PLX Technology Q3 2007 Earnings Call Transcript

| About: PLX Technology, (PLXT)

PLX Technology, Inc. (NASDAQ:PLXT)

Q3 2007 Earnings Call

October 22, 2007 5:00 pm ET

Executives

Art Whipple - Chief FinancialOfficer

Mike Salameh - President

Analysts

Sandy Harrison - Signal Hill

Christian Schwab - Craig-HallumCapital Group

Jed Dorsheimer - Canaccord Adams

Richard Shannon - NorthlandSecurities

Operator

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

Art Whipple - Chief Financial Officer

Good afternoon and thank you forjoining us today. I will start this session with a review of our financialperformance. Next, Mike Salameh, our CEO, will provide more information on thebusiness and I will finish by providing fourth quarter 2007 financialestimates.

As we begin, I would like to pointout that certain statements made in the course of this conference callregarding our expectations and our associated projections will beforward-looking statements. These statements will include comments relating tothe introduction and adoption of new products, the projection of financialresults, our future growth, the development of next-generation technologies andother areas. These statements will be made in both our prepared remarks and inthe subsequent Q&A session.

These statements deal with futureevents and are subject to risks and uncertainties and our actual results coulddiffer materially from our current expectations. Some of the factors that couldcause 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 thequarters ended March 31 and June 30, 2007, and our report on Form 10-K for theyear ended December 31, 2006.

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

PCI Express product revenues grewsequentially in the third quarter by 20% to $7.7 million. PCI Express revenuesrepresented 36% of total revenues for the current quarter, up from 33% lastquarter and 22% in the same quarter a year ago. Third quarter gross margin rose3 percentage points to 62%. This improvement was driven by improved PCI Expressgross margins and improved product mix. While our PCI Express gross margins arelower than our average gross margins, they have steadily improved this year.

Operating expenses for the thirdquarter were $11.8 million, a sequential decline of $727,000 or 6% from $12.6million for the prior quarter. R&D costs fell as anticipated third quarter spendingfor new product, non-recurring engineering costs scheduled late in the thirdquarter, 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 expenseswere up $578,000. Research and development expenses were up $474,000 as aresult of increased compensation costs, software design tools and IP purchases.SG&A expenses were up $303,000 primarily from increased compensation costsin sales and marketing.

Interest income expense and othernet for the third quarter was $624,000, up from $607,000 in the previousquarter as a result of higher cash and investment balances. Our net income forthe third quarter ended September 30, 2007 was $1 million or $0.03 per dilutedshare. 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 ofcharges of $1 million for stock-based compensation and $241,000 foramortization of acquired intangibles.

Next, I will review some of thehighlights of our balance sheet. The company's balance sheet remains strong. Wewere 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 endof last year. We ended the quarter with 38 days of receivables compared to aDSO of 34 days at the end of the year.

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

Now, Mike has comments on thebusiness.

Mike Salameh - President

Thanks, Art. In the thirdquarter, we continued to improve our financial results and our leadershipposition in the PCI Express market, which is our long-term growth initiative.In addition to achieving 20% sequential revenue growth in the PCI Expressproduct line, we announced a new family of Gen 2 PCI Express chips. We alsocontinued to broaden the customer base of new designs, including the HP ProLiantserver design we announced last week. Also, our continued cost reductionefforts in PCI Express contributed to total company gross margin improvement.

Those were some of thehighlights, and now will I describe the main events of the quarter in moredetail, starting with PCI Express product development. In September, weannounced the first chips of our Gen 2 PCI Express product family, fiveswitches ranging in capacity from 12 lanes to 48 lanes, plus four additionalGen 1 chips. We expect to start sampling our Gen 2 chips in the fourth quarter.

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

Our Gen 2 products are based onthe architecture of our widely used Gen 1 products and will carry forward ourperformance advantages. Furthermore, our Gen 1 to Gen 2 feature compatibilitymakes it easy for our broad base of PCI Express customers to develop new Gen 2systems. 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 1continues in these markets, plus the communications, embedded and PC peripheralmarkets. Therefore, we expect to continue to develop and support both Gen 1 andGen 2 products in parallel in the future.

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

We are also broadening the numberof customers buying production volumes of our chips, expanding beyond the earlyadopters. By the end of the third quarter, over 75 customers had startedproduction 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 lifecycles, so we see this as another leading indicator of future growth.

We are pleased to see continuedbroadening of our customer base in the types of applications and marketsegments using our chips. Last week, we announced the switch design in HP'sProLiant DL580 G5 server, one example of the many types of products that useour chips. The PCI Express architecture is becoming widely adopted in manymarkets and our revenue producing applications include servers, storagesystems, host bus adapters, graphics, HDTV encoders, embedded computers andcommunications.

Our outlook for the fourthquarter 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 in2006, and we expect it to be over $28 million in 2007 and continue to growstrongly over the next several years. Our legacy PCI and USB business was upabout 1% sequentially and we expect that this business will decline a fewpercent in next quarter, and then be up or down in a narrow range over the nextseveral quarters.

Although PCI is a maturestandard, our PCI chips are used in communication and embedded systems thathave five- to seven-year lifetimes, and in some cases, our customers continueto design new systems using PCI to maintain legacy compatibility. Therefore, weexpect little change in PCI revenues.

In USB, we continue to win newdesigns in PC peripherals, smart phones and consumer products which canmaintain or potentially grow this business.

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

Now, Art will provide estimatesfor fourth quarter financial performance.

Art Whipple - Chief Financial Officer

Thank you, Mike. Now for a lookat our fourth quarter 2007 business outlook. Please remember that the followingstatements are based on our current expectations. We do not intend to update orconfirm this guidance during the quarter.

Revenue for the fourth quarter of2007 is expected to be between $21.5 million and $22.5 million withapproximately 42% of total revenues attributable to PCI Express products. Grossmargin is expected to be approximately 60%. Operating expenses are expected tobe approximately $13.2 million. The increase in operating expenses is driven byexpenditures related to the cost of non-recurring items for several newproducts.

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

In closing, I'd like to commenton our plans to achieve profitable growth. We expect to expand revenues, particularlythrough increased sales of our PCI Express products. We expect to maintain ourgross margins in the low 60% range and we plan to closely control our OpExspending.

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

Question-and-Answer Session

Operator

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

Sandy Harrison - Signal Hill

Thanks. Good afternoon guys. Howare you?

Michael Salameh

Hey.

Sandy Harrison - Signal Hill

Just a quick kind of tighteningin on some of the outlook you guys gave. So the margins, you had a real nicebump in the September quarter as far as -- it looks like not having the masscharges that slip into Q4, I got that. And then, the top or gross margin was alittle bit better as well. So with it sort of slipping back on the Decemberquarter, 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 thehigher margins becoming less of a percentage? Have you guys made sort of a lotof the early moves in the PCI Express? Just if you could give a little bit moreto 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 variabilitythat happens because of the range in gross margins between our legacy productsand our PCI Express products. Things are improving in general, but you shouldn'tread that as a trend. I think we're looking at margins going forward in thevery low 60s because as we work the cost improvement against the improving orthe increasing mix of our PCI Express products, staying in the 60s will beplenty of work rather than to try and drive them much higher than they are.

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

Sandy Harrison - Signal Hill

Got you. Then in the preparedremarks, you talked a little bit, when you were talking about sort of thebalance sheet and inventories, you thought that your inventory levels weresatisfactory for the -- or appropriate, I think you said, for the currentmarket or the current environment. What are lead times doing? How is theavailability of silicon? We've heard from different places, different datapoints. 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 ofthese newer products?

Art Whipple - Chief Financial Officer

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

Sandy Harrison - Signal Hill

Correct.

Art Whipple - Chief Financial Officer

That has been stable. We havelots of different things that we buy and some got out and some come in, butit's relatively stable.

Sandy Harrison - Signal Hill

And then the lead times forproducts 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 andask another question later.

Operator

Your next question is from ChristianSchwab 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 foryour core PCI revenue in the quarter to help understand the gross margins?

Art Whipple - Chief Financial Officer

The legacy products are both ourPCI 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 youare 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 -- yourlegacy PCI business?

Art Whipple - Chief Financial Officer

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

Christian Schwab - Craig-Hallum Capital Group

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

Art Whipple - Chief Financial Officer

I think the legacy products areprobably 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 Expressrevenue, you know, for that business, or it looks like we're going to grow thatbusiness slightly more than 50% this year, north of $23 million. Given the factthat we're expanding the customer base and expanding the volume productionopportunities, is it logical to assume that that will grow at a rate fasterthan that next year, year-over-year?

Art Whipple - Chief Financial Officer

What we have been trying to dohere is to grow the business, that part of the business, at about 20% perquarter. We have three data points that look like that so far and projectinganother one here. I think you had a number there where it looks like the PCIExpress revenues for this quarter or for this year should be someplace in the $28to $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 throughsome of the numbers. It was $4 million in '05, $18 million in '06. We'reestimating $28 million plus in '07. And it's a little difficult to predict thegrowth 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 growthaccelerators, potential growth accelerators in the market, is thecommunications, which is now in a heavy design phase. As that gets inproduction, that starts to make an impact next year, and also, as some of thehigher volume embedded applications, like multifunction printers that are nowin a design phase. So we still think the markets -- we're expecting to growstrongly for several years.

Christian Schwab - Craig-Hallum Capital Group

Right, so if we do 20% sequentialgrowth 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'tforecasting that yet because we don't have the business, right. So our guidanceis typically only out one quarter.

Christian Schwab - Craig-Hallum Capital Group

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

Art Whipple - Chief Financial Officer

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

Christian Schwab - Craig-Hallum Capital Group

Yeah, I understood. Great. Thanksa lot guys.

Arthur Whipple - Chief Financial Officer

Okay

Mike Salameh - President

Okay. Thanks

Operator

Next question is from CanaccordAdams' Jed Dorsheimer.

Jed Dorsheimer - Canaccord Adams

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

Mike Salameh - President

We have 70 -- the number we've givenout is, we have over 75 customers in production, and so we have a measure ofhow 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 alot of headroom as more get into production and as the business spreads outamong more customers.

Jed Dorsheimer - Canaccord Adams

And when were those 10 -- theones 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 onthe expense side, a little disappointing to see that tapeout is still hamperingsome of the leverage. As we look at next year, how many tapeouts -- did you saythere were four tapeouts that are -- that sell into Q4?

Art Whipple - Chief Financial Officer

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

Jed Dorsheimer - Canaccord Adams

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

Art Whipple - Chief Financial Officer

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

Mike Salameh - President

So, Jed, the fourth quarter has alarger number of the tapeout-related activity, NRE-related activity than wehave had in the past, and so higher than we would -- it's like the high pointfor the year, and probably for most of next year as far as what we do in aquarter. So the fourth quarter is pushed up by that. We expect the firstquarter to be below that, and in general we are looking to control ourexpenses. So, we are looking to grow the top-line revenue and maintain themargins in the low 60s and maintain and control the expenses so we can get someleverage 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 goover back to Sandy Harrison.

Sandy Harrison - Signal Hill

Thanks. Just to kind of follow onto a couple of questions before as far as customers. Obviously, the HP win wasa nice win and sort of breaking in there. Are there other customers or othermarket segments -- or, let me ask that differently. What other customers, whatother segments would you like to have on that list of 75, and eventually, the10 or so that are driving 80% of the business that we could be looking for?

Mike Salameh - President

So, most of the revenue that weget 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, thatthe market is going to be evenly distributed. So we're looking for continuedgrowth in servers and storage and PC peripherals, but even faster growth in command 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 largeopportunities that we are working and more to come for many years in thismarket.

Sandy Harrison - Signal Hill

Got you then. I guess when youlook -- 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 marketsand 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 yousee a potential couple of breakout design wins going to production that wecould see another stair-step or breakout to a different level? Or, do youexpect it just to be steady, consistent, quarter after quarter?

Mike Salameh - President

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

The next set of applications wesee that can fuel the market growth rate is the communications and the embeddedsystems, including things like multifunction printers. So those would be thenext 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 amstanding 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 wantto keep the feedback here that I can hear very well. Going back to the HPannouncements you had last week, would HP have been one of those customers inthe server group that you mentioned in past quarters has been one of the topfew server OEMs that were contributing materially to your revenues in PCIExpress before?

Mike Salameh - President

I cannot answer specificallyabout revenues to HP or any other customer.

Richard Shannon - Northland Securities

Not even the presence or lackthereof?

Mike Salameh - President

No, because we generally don'treport 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 nicewin for you there, by the way. Second question on a similar topic, I took alook at that particular server from HP that you're in, and I noticed that thenumber of total PCI Express lanes available on that one versus its predecessorwas a huge increase. I think it was like 72 lanes from 24. I want to get yourperspective on whether you see other server customers implementing largeincreases in the total number of PCI Express lanes available on their systemsand whether there are any particular drivers to that, like these reductions tothese quad core processors from Intel and others that are on the MP side of theserver line?

Mike Salameh - President

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

Richard Shannon - Northland Securities

Okay. Great. I will jump out ofline. Thank you.

Operator

As a final reminder, ladies andgentlemen "*" "1" please. Mr. Whipple, there are no furtherquestions at this time.

Art Whipple - Chief Financial Officer

Okay.

Mike Salameh - President

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

Operator

Ladies and gentlemen, that doesconclude our conference today. We thank you for your participation, have agreat rest of your day.

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