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PLX Technology, Inc. (NASDAQ:PLXT)

Q3 2007 Earnings Call

October 22, 2007 5:00 pm ET

Executives

Art Whipple - Chief Financial Officer

Mike Salameh - President

Analysts

Sandy Harrison - Signal Hill

Christian Schwab - Craig-Hallum Capital Group

Jed Dorsheimer - Canaccord Adams

Richard Shannon - Northland Securities

Operator

Good afternoon ladies and gentlemen and welcome to the PLX Technology Inc. Third Quarter 2007 Earnings Conference. Today's call is being recorded. We will open the conference up for questions and answers after the presentation. At this time, I would like to turn the conference over to Mr. Arthur Whipple, Chief Financial Officer of PLX Technology.

Art Whipple - Chief Financial Officer

Good afternoon and thank you for joining us today. I will start this session with a review of our financial performance. Next, Mike Salameh, our CEO, will provide more information on the business and I will finish by providing fourth quarter 2007 financial estimates.

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

These 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 October 22, 2007, and in our SEC filings, including our reports on Form 10-Q for the quarters ended March 31 and June 30, 2007, and our report on Form 10-K for the year ended December 31, 2006.

Now, let's take a look at this quarter's financial performance. Net revenues for the third quarter ended September 30, 2007 were $21.2 million. Revenues were up 1% from $21 million for the same quarter a year ago and up 7% from $19.8 million last quarter.

PCI Express product revenues grew sequentially in the third quarter by 20% to $7.7 million. PCI Express revenues represented 36% of total revenues for the current quarter, up from 33% last quarter and 22% in the same quarter a year ago. Third quarter gross margin rose 3 percentage points to 62%. This improvement was driven by improved PCI Express gross margins and improved product mix. While our PCI Express gross margins are lower than our average gross margins, they have steadily improved this year.

Operating expenses for the third quarter were $11.8 million, a sequential decline of $727,000 or 6% from $12.6 million for the prior quarter. R&D costs fell as anticipated third quarter spending for new product, non-recurring engineering costs scheduled late in the third quarter, are moving into the beginning of the fourth quarter.

SG&A spending was down by $149,000 or 2%. Compared to the same quarter a year ago, operating expenses were up $578,000. Research and development expenses were up $474,000 as a result of increased compensation costs, software design tools and IP purchases. SG&A expenses were up $303,000 primarily from increased compensation costs in sales and marketing.

Interest income expense and other net for the third quarter was $624,000, up from $607,000 in the previous quarter as a result of higher cash and investment balances. Our net income for the third quarter ended September 30, 2007 was $1 million or $0.03 per diluted share. This compared to a net income of $1 million, or $0.04 per diluted share, in the same quarter a year ago, and with a net loss of $82,000 or a net loss of $0.00 per diluted share last quarter. The current quarter net income was net of charges of $1 million for stock-based compensation and $241,000 for amortization of acquired intangibles.

Next, I will review some of the highlights of our balance sheet. The company's balance sheet remains strong. We were again cash flow positive and cash and investments have increased by about $7 million so far this year. Accounts receivable are up slightly from the end of last year. We ended the quarter with 38 days of receivables compared to a DSO of 34 days at the end of the year.

Net inventories were $8.3 million at September 30, 2007, unchanged from $8.3 million at the beginning of the year. We have approximately 93 days of inventory on hand, which we believe is appropriate for today's supply chain lead times.

Now, Mike has comments on the business.

Mike Salameh - President

Thanks, Art. In the third quarter, we continued to improve our financial results and our leadership position in the PCI Express market, which is our long-term growth initiative. In addition to achieving 20% sequential revenue growth in the PCI Express product line, we announced a new family of Gen 2 PCI Express chips. We also continued to broaden the customer base of new designs, including the HP ProLiant server design we announced last week. Also, our continued cost reduction efforts in PCI Express contributed to total company gross margin improvement.

Those were some of the highlights, and now will I describe the main events of the quarter in more detail, starting with PCI Express product development. In September, we announced the first chips of our Gen 2 PCI Express product family, five switches ranging in capacity from 12 lanes to 48 lanes, plus four additional Gen 1 chips. We expect to start sampling our Gen 2 chips in the fourth quarter.

With a 5 gigabit per second data rate, Gen 2 provides double the data rate of the currently deployed Gen 1 standard. Gen 2 is backward compatible with Gen 1, similar to the backward compatibility of the various speed grades of Ethernet and fiber channel.

Our Gen 2 products are based on the architecture of our widely used Gen 1 products and will carry forward our performance advantages. Furthermore, our Gen 1 to Gen 2 feature compatibility makes it easy for our broad base of PCI Express customers to develop new Gen 2 systems. The initial uptake for our Gen 2 products is expected to be in server, storage and graphics applications. In the meantime, design activity for Gen 1 continues in these markets, plus the communications, embedded and PC peripheral markets. Therefore, we expect to continue to develop and support both Gen 1 and Gen 2 products in parallel in the future.

We see continued strong adoption of the PCI Express standard in general. By the end of the third quarter, PLX had shipped production units, samples or development systems to over 750 different customers since we launched the product line, about 50% greater the number of this time last year. While not all of these customers will achieve volume production, the size of the total customer base is an indication of the broad adoption of both the PCI Express standard and our products.

We are also broadening the number of customers buying production volumes of our chips, expanding beyond the early adopters. By the end of the third quarter, over 75 customers had started production of products using our chips, up 60% compared to this time last year. Most of our customers' products are still in the early stage of their life cycles, so we see this as another leading indicator of future growth.

We are pleased to see continued broadening of our customer base in the types of applications and market segments using our chips. Last week, we announced the switch design in HP's ProLiant DL580 G5 server, one example of the many types of products that use our chips. The PCI Express architecture is becoming widely adopted in many markets and our revenue producing applications include servers, storage systems, host bus adapters, graphics, HDTV encoders, embedded computers and communications.

Our outlook for the fourth quarter is that we expect PCI Express revenue to grow about 20% sequentially. Revenue for this product line grew from $4 million in 2005 to $18 million in 2006, and we expect it to be over $28 million in 2007 and continue to grow strongly over the next several years. Our legacy PCI and USB business was up about 1% sequentially and we expect that this business will decline a few percent in next quarter, and then be up or down in a narrow range over the next several quarters.

Although PCI is a mature standard, our PCI chips are used in communication and embedded systems that have five- to seven-year lifetimes, and in some cases, our customers continue to design new systems using PCI to maintain legacy compatibility. Therefore, we expect little change in PCI revenues.

In USB, we continue to win new designs in PC peripherals, smart phones and consumer products which can maintain or potentially grow this business.

In conclusion, the results of the third quarter indicate that our long-term revenue and net income revenue growth plans are working. Growth in PCI Express combined with steady revenues from PCI and USB delivered total revenue growth. Margin improvement in PCI Express helped increase total company gross margins, and the overall result was improvement in operating income and earnings per share.

Now, Art will provide estimates for fourth quarter financial performance.

Art Whipple - Chief Financial Officer

Thank you, Mike. Now for a look at our fourth quarter 2007 business outlook. Please remember that the following statements are based on our current expectations. We do not intend to update or confirm this guidance during the quarter.

Revenue for the fourth quarter of 2007 is expected to be between $21.5 million and $22.5 million with approximately 42% of total revenues attributable to PCI Express products. Gross margin is expected to be approximately 60%. Operating expenses are expected to be approximately $13.2 million. The increase in operating expenses is driven by expenditures related to the cost of non-recurring items for several new products.

Included in operating expenses are share-based compensation and acquisition-related costs which are expected to be approximately $1.4 million. Currently, we expect first quarter 2008 operating expenses to decline relative to the fourth quarter. Our effective tax rate is expected to be about 39% for 2007.

In closing, I'd like to comment on our plans to achieve profitable growth. We expect to expand revenues, particularly through increased sales of our PCI Express products. We expect to maintain our gross margins in the low 60% range and we plan to closely control our OpEx spending.

That concludes our prepared remarks. We are now ready to entertain your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time, if you would like to ask a question, please press "*" "1" on your telephone. If you are using a speakerphone, we ask that you make sure your mute function is turned off to allow your signal to reach our equipment. Once again it is "*" "1" please. And we will go first to Sandy Harrison with Signal Hill

Sandy Harrison - Signal Hill

Thanks. Good afternoon guys. How are you?

Michael Salameh

Hey.

Sandy Harrison - Signal Hill

Just a quick kind of tightening in on some of the outlook you guys gave. So the margins, you had a real nice bump in the September quarter as far as -- it looks like not having the mass charges that slip into Q4, I got that. And then, the top or gross margin was a little bit better as well. So with it sort of slipping back on the December quarter, or given some of that back, could you help us understand a little bit, sort of, of the mix issues? Is this some of the more legacy products with the higher margins becoming less of a percentage? Have you guys made sort of a lot of the early moves in the PCI Express? Just if you could give a little bit more to that commentary?

Mike Salameh - President

Yes, Sandy. One of the things I want to do is 62% that we did this quarter was off of 59% last quarter. I think that what you're seeing here is some of the variability that happens because of the range in gross margins between our legacy products and our PCI Express products. Things are improving in general, but you shouldn't read that as a trend. I think we're looking at margins going forward in the very low 60s because as we work the cost improvement against the improving or the increasing mix of our PCI Express products, staying in the 60s will be plenty of work rather than to try and drive them much higher than they are.

Relative to the spending, I think what happened was, we have moved some of the costs of these big tapeouts spread over several weeks, and more of it made it into the fourth quarter than into the third. I think if you look at what our expenses were in the third and fourth quarters in the models that we had at this time last quarter, the total for the second half is going to be about the same. So we're basically moving some expense into the fourth quarter from the third quarter, although we do expect that the first quarter numbers will be down again.

Sandy Harrison - Signal Hill

Got you. Then in the prepared remarks, you talked a little bit, when you were talking about sort of the balance sheet and inventories, you thought that your inventory levels were satisfactory for the -- or appropriate, I think you said, for the current market or the current environment. What are lead times doing? How is the availability of silicon? We've heard from different places, different data points. We would be interested in sort of how you guys are seeing your lead times, and is that moving in, moving out? And how is your availability on some of these newer products?

Art Whipple - Chief Financial Officer

I assume you're talking about the availability from our suppliers to us?

Sandy Harrison - Signal Hill

Correct.

Art Whipple - Chief Financial Officer

That has been stable. We have lots of different things that we buy and some got out and some come in, but it's relatively stable.

Sandy Harrison - Signal Hill

And then the lead times for products or lead times for wafers and so forth seems stable as well?

Art Whipple - Chief Financial Officer

Roughly, yes.

Sandy Harrison - Signal Hill

Okay. I will go in the queue and ask another question later.

Operator

Your next question is from Christian Schwab with Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital Group

Hey guys.

Art Whipple - Chief Financial Officer

Hi Chris.

Christian Schwab - Craig-Hallum Capital Group

What was the percentage mix for your core PCI revenue in the quarter to help understand the gross margins?

Art Whipple - Chief Financial Officer

The legacy products are both our PCI and USB, and it was -- the USB part of that was a little bit more than 15, and that's basically where we said it has been for awhile. Is that where you are getting?

Christian Schwab - Craig-Hallum Capital Group

Yes, that will help do the math. And then, why did the drop in PCI sequentially in the December quarter -- your legacy PCI business?

Art Whipple - Chief Financial Officer

I think what we're saying is that we're expecting that the revenues in the legacy products are going to trade in a band. We don't see any real trend up or down. We're more or less in the same region that we have been. So expect it to be down a bit. That is mostly based on backlog that we have already been able to book this year , so we're -- you know, for the fourth quarter. So I don't think we are reading into that a trend. I think what we are saying is that just business looks just a little weak in the fourth quarter.

Christian Schwab - Craig-Hallum Capital Group

So that new band would be somewhere between like $9.5 and $11.5 million, versus the $11.5 to $13 million roughly last year?

Art Whipple - Chief Financial Officer

I think the legacy products are probably going to be someplace in the $13 million, low $13 million range.

Christian Schwab - Craig-Hallum Capital Group

On a quarterly basis?

Art Whipple - Chief Financial Officer

Yes, on a quarterly basis.

Christian Schwab - Craig-Hallum Capital Group

Okay. And then on the PCI Express revenue, you know, for that business, or it looks like we're going to grow that business slightly more than 50% this year, north of $23 million. Given the fact that we're expanding the customer base and expanding the volume production opportunities, is it logical to assume that that will grow at a rate faster than that next year, year-over-year?

Art Whipple - Chief Financial Officer

What we have been trying to do here is to grow the business, that part of the business, at about 20% per quarter. We have three data points that look like that so far and projecting another one here. I think you had a number there where it looks like the PCI Express revenues for this quarter or for this year should be someplace in the $28 to $29 million range by the time we are done off of 18 in the last year.

Christian Schwab - Craig-Hallum Capital Group

Right, so somewhere between 52% and 60% year-over-year?

Mike Salameh - President

This is Mike. Just to go through some of the numbers. It was $4 million in '05, $18 million in '06. We're estimating $28 million plus in '07. And it's a little difficult to predict the growth of the market, but we think the market is roughly doubling each year, some years more than that, some years less. And some of the growth accelerators, potential growth accelerators in the market, is the communications, which is now in a heavy design phase. As that gets in production, that starts to make an impact next year, and also, as some of the higher volume embedded applications, like multifunction printers that are now in a design phase. So we still think the markets -- we're expecting to grow strongly for several years.

Christian Schwab - Craig-Hallum Capital Group

Right, so if we do 20% sequential growth next year, that business could do close to $60 million in revenue, right? Is that another way?

Art Whipple - Chief Financial Officer

That's the math, but we aren't forecasting that yet because we don't have the business, right. So our guidance is typically only out one quarter.

Christian Schwab - Craig-Hallum Capital Group

Right, but we feel comfortable in the fact that the business can -- I guess what everybody really wants to know is, given all of the design wins and being first to market, and for example, on the Hewlett-Packard win, my takeaway on that is you have won probably the first big design win there, which should make it much easier for you to win all of the other design wins at a large customer like that as they develop more and more PCI Express products down the road. So I guess let me say it one more time. You would anticipate the current trend of 20% sequential revenue growth to continue throughout next year given the marketplace and your design wins in hand would be your goal?

Art Whipple - Chief Financial Officer

That's a goal, but we don't have a -- it really relies on our customers taking their products to market. So it's not one that we can drive directly.

Christian Schwab - Craig-Hallum Capital Group

Yeah, I understood. Great. Thanks a lot guys.

Arthur Whipple - Chief Financial Officer

Okay

Mike Salameh - President

Okay. Thanks

Operator

Next question is from Canaccord Adams' Jed Dorsheimer.

Jed Dorsheimer - Canaccord Adams

Thanks guys. I missed the beginning part of the call, so I apologize in advance if you've already answered this, but I was wondering in the PCI Express, how many design wins are roughly driving that revenue level right now?

Mike Salameh - President

We have 70 -- the number we've given out is, we have over 75 customers in production, and so we have a measure of how much revenue puts you in production. But it's a smaller portion of that, it's probably 10 or so that drive 78% of the business. So we think we have a lot of headroom as more get into production and as the business spreads out among more customers.

Jed Dorsheimer - Canaccord Adams

And when were those 10 -- the ones that are in the volume right now driving that -- when were those won?

Mike Salameh - President

It's all over the map, but it was -- in general, it was over year ago, a year to two years ago, or more.

Jed Dorsheimer - Canaccord Adams

Got you. All right. And then on the expense side, a little disappointing to see that tapeout is still hampering some of the leverage. As we look at next year, how many tapeouts -- did you say there were four tapeouts that are -- that sell into Q4?

Art Whipple - Chief Financial Officer

I don't think we ever gave a number like that, but we have routine tapeouts. Some are significant in the 90 nanometer, but we have lots of other issues that are going on at 130 nanometers as well. So I think there's a fair amount of money that was spent in the third quarter, we just didn't get all of the money spent that we expected to.

Jed Dorsheimer - Canaccord Adams

The interesting question that I have is, as we look to -- there is always going to be a constant next generation and you're going to have to maintain the lead. But, as we look to next year, do you see the rate of the tapeouts actually slowing or maintaining status quo, or how do you look at that?

Art Whipple - Chief Financial Officer

Well, I think -- we haven't really done the detailed planning for next year, but there will be more 90 nanometer tapeouts for sure, and so that cost will likely go up. I don't think we have anything planned at 65 nanometers yet.

Mike Salameh - President

So, Jed, the fourth quarter has a larger number of the tapeout-related activity, NRE-related activity than we have had in the past, and so higher than we would -- it's like the high point for the year, and probably for most of next year as far as what we do in a quarter. So the fourth quarter is pushed up by that. We expect the first quarter to be below that, and in general we are looking to control our expenses. So, we are looking to grow the top-line revenue and maintain the margins in the low 60s and maintain and control the expenses so we can get some leverage on the operating income.

Jed Dorsheimer - Canaccord Adams

Great. I will jump back in, thanks.

Operator

Once again, ladies and gentlemen, "*" "1" please if you have a question today. We will go over back to Sandy Harrison.

Sandy Harrison - Signal Hill

Thanks. Just to kind of follow on to a couple of questions before as far as customers. Obviously, the HP win was a nice win and sort of breaking in there. Are there other customers or other market segments -- or, let me ask that differently. What other customers, what other segments would you like to have on that list of 75, and eventually, the 10 or so that are driving 80% of the business that we could be looking for?

Mike Salameh - President

So, most of the revenue that we get today comes from the server, storage and PC peripheral market, in that order. Eventually, we expect as the comm and embedded markets adopt PCI Express, that the market is going to be evenly distributed. So we're looking for continued growth in servers and storage and PC peripherals, but even faster growth in comm and embedded, which are now just in the design stage for the most part.

Sandy Harrison - Signal Hill

Okay.

Mike Salameh - President

So there is still a lot of large opportunities that we are working and more to come for many years in this market.

Sandy Harrison - Signal Hill

Got you then. I guess when you look -- and again, realizing you don't give guidance outside of the quarter -- just sort of looking in your crystal ball and your experience with the markets and what the growth rates are, do you see this sequential growth potentially? Is there a stair-step out there to a new level, or is this sort of -- do you see a potential couple of breakout design wins going to production that we could see another stair-step or breakout to a different level? Or, do you expect it just to be steady, consistent, quarter after quarter?

Mike Salameh - President

It has been lumpy quarter to quarter because the business is fairly concentrated. On the one hand, we expected some quarters that will grow more than others. On the other hand, there generally isn't a single application that would move the needle that much. Just maybe to go through what I was saying before, is we look at the market as roughly doubling ever year and the next -- and there's various drivers as new applications come in.

The next set of applications we see that can fuel the market growth rate is the communications and the embedded systems, including things like multifunction printers. So those would be the next things that -- but, that would represent many different designs.

Sandy Harrison - Signal Hill

Got you. And then, when you look -- I will drop back in the queue. I think that about covers me.

Mike Salameh - President

Okay. Thank you.

Operator

And we’ll now hear from Richard Shannon with Northland Securities.

Richard Shannon - Northland Securities.

Well, hi guys. How are you?

Mike Salameh

Hi, Richard

Richard Shannon - Northland Securities

Can you hear me well? Well, I am standing in airport here, so could be a little loud.

Mike Salameh - President

We can hear you.

Richard Shannon - Northland Securities

Okay. Great. I will keep my questions brief, I don't want to keep the feedback here that I can hear very well. Going back to the HP announcements you had last week, would HP have been one of those customers in the server group that you mentioned in past quarters has been one of the top few server OEMs that were contributing materially to your revenues in PCI Express before?

Mike Salameh - President

I cannot answer specifically about revenues to HP or any other customer.

Richard Shannon - Northland Securities

Not even the presence or lack thereof?

Mike Salameh - President

No, because we generally don't report on the revenue. We have confidentiality agreements with the customers, and so we don't talk about revenue in any particular quarter with the customer. Clearly, they're one of the top server companies in the world.

Richard Shannon - Northland Securities

Obviously, yes. And a very nice win for you there, by the way. Second question on a similar topic, I took a look at that particular server from HP that you're in, and I noticed that the number of total PCI Express lanes available on that one versus its predecessor was a huge increase. I think it was like 72 lanes from 24. I want to get your perspective on whether you see other server customers implementing large increases in the total number of PCI Express lanes available on their systems and whether there are any particular drivers to that, like these reductions to these quad core processors from Intel and others that are on the MP side of the server line?

Mike Salameh - President

So, as you know, the various server companies have many different models of servers, and in general, the more processing power you have, the more IO you need because you are talking to -- through Ethernet controllers and fiber channel controllers. So in general when you have more processing horsepower, you need more IO slots and you need more switching capability. So yes, that is true.

Richard Shannon - Northland Securities

Okay. Great. I will jump out of line. Thank you.

Operator

As a final reminder, ladies and gentlemen "*" "1" please. Mr. Whipple, there are no further questions at this time.

Art Whipple - Chief Financial Officer

Okay.

Mike Salameh - President

All right. So thanks very much for joining us and we will talk to you in January.

Operator

Ladies and gentlemen, that does conclude our conference today. We thank you for your participation, have a great rest of your day.

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