PMC-Sierra Inc.Q1 2008 Earnings Call Transcript

| About: PMC - (PMCS)

PMC-Sierra Inc.(NASDAQ:PMCS)

Q1 2008 Earnings Call

April 17, 2008 4:45 pm ET

Executives

Bob Bailey - Chairman and CEO

Mike Zellner - VP and CFO

David Climie - VP of Marketing and Communications

Analysts

James Schneider - Goldman Sachs

Romit Shah - Lehman Brothers

Shawn Webster - JPMorgan

Ruben Roy - Pacific Crest Securities

Sandy Harrison - Signal Hill

Patrick Ho - Stifel Nicolaus

Allan Mishan - Oppenheimer

Taunya Sell - Ragen MacKenzie

Operator

Welcome to PMC-Sierra's first quarter 2008 earnings release and conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Climie, VP Marketing and Communications. Please go ahead, sir.

David Climie

Thank you, operator. Good afternoon everyone, and thank you for attending our investor conference call. With us on the call today is Bob Bailey, Chairman and CEO; and Mike Zellner, Vice President and CFO. Please note that our first quarter 2008 earnings release was disseminated today via business wire after market close. A copy of the release can be downloaded from our website.

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

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

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

Mike Zellner

Thanks Dave. I'll review our first quarter 2008 results and financial position, and then turn it over to Bob to discuss our business activity in detail.

Q1 was another strong quarter for PMC-Sierra with revenues of a $125 million, representing an increase of $1.5 million or 1.1% versus Q4. This increase in revenue was primarily the result of improved activity in our fiber to the home and printer related businesses. Our “turns” business meaning: those orders booked and shipped within the same quarter was 23% of revenue in Q1 compared with 21% turns in Q4.

In Q4, our two largest customers, Cisco and Hewlett-Packard each exceeded 10% of overall revenue for the quarter. No other customer accounted for more than 10%. EMC our third largest customer is just below 10%.

By region, Asia continued to generate the strongest results in the quarter with geographic breakdown as follows: China at 24%, Japan at 21%, other Asia at 27%, North America 24%, Europe and other at 4%. Quarter-over-quarter revenue growth was strongest in Japan and North America.

On a non-GAAP basis, gross margins in Q1 were 65.6% versus 65.3% in Q4 due in part to increased margins in some of our key products associated with EPON new, router and multi-service switching and Metro transport.

On a non-GAAP basis, operating expenses were up $700,000 to $54.8 million in Q1 versus $54.1 million in Q4. Operating expenses increased primarily due to reset of employee benefits at the beginning of the calendar year offset by decreases in photomask and wafer costs on fewer tapeouts.

Breaking down operating expenses, non-GAAP R&D was $34.1 million in Q1 versus $33.3 million in Q4 and non-GAAP SG&A was $20.7 million in Q1 versus $20.8 million in Q4. In Q1, non-GAAP operating income, before other income and taxes was $27.2 million, or 22% of sales, which aligns with our targeted operating margin level of 20% to 25%. Net-interest income of $2.2 million in Q1 was down $700,000 from Q4 due to slightly lower yield in our investments.

Our non-GAAP effective tax rate was 18% for the quarter, down from 30% in Q4. This was mainly due to changes in our foreign income and product mix during Q1. Although it is difficult to predict quarterly tax rates due to the impact of our FIN 48 positions on foreign earnings, we expect the non-GAAP effective tax rate to be in the high teens to low 20s for the second quarter depending on product and foreign income mix.

Non-GAAP profit after tax for Q1 was $23.5 million or $0.11 per share on a diluted basis. For a detailed reconciliation between GAAP and non-GAAP results, please see our press release issued today. Q1 GAAP loss per share was $0.10.

The primary reconciliating items for Q1 are as follows: Stock option expense associated with FAS 123R of $7 million, amortization of intangible assets of $9.8 million, net unrealized foreign exchange gain of $3.6 million related to our foreign denominated Fin 48 liabilities. A net gain of $1.4 million on the repurchase of $98 million of our convertible notes was realized. Restructuring charges of $900,000 and the tax provision adjustments of $30.3 million related to a foreign FIN 48 item arising in prior years and related interest to that. $2.3 million tax impact related to repatriation of earnings from a foreign jurisdiction and $800,000 income tax provision related to the non-GAAP adjustments mentioned above.

During the quarter the company received written communication from foreign taxing authority. As a result we recorded an additional FIN 48 liability of $26.4 million, including associated interest of $7.5 million. Discussions related to this matter are ongoing. As with all estimates further adjustments maybe required.

Turning to the balance sheet; we ended the quarter with $285.6 million of cash and cash equivalents. During Q1, the company repurchased $98 million of its outstanding convertible notes in the open market for $95.5 million. Following the repurchase, a total of $127 million of our convertible notes are outstanding.

Due to decreasing yields, and as a part of our efforts to capitalize on soft market conditions, the repurchase of the convertible notes will have a positive impact on future net income and will reduce exposure to future dilution.

Free cash and cash equivalents, net of our convertible note increased $18.7 million to $158.6, up from $139.9 million in Q4. The primary reasons for the increase in the company's net cash positions were as follows: Positive non-GAAP cash flow from operations of $18.9 million, cash received from stock issuance of $3.9 million offset by $5.7 million associated with expenditures on capital and intellectual property. Accounts receivable increased $6.3 million to $45.7, which equate to 33 days of sales outstanding based on the quarterly sales volume.

Our net inventory at the end of Q1 was $35.9 million, an increase of $1.7 million from prior quarters. Net inventory turns on an annualized basis were 4.8, down slightly from the prior quarter's 5.0.

I'll now turn the call over to Bob for his briefing.

Bob Bailey

Thanks, Mike, PMC had a solid performance in the first quarter of 2008. We announced a number of new products, partnerships and leading-edge reference designs in Q1. Revenue in the first quarter increased 21% year-over-year, which speaks highly of our key growth platforms and fiber-to-the-home and enterprise storage. This result was achieved despite softer telecom demand in the first quarter of this year.

We experienced very strong bookings late in the first quarter, which is carrying on into April, resulting in a book to bill exceeding one. Our backlog position for Q2 is very strong.

Total design wins are up sequentially this past quarter, led by fiber-to-the-home and enterprise storage. Also, orders have resumed in our wireline products. Therefore, as predicted, we see Q1 as a bottom for these products.

As we indicated during our last call, we're not seeing any supply-chain inventory issues in the markets we serve, and inventory turns appear to be at or above model levels. We believe our demand is being driven by end markets.

During Q1, the company generated non-GAAP operating income of $27.2 million compared to $4.3 million in the first quarter one year ago. Our year-over-year improvement is a function of market share gains in storage, printers and fiber-to-the-home, as well as stable gross margins and tight expense control.

Japan was our fastest growing market in Q1, followed by North America and then China. In the fourth quarter of 2008, our fiber-to-the-home business picked up rapidly based on increased EPON build-outs by NTT in Japan, and increasing field trial activities in China.

In storage, our SAS interconnect business continued to ramp and our Fiber Channel Controller and disk interconnect shipments increased quarter over quarter.

During Q1, our telecom business was lower as we had expected, due to seasonality in a very strong second half of 2007. Our microprocessor business experienced a solid pickup in laser printer shipments in Q1.

During Q1, we introduced several key new products and an exciting new joint development partnership with IBM. As we announced earlier this month, PMC has entered into a multi-year joint development agreement with IBM for RAID technology. We expect this agreement to accelerate the development of innovative RAID chipsets and software solutions for 6Gig next-gen enterprise servers and storage systems.

This joint program, which we have been working on for sometime, combines the strengths of PMC and IBM to accelerate the development of RAID solutions for our broad customer base. This will entail joint roadmap planning, as well as joint engineering development projects. While we need to execute on this program and then achieve design wins, we believe it provides another significant growth opportunity for the company going into 2010.

With regards to new product announcements, in storage we introduced a new family of controller based encryption solutions for secure enterprise storage. The Tachyon QE8E Plus for Fiber Channel and the SPCE 8x6Gig for SAS SATA, both feature our new StorClad encryption technology that boost system performance and improves manageability compared to current data security solutions. Data-at-rest security is becoming a requirement by most corporate IT departments.

We also announced this quarter the SXP 24x6GSec and the SXP 36x6GSec SAS expanders making PMC the first provider of end-to-end chipset solutions for 6Gig SAS/SATA enterprise storage systems and server RAID.

In our fiber-to-the-home product line we announced the availability of a complete 10G EPON reference design for Optical Line Terminals and Optical Network Units. These leading reference designs leverage our EPON capabilities and integrate all the functionality to enable 10Gig IEEE 802.3av EPON and we have received very positive responses already for many of our existing and new OEM customers on this 10Gig development platform. 10G EPON promises to be disruptive in the marketplace and will further enable advanced web 2.0 applications as well as truncate further DSL infrastructure investment.

With regards to PMC design wins in Q1, we had another solid quarter in enterprise storage with our tier one storage customers. We locked out several new design wins with our Tachyon SPC 8/6 Gig SAS controller, which enables the first generation SAS 2.0 enterprise class tiered storage.

Our storage team also achieved design wins with our SXP 24/3 Gig SAS expander switch, a 36-port expander switch and our SPS intelligent SATA/MUX. We are continuing to win the lion share of the next-gen SAS 2.0 Controller sockets and we are extending the reach of our SRC 6 Gig radar chip with additional design wins. PMC has a strong and growing position in the enterprise storage market and this could be our highest revenue producing business in 2008.

In the wireline communications market, we believe we experienced the bottoming in the first quarter. Orders have resumed in Asia and other markets as we enter the early part of the second quarter. We are seeing growth in our access products and are achieving continued penetration into 3G wireless backhaul platforms in Asia and Europe with our TEMUX 336.

We also have secured high volume SONET/SDH business in China, recorded design wins in Korea with our [SAS] product line. Carriers are continuing to work through their plans to make video-ready their metro networks with packet and WDM Aware transport and routing equipment specially those carriers that are investing in EPON and have significant bandwidth requirements as they move more traffic from the edge to core of their networks. With our WiMAX RFIC chip, which we refer to as the wizard chip we continue to add design wins with several of our Chinese, Korean and European customers. We are now focused on converting these designs into production revenue. We should be shipping millions of dollars worth of WiMAX chips in the second half of 2008.

Overall, we believe that PMC is gaining market share in the communications business, which we expect should improve as we progress through the year. The telecom legacy portion of our business, which makes up approximately 5% of our revenues, looks to be stable as it continues a flat trend.

In fiber-to-the-home, we saw business climb in the first quarter as our Japanese customers move delivery from Q4 into the first quarter this year to meet their build-out requirements. In addition, we saw the mix of our Japanese fiber-to-the-home business improved with increased orders for central office OLTs due to parallel next-gen networks build outs undertaken by NTT.

In China, EPON is the technology of choice for fiber-to-the-home and field trials are rapidly expanding. In addition, following the terrible ice storms that hit the southern provinces of China earlier this year, many of the carriers are replacing the damaged copper lines with fiber due to high cost of copper, which is also helping the fiber-to-the-home build out.

We have a very strong backlog for China going into the second quarter, and therefore are expecting strong sequential growth in this area in Q2. Again, the mix is favorable as early-stage PON development continue a high ratio of OLTs to ONUs PON initial build out, and then the ratio slowly goes down overtime.

In Korea, we saw improvement in first quarter shipments, and we believe this should continue through the year as fiber-to-the-home competition is increasing in that market. We are also getting some early-stage design wins on EPON and GPON residential gateways, which are a natural extension of our fiber-to-the-home PON businesses.

Overall, given the Asia build out and China field trial activity, we expect that our fiber-to-the-home business will show strong year-over-year growth in 2008.

In our microprocessor business, we experienced a solid increase in revenue during Q1, as several of our system-on-chip design wins in the laser printer market went into production. These are design wins that we secured with leading OEM customers in North America and Japan in the mid to high end color and multi-function printer markets. In the first quarter, we secured several new design wins with one of our leading Japanese printer customers.

In the area of networked attached storage or NAS that utilize our SOC products, we won several design wins in the small to medium business market with Linksys. Our NAS solutions are also being looked at for integration with IP video surveillance network systems. We do expect our microprocessor business to grow in double-digits in 2008.

Now for the outlook. Based on our backlog and bookings to date, as well as expected levels of capital spending in the end markets that we serve, we expect PMC-Sierra's revenues in the second quarter of 2008 to increase to the range of $135 million to $140 million, which is an increase of between 8% and 12%.

In terms of business demand, we have experienced very strong ordering activity in our fiber-to-the-home business. This includes China, with new EPON field trials, as I have previously mentioned. We expect our wireline communications business and enterprise storage businesses to be up sequentially, while our microprocessor business going into laser printers and enterprise networking platforms are expected to be flattish in the second quarter compared to the first.

With regards to PMC's senior executive team, earlier this month, we announced that Greg Lang will be joining our company as President and CEO. Greg has a very strong background in the semiconductor industry, with seven years as President and CEO of Integrated Device Technology, and before that, fifteen years at Intel as VP and General Manager of the platform networking group.

Greg has many accomplishments and is a strong fit for PMC and he will be starting in his new position at the end of this month. He will serve as a Director on our Board as well and I will continue to serve as Chairman of PMC-Sierra. I am very excited to have him join our management team and our Board. Thank you and I will now hand the call back to Mike for more details on our outlook for the second quarter of this year.

Mike Zellner

Thanks, Bob. I will now provide more information about our Q2 outlook. Judged, shipped and shippable backlog at the beginning of Q2 was approximately $106 million compared to $95.5 million at the beginning of Q1. As of today, judged backlog including shipped plus shippables is approximately $124 million.

Based upon this information, considering current levels of demand and general uncertainty as to the booking rates throughout the quarter, we estimate that the potential revenue for PMC-Sierra for Q2 is in the range of $135 to $140 million.

On a non-GAAP operating basis, we expect our overall gross margin percentage in Q2 to remain consistent with that in Q1. We expect non-GAAP Q2 operating expenses to be approximately $2 million to $3 million higher than Q1 levels, due to increase in tapeouts and expenses associated with our recently announced IBM RAID partnership.

We are substantially hedged on our Canadian dollar operating expenses at roughly at par through Q4 '08. We expect non-GAAP net other income, which is primarily net interest income from our cash positions to be approximately $1 million.

As previously noted, we expect the effective tax rate will remain in the high teens to low twenties since second quarter. As a reminder, the effective tax rate can be impacted by a number of variables associated with our FIN 48 liabilities, included but not limited to a change in foreign income and product mix and potential or partial or full resolution of the underlying tax matters.

We are somewhat cautious related to the second half shipment as we consider the following: China EPON fiber-to-the-home build outs may moderate and reductions in some end of life shipments and typical Q3 seasonality.

Regarding share count we ended Q1 with the basic share count of 220 million and a diluted share count of 221 million. Our basic share count is expected to be between 220.5 million and 222 million in Q2. And our diluted share count is expected to be between 222 million and 223.5 million.

For the second quarter of 2008 we plan for the following significant GAAP to non-GAAP reconciling items. Amortization of purchased accounting costs associated with past business acquisitions, stock option expense as required under FAS 123R and, FX gains or losses and interest on our FIN 48 liability. Additional non-reoccurring items associated with restructuring or other costs, positive or negative, are always possible.

I would now like to open the call out for questions.

Question-and-Answer Session

(Operator instructions). The first question comes from James Schneider from Goldman Sachs. Please go ahead.

James Schneider - Goldman Sachs

Hi, good afternoon. Bob maybe you could talk about the trends you are seeing and expecting in enterprise storage right now and discuss what you expect next quarter and perhaps you could expound for us, how much of the growth you are expecting or you saw this quarter and you expect next quarter is organic, is preexisting business, and how much is due to new design wins?

Bob Bailey

Sure. Well, the storage business is doing very well, and it's growing sequentially as we mentioned, it did in Q1, we expected to do it again in Q2. Your definition of organic, they all result from design wins at one point in time, and it's really the products that we acquired through acquisitions as well as ones that we developed in-house, they are all growing, but we see the fiber channel business growing, but we also see the SAS business growing even faster coming off a smaller base.

James Schneider - Goldman Sachs

Great. I guess, and really what I meant was, new design wins just coming to production in Q1 versus one you had already in Q4, that is kind of what I was referring to?

Bob Bailey

Well, I'm not aware of that. It's too hard to figure out when something started ramping from one quarter the next. It's more the aggregate of the business that we're commenting on.

James Schneider - Goldman Sachs

Fair enough. And could you comment on whether your book-to-bill at this point right now is higher or lower than it was last quarter at the same time?

Bob Bailey

Well, we usually just do a book-to-bill at the end of the quarter, we don't do it in the middle of the quarter because this really doesn’t -- you can get some nonsensical numbers, but I think our backlog, as Mike pointed out is in a stronger position now compared to this time last quarter.

Operator

Thank you. The next question comes from Romit Shah from Lehman Brothers. Please go ahead.

Romit Shah - Lehman Brothers

Yeah. Nice job guys. You touched on seasonality being a factor in the third quarter. I know you are not providing guidance, but could your remind us on how we should think about seasonality in Q3?

Bob Bailey

Well, you know, seasonality, I would say it's not a guarantee and it's not like the Christmas season or something but our last summer quarter, for example, was very strong for us. But maybe three out of five summers, things kind of slow a little bit, because people have shutdowns in their factories etc. So we're just cautious that’s all we're saying. Its that if you were to take the growth rate in Q1 and the expected growth rate in Q2, to just assume that will continue at that pace, at infinitum is probably not a good planning approach, and that's all we're saying, let's be a little bit cautious.

Operator

Thank you. The next question comes from Shawn Webster from JPMorgan. Please go ahead.

Shawn Webster - JPMorgan

Thank you for taking my question. Just to poke around a little bit more on the second half seasonality question, Bob, is there anything in terms of the linearity of your bookings that's making you plan out your second half or it seems uncertain or is there anything tangible or is it just kind of the macro stuff without anything tangible you're seeing?

Bob Bailey

You know, I think it's more of the scars that we all have from seeing the rapid build-up in NTT and in China, and then -- they digest the material that they acquired from us. And during that period of digestion, we could see some moderating of that growth, and so, we experienced this in our wireline business in Q1. So we don't have any specific signs of anything. We're just saying; let's just see what that looks like before you say we're going to grow 8% to 12% forever per quarter.

Operator

Thank you, sir. The next question comes from Ruben Roy from Pacific Crest Securities. Please go ahead.

Ruben Roy - Pacific Crest Securities

Sorry, Bob. I am sorry I am going to take another shot at that. I thought and just specifically in terms of China, I thought you said in your comments that you thought that the EPON build out was going to strengthen and I understand that's a small -- a start from a small base. But you talked about strengthening of EPON second half for China and then I think the moderating comments were still in reference to EPON, is that correct?

Bob Bailey

It's in reference to EPON but it's also -- we had some small amount of end-of-life in Q2 that won’t repeat in Q3. We had, again there is the seasonality question on a macro level. So we are just again, trying to say let's be cautious in projecting what we are going to do out there. We don't have backlog in Q3 that can give you anything meaningful that can give you any guidance from that point of view. That's why we don't guide out past one quarter. So there is no specific event that is telling us to do anything differently other than experienced.

Operator

Thank you. The next question comes Sandy Harrison from Signal Hill. Please go ahead.

Sandy Harrison - Signal Hill

Yeah, thanks for taking my calls and Bob enjoy the last couple of years and good luck as you move upstairs.

Bob Bailey

Okay. Thank you, Sandy.

Sandy Harrison - Signal Hill

I have a few questions on some of the new products which you discussed. The StorClad product; is that more of a software; is that a hardware and is that something you've got integrated into the chipset? Perhaps if you could elaborate on the technology involved. It seems like it could be an interesting piece of the puzzle.

Bob Bailey

Sure. It's actually a combination of both. We have our controller products, which have functionality in them that help facilitate the -- as I call the data at rest security or encryption but there is also some firmware and middleware that we provide the customers as well to deploy this technology. And so it's really the trend of our business where we are providing these complex SoC technologies in silicon with software and firmware and middleware to compliment that and provide a comprehensive solution.

Sandy Harrison - Signal Hill

Understood. And then, as you sort of look to your stores business in some of the contracts you've announced historically with HP and some of the others that is price that you expect to see start to come up in the second half of the year. So as you see HP and some of these other designs you announced couple of quarters ago comes up in the second half, something that could potentially offset some of the seasonal issues that you highlighted.

Bob Bailey

It's possible, but it's until you see the ramps happening, there are always risks they could slide out. So that's why we've always been cautious on new product ramps.

Operator

Thank you. The next question comes from Cody Acree from Stifel Nicolaus. Please go ahead.

Patrick Ho - Stifel Nicolaus

Yeah. This is Patrick coming in for Cody Acree. I just have a couple of house keeping questions. I know you guys have said that tax rate can change largely based on where your revenues recognized, but on a longer term rate you guys had looking out in 2009, I think you guys have previously guided for approximately 30%. Is that still kind of a long-term range that we're looking at?

Bob Bailey

Well, we don't give guidance out beyond the quarter. And as I said high-teens, low-20s is what we're for Q2. Again, these things can move around and do move around a bit. It could be a bit difficult to predict. So I think going out too much beyond that -- using a kind of a similar tax rate that we're talking about in Q2, in '07 that you should probably give for your models, but we're not specifically guiding it.

Patrick Ho - Stifel Nicolaus

Okay. I guess I will rephrase. Do you expect that slight upward trend from current levels to continue for the longer-term?

Bob Bailey

We're continually looking at our legal structure, and we're trying to optimize it. And with net income of $30 million, right? $300,000 tax since that's your denominator -- 300,000 in tax can swing at a point. So it's pretty sensitive that way in terms of the percentage basis.

So again, at this point, we've given the guidance for Q2, and using that kind of rate for the next couple of quarters is I think a reasonable take on it. But beyond that we haven't given any guidance.

Operator

Thank you. The next question comes from Allan Mishan from Oppenheimer. Please go ahead.

Allan Mishan - Oppenheimer

Hi. Just to clarify your comment about Q3, are you expecting slower growth sequentially? Are you most likely expecting a decline for Q3?

Mike Zellner

Allan, we don't have any specific information or backlog that leads us to have a definitive position on Q3. Only that we're cautious and are asking you all to be somewhat cautious that the growth rate that we're seeing right now as much as we're excited about it, we don't believe will be sustained for a long period of time that is the 8% to 12% per quarter. And so, we don't know what's going to happen in Q3 yet.

Allan Mishan - Oppenheimer

Okay.

Operator

Thank you sir. The next question comes from Eric Ghernati from Banc of America Securities. Please go ahead.

Unidentified Analyst

Hi. This is [Ian] in for Eric. I just had a question on the deferred income line. Well, they are big in absolute dollar terms but it up significantly sequentially. Can you just talk through that? That’s all and then I have a quick follow up.

Mike Zellner

You know, we -- deferred income is really essentially when we have -- when we had arrangements with our customers and for whatever reason, accounting reasons, we can't necessarily take that to the P&L, so it ends up in that line item and we have some NRE arrangements with some of our customers and in some cases, we can't immediately take the NRE associated with that to our P&L.

So there's some of that, and I think as we mentioned last time, actually there tends to be a little more NRE activity with our customers going on more recently. So it's nothing exceptional other than that.

Operator

Thank you. (Operator Instructions). We have a follow up question from Shawn Webster from JPMorgan. Please go ahead.

Shawn Webster - JPMorgan

Yeah. Thank you. A couple -- the turns required, I calculated, is 23% and is your lead times go out, come back or are they stable?

Bob Bailey

Shawn, 23% from when? At the beginning of the quarter?

Shawn Webster - JPMorgan

From your opening backlog

Bob Bailey

Yeah. The lead times are pretty stable. I think, they are probably somewhere in the 10 to 12 weeks on average.

Shawn Webster - JPMorgan

And where are we in terms of your any head count reduction plans or is most of the operational expense reduction behind us from a restructuring perspective or what we are going to expect in terms of future expenses on that for the restructuring?

Bob Bailey

We have no restructuring plan. I think that our plant head count is approximately flat for the remainder of the year. Maybe slightly up with this new IBM deal we might add a dozen or so people from where we are.

Shawn Webster - JPMorgan

Right. Thank you.

Bob Bailey

Okay.

Operator

The next question comes from Taunya Sell from Ragen MacKenzie. Please go ahead.

Taunya Sell - Ragen MacKenzie

Hi, this is Taunya Sell from Ragen MacKenzie, Wells Fargo and I had a question, just kind of again on the tax rate here. In terms of the tax rate coming down in the second quarter, how do you look at that in the context of the FIN 48 $30 million item in the first? I guess I am trying to get a sense for where -- I mean if you are bringing the tax rate down and why did we have this charge in the first quarter and kind of what we should think about that going forward?.

Mike Zellner

Sure Sell. The charge that we talked about really had to do with prior year activity associated with some foreign taxing jurisdictions reviewing those due audits. So it's just because of the FIN 48, the rules around FIN 48 require reserves associated with that long before the actual underpinning tax matters are settled and that's really all it is. When we talk about out non-GAAP rate, we actually pull those large items out in terms of doing the calculation.

So, again, with our Q1 -- sorry Q1 tax rate at around 18%, that's our non-GAAP tax rate. So that 30 -- roughly $30 million adjustment associated with prior year activity is not a part of that and nor is it a part of anything that we would talk about in terms of high-teens to low 20s in Q2.

Taunya Sell - Ragen MacKenzie

Yeah. And just to kind of expand on that, I think I remember last year you guys had a special tax item as well, is this related to that or can you talk about that?

Mike Zellner

It's similar to it in that. It's a item that comes about because of -- again, reviews of taxes associated with prior activity with the company, so it's certainly similar to that. One that you observed I think it was in Q1 as I recall last year.

Taunya Sell - Ragen MacKenzie

Okay. Thanks.

Operator

Thank you. There is another follow-up question from Allan Mishan from Oppenheimer. Please go ahead.

Allan Mishan - Oppenheimer

Can you talk a little bit more about the IBM rate program? Is it the case that you are developing product along with them that you sell as a merchant supplier or does this relationship with IBM imply that you have opportunities specifically at IBM to serve them in a rate capacity?

Bob Bailey

Sure. It's a both, Allan. Basically, the development, the joint development does not guarantee us any business anywhere for that matter. But we're working very closely with our engineers and their engineers and road mapping together and there is specific projects. And if we execute on those, we believe and we are hopeful that we will capture some IBM business. The same product and the goal is to make it a merchant market product. The same product will be sold to the rest of the world, and that's a good thing for the industry as we standardize on array technology.

Operator

Next question comes from Jim Snyder from Goldman Sachs. Please go ahead.

James Snyder - Goldman Sachs

Bob, just a follow-up, could you give us just an update on the status of GPON design activity in the US and Europe please?

Bob Bailey

Sure. We have won several designs this quarter. And we've got a lot of evaluation activity. And so we're bullish, the market has been very slow to develop. I don't know the exact market size for GPON, but it would be very small fraction of what it is in EPON. And so we're continuing to pursue that, but we've got some good momentum there. And it's in both in Europe as well as North American opportunities.

Operator

Thank you, gentlemen. There are no further questions at this time. Please continue.

David Climie

Thanks, Operator. Just I'd like to turn it over to Bob for some concluding remarks.

Bob Bailey

Great, as this is my last quarterly conference call at PMC-Sierra, I would like to thank all of our investors, research analyst and media who I have had the pleasure of working with over the last 14 years of the Company. It's been an incredible journey. PMC-Sierra has completely reinvented itself. We have a solid growth strategy and a more competitive technology and cost position. Rest of all, we have the greatest employees in the world. They have been through a lot of turmoil as we survive the tech meltdown. We pull together as a team and we never quit. As Antonio Pierce of the New York Giants recently said after winning the NFC Championship, look where we're at now. So, goodbye, everybody.

David Climie

Thank you, Bob, for the comments, and I'd like to thank the Investment community for attending the conference call today. We will be scheduling our second quarter 2008 earnings release for the second week of July. And at that time, we'll be reviewing our quarterly results and providing outlook for the third quarter. Thank you. And that ends today's call.

Operator

Thank you, ladies and gentlemen. This concludes the conference call for today. You may now disconnect your line and have a great day.

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