't --the European wireless stuff, we don't have as a significant percentage ofour business, so it really didn't impact us much. But we also see a lot of our Asian customersseem to be gaining share.
Allan Mishan – CIBC World Markets
Okay. Fair enough. Thanks again.
Operator
The next question comes fromRuben Roy, Pacific Crest Securities. Pleasego ahead.
Ruben Roy – Pacific Crest Securities
Yeah. Thank you. Bob, I was wondering if you would comment a bit more on the FTTH businessin terms of the competitive landscape? Oneof your smaller competitors announced some design wins in Japan in the NTTnetwork, and I was wondering if you would comment on that and what thecompetitive landscape looks like in other geographies like Korea and China. Thanks.
Bob Bailey – Chairman and Chief Executive Officer
Sure. Yeah, there was an announcement by acompetitor that has presumably been qualified to ship some product into the NTTnetwork in the ONU or the subscriber side only. We have that factored into our business plans and our guidance, and westill have the vast majority of market share. We have newer products coming out that we don't believe anyone else willbe able to match in the EPON space that we are working on as we speak. And so we feel very strong competitive wise. I think it is unreasonable for us to expectthat in a business that we believe is going to be very strategic and veryimportant to all of the carriers that we will have 100% market share. So we figured that there would be somebodywho would show up and start to get qualified, but we are not too concernedabout it. I mean we always have to tryto maximize that share, and we are doing that.
Korea,they are going through, you might have heard of this book Geoffrey Moore did "Crossingthe Chasm." And basically we feellike it's a "crossing the chasm" situation in PON, especially in Koreawhere you make an initial deployment and then they digest. They figure out all the bugs and variousthings, and they slow down and took a rest I guess. And then it takes off after they really ironout everything. I don't have anyofficial information to that effect. It'sjust -- having seen these cycles before, that's what it looks like.
And then in China,we are -- seem to be running thetables there, and that looks like it's going to be a big EPON deploymentstarting next year and ramping up. Couldbe as big as NTT at some point in the future, not in '08, but possibly '09 or2010. So we feel very good about it andas we said, we are starting to engage with some cable companies, we arestarting to sample and get evaluations going on the GPON products. You will hear more about that in the comingmonths. So we are making progress.
Ruben Roy – Pacific Crest Securities
Okay. Thanks. I just have a quick one for Mike. The tapeout, increased tapeout activity, is that a one-quarter deal?
Mike Zellner – Vice President and Chief Financial Officer
Well, I mean, obviously tapeoutscome about as a result of all the R&D activity we do. It ebbs and flows a bit. So the fact that it was particularly minor inQ3 is a little bit anomalous. But thereare quarters where we don't have any tapeouts. More typically there are at least a few in a quarter, I would say.
Ruben Roy – Pacific Crest Securities
Right. What I was getting, I am sorry about that, Mike, I was just -- it's an increase that you related to the $1 million to $2million in higher OpEx to that tapeout activity. So it sounded like there are some engineeringtapeouts that are happening this quarter that may fall off in Q1. Is that the way to look at it or...?
Mike Zellner – Vice President and Chief Financial Officer
Well, we are not -- we haven't really talked much aboutQ1. So, you don't want to go into thatyet. But again, I mean, we do tapeoutsregularly, so...
Ruben Roy – Pacific Crest Securities
Right. Okay. Well,thank you very much.
Operator
The next question comes fromKathryn Buergert, A.G. Edwards. Pleasego ahead.
Kathryn Buergert – A.G. Edwards
Thank you. Again on the OpEx, it looks like you may haveexceeded the restructuring savings if you are targeting $20 million, $24million on a per annum basis. Can youtalk about that, the OpEx levels kind of going forward and the savings you areachieving?
Mike Zellner – Vice President and Chief Financial Officer
Okay. So again, I don't want to -- we are not talking about next year here at all. But for sure, we did a bit better than we hadoriginally predicted, both in terms of the absolute amount of the savings, aswell as we actually completed it a bit early. That is, originally we thought that it would take us into Q4 before wewere complete, and we really essentially got it done in Q3. So it definitely helped us relative to whatwe had originally thought. So we areobviously pretty happy about that. Imean, we continue to focus on saving costs where we can, and that's notsomething that necessarily is flagged by a restructuring event like we did inQ1, but rather it's really ongoing.
Kathryn Buergert – A.G. Edwards
And when you talk about theabsolute level being achieved, you've kind of set the bar at a better level forstarters now going forward for 2008?
Mike Zellner – Vice President and Chief Financial Officer
Yeah. Again, we will talk about 2008 in our nextcall. At this point, we aren't talkingabout it.
Kathryn Buergert – A.G. Edwards
Okay, I got it. Thank you.
Operator
The next question comes fromSeogju Lee from Goldman Sachs. Please goahead.
Seogju Lee – Goldman Sachs
Thank you. Solid execution there. Just in terms of the margin model, maybe Icould ask the question in a different way. Can we talk about like the -- howyou are looking at the target margin model just going forward and what sort ofleverage we might expect to see as the revenues grow here and how you arelooking at the target model?
Mike Zellner – Vice President and Chief Financial Officer
You are talking about operatingmargin, I assume.
Seogju Lee – Goldman Sachs
That's correct.
Mike Zellner – Vice President and Chief Financial Officer
Yeah. So we've said that -- both Bob and I have said that our target is to hit operatingmargins of between 20% and 25%. And itdepends on which quarter. Sometimes, wewill have quarters where revenues won't be quite as strong, in other quartersthey'll be stronger. But at the end ofthe day, we believe that we should run-- that we can run this -- shouldand can run this company at that range. Interms of any specific quarter we'll see, but that's certainly the target thatwe are shooting for, and we can -- absolutely believe we can achieve it. In fact, we did achieve it in Q3.
Seogju Lee – Goldman Sachs
Okay. And just to clarify, that's a pro formaexcluding options expense?
Mike Zellner – Vice President and Chief Financial Officer
That's correct.
Seogju Lee – Goldman Sachs
Okay. And so now that you are solidly in the middleof that range at this point, and you have just executed some additionaloperating -- you have completed yourcost reduction efforts in terms of the OpEx, is there a possibility or is therea point in terms of when we might start to rethink that target model, or...?
Mike Zellner – Vice President and Chief Financial Officer
You mean -- are you suggesting would the target model go to a higher level? I am not quite sure what your questionis.
Seogju Lee – Goldman Sachs
Yeah, potentially.
Mike Zellner – Vice President and Chief Financial Officer
I mean, Bob can answer. -- I mean, we still are absolutely atechnology company. So in -- my opinion,running the company much hotter than say 25%, we'd be mortgaging the future atsome level. So I mean, we always look atthat, and we will continue to look at it. But my sense is at least for the foreseeable future, I think it's areasonable range.
Bob Bailey – Chairman and Chief Executive Officer
Yes, Seogju, it fluctuates. If you look at the history of PMC, itfluctuates. And rather than have that bethe high watermark, we like it to be -- wewould take the fluctuations out if we can, and we'll always have somefluctuations. And then -- and really be driving top-linegrowth at that operating margin, that's what I think is our goal going forward.
Seogju Lee – Goldman Sachs
Appreciate that. And Bob, just in terms of -- you talked a littleabout sort of ebbs and flow related to fiber-to-the-home, but just in terms ofthe recent strength that you are seeing in Asia morebroadly, it sounds like it is on the telecom side. How are you thinking about the sustainabilityof that or -- and what are the keydrivers that have been driving this recent strength, and just how are youthinking about potential ebbs and flows?
Bob Bailey – Chairman and Chief Executive Officer
Well, a couple of things. One is as I pointed out during my portion ofthe call, the design wins that are driving a lot of the revenue today happenedseveral years ago. And we weresuccessful in changing the way our customers develop and bring to market theseoptical transport boxes, where they are using a lot more of our technology thanthey ever have, so we are gaining share in the overall market as a result ofthat. And that's pretty much all thecompanies. I mean, they can't reallyafford to do things in a vertically integrated manner like they did in let'ssay the '90s.
Secondly, we believe that thesecompanies in Chinaare gaining share on a global basis. Soone in particular I know, their optical transport business is only about 50%China and 50% the rest of the world, where it used to be all China. And so they are taking share themselves. So we are gaining share, and they are gainingshare; as a result, this is growing our business, which is good.
Having said that, and we alreadysee a little bit of the signs, some of them are going to order a lot of stuff,and then they are going to soften a bit for a quarter or two. And we hope that some of our other businesseslike the enterprise storage business or the fiber-to-the-home business orwhatever will pick up the slack. That'sreally the diversification that we hoped would dampen these cycles.
Seogju Lee – Goldman Sachs
Great, thanks, and good luck.
Bob Bailey – Chairman and Chief Executive Officer
Thanks.
Operator
The next question comes fromJeremy Bunting, Thomas Weisel Partners. Pleasego ahead.
Jeremy Bunting – Thomas Weisel Partners
Thanks. Bob, could you just give us an update on,specifically on the SAS RAID products that you announced earlier in summer? There was talk about ramping with HP. Has the timeframe for that changed at all, andhave you got any other business with any other server OEMs? And then I have a question for Mike.
Bob Bailey – Chairman and Chief Executive Officer
Sure. The timeframe hasn't changed that we know of. It's driven a lot off of the server platformslike thoroughly and -- from Intel and there's an AMD equivalent, the nameescapes me right now. And so that hasn'treally changed to date, because we are on schedule on that development. There are several opportunities that we arepursuing right now, and so I don't want to tip my hand too much to my esteemedcompetitors. But hopefully, we will havesomething to talk about in the near future.
Jeremy Bunting – Thomas Weisel Partners
And for Mike. I understand the reasons for the near-termhigher tax rates. But in terms ofbringing it back below 30%, are we talking a couple of quarters or longer thanthat?
Mike Zellner – Vice President and Chief Financial Officer
The timeframe is hard to predictbecause it is underpinned by some FIN 48 liability issues. There are taxing jurisdictions that come intoplay and it's -- some of the timing of that is not directly in our control. We can influence it I guess at some level,but it's not directly in our control. Soit's hard to say or pin it down to a specific quarter.
Jeremy Bunting – Thomas Weisel Partners
Okay. Thanks.
Operator
Ladies and gentlemen, if thereare any additional questions at this time, please press "*""1" on your touchtone phone. Thenext question comes from Romit Shah from Lehman Brothers. Please go ahead.
Romit Shah – Lehman Brothers
Yes. Thank you. Could you just explain a little further how the convert is impacting theshare count in Q4 and on a go-forward basis, please?
Mike Zellner – Vice President and Chief Financial Officer
Yeah. It's above -- once the price of the stock gets above 880, then additionalshares come into the market that way. Soobviously, we don't speculate on the stock price per se, and so that willimpact where the stock price ends up. Ifthe stock price ends up below 880, then of course it won't have any impact.
Romit Shah – Lehman Brothers
Could you just -- could you help me out with themath? I mean, for every point increasein the stock price, what the impact would be to the share count?
Mike Zellner – Vice President and Chief Financial Officer
Yeah. It's pretty complicated. So we can go through the details of that withyou offline, so you can understand the specifics. A lot of the details obviously is in the K,but we can go through that with you as well, but kind of to go through thedetail on the call...
Romit Shah – Lehman Brothers
Sure. If I could just lastly, with the strong freecash and the rising cash balance, are you guys thinking at all about payingdown the convert or taking a fresh look at your balance sheet?
Mike Zellner – Vice President and Chief Financial Officer
So we -- I would say on a regular basis we talk about the capitalstructure of the company, and some of the various things we can do with thecash once -- first of all, when isenough cash enough and all that. So wetalk about it, Bob and I talk about it on a regular basis, and I can't talkabout it beyond that. But we certainlyconsider these various options for sure.
Romit Shah – Lehman Brothers
Okay. Thank you.
Operator
Gentlemen, there are no furtherquestions at this time. Please continue.
David Climie – Vice President, Marketing Communications
Thank you for attending ourconference call today, and we will be scheduling our fourth quarter 2007earnings release for the third week of January. And at that time, we will be reviewing the quarterly results andproviding an outlook for the first quarter of 2008. So thank you, and that ends today's call.
Operator
Ladies and gentlemen, thisconcludes the conference call for today. You may now disconnect your line, and have a great day.
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