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EZchip Semiconductor Limited (NASDAQ:EZCH)

Q2 2012 Earnings Call

August 8, 2012 10:00 am ET

Executives

Ehud Helft – Investor Relations, CCG Investor Relations

Eli Fruchter – President and Chief Executive Officer

Dror Israel, Chief Financial Officer

Analysts

Gary Mobley – The Benchmark Company, LLC

Daniel A. Berenbaum – MKM Partners LLC

Joseph Wolf – Barclays Capital

Daniel Meron – RBC Capital Markets

Jay Srivatsa – Chardan Capital Markets LLC

Paul McWilliams – Next Inning Technology Research

Sundeep Bajikar – Jefferies & Co.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the EZchip Second Quarter 2012 Results Conference Call. All participants are at present in listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded, August 8, 2012.

I would like to remind everyone that forward-looking statements for the respected company’s business, financial condition and results of its operations are subject to risks and uncertainties, which could cause actual results to differ materially from those contemplated.

Such forward-looking statements include but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development and the effect of the company’s accounting policies as well as certain other risk factors which are detailed from time to time in the company’s filings with the various securities authorities.

I’d now like to hand the call over to Mr. Ehud Helft of CCG Investor Relations. Mr. Helft, please go ahead.

Ehud Helft

Thank you, operator, and good day to everybody. I would like to welcome all of you to EZchip’s second quarter 2012 conference call and thank EZchip’s management for hosting this call. With us on the line today are Mr. Eli Fruchter, CEO; and Mr. Dror Israel, CFO.

Before we begin, I’d like to point out that during this call certain non-GAAP financial measures will be discussed. These non-GAAP measures are used by management to make strategic decisions and forecast future results, and the company believes that these figures provide a better method of evaluating the company’s current performance. A full reconciliation of the company’s non-GAAP financial measures to GAAP financial measures is included in the earning release.

I’d now like to hand over the call to EZchip’s CEO, Eli Fruchter. Eli?

Eli Fruchter

Thank you, Ehud. Good day, everyone, and welcome to our second quarter 2012 conference call. Revenues for the second quarter totaled $15.8 million dollars, up 10% sequentially and down 9% compared to the second quarter last year. Gross margin on a non-GAAP basis for the quarter reached 82.2%, with non-GAAP net income of $8.4 million for the quarter representing an outstanding 53.4% non-GAAP net income margin. Furthermore, we increased our cash balance by $8.5 million to $154 million with zero debt at the end of the quarter, further solidifying our already very strong financial position.

Looking at our quarterly revenues in further detail. Second quarter revenue from Cisco reached $5.8 million, 37% of our revenues in the second quarter, down 18% sequentially and up 9% from the second quarter of last year. Moving forward, we continue to feel very comfortable about Cisco, especially with the ASR 9000 product that is expected to be our main revenue generator at Cisco and with the ASR 5000 that is also using the NP-4 and is in initial production.

There is one additional NP-4 based platform at Cisco, which is scheduled to move to production later in 2012. We continue to believe that Cisco will contribute approximately 40% of our revenues in 2012, up from 27% in 2011 and 20% in 2010. We’re seeing more opportunities at Cisco for NP-4 and NP-5 and believe that we will be able to expand to additional platforms.

Second quarter revenues from ZTE reached $3.6 million or 23% of revenues, up 137% sequentially and up 64% from the second quarter last year, making ZTE our second largest customer for the first time. We are pleased with ZTE’s strong revenue growth in the second quarter attributed to strong NP-3 based product purchases and to significant increase in initial production shipments of NP-4 based systems. We recently won another platform at ZTE with the NP-4L, our low cost version of NP-4 and are expecting this platform to move to production before the end of the year. Overall, we see a lot of activity at ZTE that is expanding the use of our product and we are benefiting from the use of the NP-4 software investment across multiple platforms.

As we stated in our last earning call, ZTE is selling to large carriers that do not purchase evenly throughout the year, but rather make large occasional project purchases and this can result in lumpiness in quarterly revenues. Additionally, carrier spending in China is currently low and is expected to remain low until the end of the year. We therefore expect to see a strong decline at ZTE in the third quarter, but a significant increase in 2012 over 2011 and continue to believe that ZTE will continue to be a greater than 10% customer throughout 2012 and beyond.

Second quarter revenues from Juniper totaled $2.2 million or 14% of the quarter’s revenues, up 24% sequentially and down 33% from the second quarter last year. We continue to expect a considerable decline in full year 2012 sales to Juniper versus 2011.

All other customer as a group, excluding Cisco, Juniper and ZTE, totaled $4.2 million dollars or 26% of the second quarter’s revenues, up 3% sequentially and down 35% from the second quarter of last year. The three large potential customers in this group, Huawei, Ericsson and Tellabs that made up 32% of Q4 2011 revenues and 7% of Q1 2012 revenues made up only 2% of the second quarter revenues and expected to have minimal contribution to our revenues in the third quarter as well. These customers are still at the design phase with NP-4 and are still using the large amounts of samples they purchased last year to complete their systems testing and move to production.

We believe that it might take these customers more time to go to production than we originally anticipated partially because they are now new to our technology and need more time for software development, but also due to the global economy worries that slow up carriers CapEx and which are likely to remain low during the second half of 2012 as well.

We believe this environment allows our new NP-4 based customers Huawei, Ericsson and Tellabs, not to rush their next generation systems and continue to sell their older systems. It is important to note that currently no NP-4 based platform are in production at any customers yet other than Cisco and ZTE. Nevertheless, we believe that NP-4 based systems at Huawei, Ericsson and Tellabs as well as many other customers will enter production by the end of the year.

Turning now to our next generation products, NP-5 is making good progress in R&D and is expected to sample in the first quarter of 2013, a delay from the previous Q4 2011 target. We continue to believe that substantially all our NP-4 customers will select the NP-5 for their next generation platforms and two of them began designing with NP-5 already.

Our new product development in Kiryat Gat is also making good progress and we expect to announce the product in September next month, a year before tape-out, as we typically do with new products. We shared the product information with a limited number of customers with extremely positive feedback and we are now starting to share it with an extended group of customers.

2012 is turning into another transition year for EZchip, a transition from Juniper to Cisco as our key customers from top line to royalty based revenue with higher gross margin and from NP-2 and NP-3 to NP-4. As we communicated in our last earnings call, our growth in the second half of 2012 depends in large on our new customers entering production with NP-4 platform and on improvement in carriers CapEx. Right now, it appears that both are delayed, it is taking our new customers longer to move to production with our new NP-4 based system and carrier spending, especially in wireline products and especially in Europe and China is still slow due to the global economy worries.

The result is the likely delay in our expected revenue ramp from the second half of the year to next year. Revenues in the second half of 2012 as a result are expected to be lower than initially anticipated with a significant sequential decline in the third quarter and with 2012 revenues likely to decline year-over-year. However, we continue to believe in our long-term strong growth potential and are now expecting the revenue ramp to start in 2014.

With regards to guidance for the upcoming quarter, we expect revenues to be at the $8 million to $10 million range, with a product and customer mix that will result in approximately 82% gross margin. It is a very disappointing short-term guidance that delays our expected revenue ramp, but we believe it is just a delay, that does not change our long-term view. We continue to believe that all our NP-4 customers will move to production until the end of the year, carriers to increase spending, the growth in edge routing to resume, and our leadership in high-speed network processors to advance.

I would now like to turn over the call to our CFO, Dror Israel, for a more detailed financial review. Dror?

Dror Israel

Thank you, Eli. In order to better understand our business, we are providing both GAAP and non-GAAP results. While we discuss the non-GAAP results in this call, the GAAP results and the reconciliation between the figures are included in our earnings release. The non-GAAP financial measures exclude the effect of stock-based compensation, amortization of intangible assets and changes in deferred tax assets.

Now to the results. Revenues for the second quarter of 2012 totaled $15.8 million, down 9% from the $17.3 million in the second quarter of 2011, and up 10% from the $14.4 million in the prior quarter. Cisco through Marvell accounted for $5.8 million or 37% of revenues. ZTE accounted for $3.6 million or 23% of revenues. Juniper accounted for $2.2 million or 14% of revenues. Our other customers which include some of the world’s tier 1 networking vendors as a group accounted for $4.2 million or 26% of revenues for the quarter. Within the other customers group, Huawei, Ericsson and Tellabs accounted together for $0.4 million or 2% of revenues.

Non-GAAP gross margin for the quarter totaled 82.2%, up from the 80% in the second quarter of 2011 and down from the 85.4% last quarter. The decrease in gross margins compared to the previous quarter resulted mainly from a lower level of revenues from Cisco coming through Marvell as royalties.

Non-GAAP R&D expenses net for the quarter totaled $3.3 million. This amount included $1.7 million in R&D grants received from the Israeli Office of the Chief Scientist. On a gross basis, our R&D expenses for the quarter totaled $5 million.

Non-GAAP operating expenses for the quarter totaled $5.2 million, compared to $4.8 million in the second quarter last year and compared to $5.1 million in the prior quarter. We expect that our annual OpEx level in 2012 will be around $22 million. Non-GAAP operating income for the quarter was $7.8 million, down 14% from the $9 million operating income in the second quarter last year and up 8% from the $7.2 million operating income in the prior quarter.

Non-GAAP net income for the quarter totaled $8.4 million, down 10% from the $9.4 million net income last year and up 9% from the $7.8 million in the previous quarter. Fully diluted EPS on non-GAAP basis was $0.29, down from $0.33 in the second quarter last year and up from $0.27 in the previous quarter.

Moving over to the balance sheet, cash, cash equivalents and marketable securities totaled $153.8 million as of June 30, 2012, compared to $145.2 million at the end of the previous quarter. Cash generated from operations during the quarter was $9.1 million, cash used in investing activities was $0.8 million and cash provided by financing activities was $0.3 million, resulting from the exercise of stock options.

With that, I would like to open the call for the Q&A session. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from Gary Mobley of Benchmark. Please go ahead.

Gary Mobley – The Benchmark Company, LLC

Hi, guys. This is actually Gary. Given the severity of the expected revenue decline in the third quarter, I wanted to dive down a little bit deeper into what’s implicit there. I’m assuming all your customers are going to be down, and could you talk about that dynamics impacting the direction of all of your sales to all of your customers, whether it be inventory related product transitions and so and so forth? And then as well, you’re expecting fiscal year 2012 revenue to likely be down compared to 2011 that would imply revenue similar in the range of $60 million to $63 million, if my definition is correct. And if that would therefore imply a big sequential revenue ramp in the fourth quarter and I’m just wondering, what gives you visibility into that revenue ramp?

Eli Fruchter

Hi, Gary, thank you for the question. So you are correct, all of our customers will be down in Q3 compared to Q2. That’s what we’re seeing right now. And I think that it is different for each one. Juniper is basically – Juniper is declining for a long time. ZTE, as I mentioned, is selling to large carriers and they don’t purchase evenly throughout the year and they made a big buy in the second quarter and it seems that the third quarter will be very low. With Cisco, it’s really unclear right now it’s also declined, but I’m not 100% sure about it. I think that it’s more like an inventory related. I don’t think that Cisco is declining in market share. The opposite I think that they are actually gaining market share.

Remember that July is the last month of the year and that’s probably inventory adjustment at the end of the year and we still expect both Cisco and ZTE to be up year-over-year in 2012 versus 2011, while in Juniper we are expecting some decline. And therefore the other customers, in terms of mainly NT-4 last year had many samples and they are still using them to build their product. None of them is in production yet.

So as I mentioned before, they are declining pretty significantly and if we compare what I did last year, where they will move, then 30% of our revenues in the fourth quarter and then they were down significantly in Q1 to 7% and now only 2% and we see something like that also in the third quarter. So all-in-all all customers are going down.

Now, we believe that next year the growth will resume and you are asking about the fourth quarter, but it’s difficult for me to say right now. I obviously assume that it will be up from the very secular focus we set for the third quarter. It will be up. I’m sure about that, I don’t know how much. That is something that we need to wait. Normally, we know where the quarter is when we are about one month into the quarter. So, when we announce third quarter, we will be able to provide guidance for the fourth quarter, but it will be higher than the third quarter for sure.

Gary Mobley – The Benchmark Company, LLC

Okay. I understand you guys are probably getting hit by a perfect storm during the third quarter, but $9 million in revenue in the third quarter is not indicative of the strong product cycle for NP-4. So, I’m just wanting perhaps a little more, a few more metrics on the sales of NP-4, what it represents as a part of your overall revenue and if you’re not willing to share that maybe you can talk about whether or not shipments of NP-4 to large customers like Cisco exceed sales of NP-3?

Eli Fruchter

Maybe Dror you want to answer for that?

Dror Israel

Yeah, Eli and hi, Gary. So in general, we want to avoid breakdown between product line but we can definitely say that NP-4 sales to Cisco are getting better even significantly better compared to last year. Remember that actually the NP-4 only entered production in Q4 of last year and also the revenues that we got last year were the samples. So naturally it’s going up I think with Cisco and ZTE, we definitely see a very positive trend with NP-4. There is short-term problem, it’s coming from the new customers that are expected to move into production and as we said it’s – in someway, it depends on them, on their internal design phase and on the other hand, on the carrier CapEx and service providers spending especially wireline and specifically as always we’re really focused and both as already mentioned, relatively strong and this is the main reason for the decline in expected revenues, we believe that they altogether this year NP-4 will probably equal and even exceed NP-3 revenue. So to summarize this, NP-4 revenues we believe so forth positive signs, but it looks like it’s going to take a bit more time and the rail growth will come next year.

Gary Mobley – The Benchmark Company, LLC

Okay. The last question from me and I’ll hop in the queue, it’s a point of clarification, in which quarter during 2011 did Ericsson, Huawei, and Tellabs represent more than 30% of revenue?

Eli Fruchter

In Q4.

Gary Mobley – The Benchmark Company, LLC

Okay. And that was 32% to be more precise.

Eli Fruchter

I can find the exact number if you like, yeah its 32 yes.

Gary Mobley – The Benchmark Company, LLC

All right. Thank you, guys.

Eli Fruchter

Thank you, Gary.

Operator

Your next question is from Daniel Berenbaum of MKM Partners. Please go ahead.

Daniel A. Berenbaum – MKM Partners LLC

Hi, thanks for taking the questions, maybe a follow-up a little bit and typically you guys give gross margin guidance for the quarters, so I’ll ask for gross margin guidance then also do you expect in Q3 any customers to be up year-over-year and specifically talk about Cisco ramping NP-4 already. Do you think, that means that Cisco could be up year-over-year in Q3?

Dror Israel

Okay for starting from gross margins, so we guided for 82% for Q3, as always it will depend on the customer and product mix. Going forward, I think that as a model we should use 81% assuming Cisco has about 40% share of the revenue with 100% gross margin and the remaining 60% customers with direct selling or then say about – between 65% to 70%, we use 68% and then further this will give us 81% gross margin as a model for the next year – at least the next year. About Cisco, we expect year-over-year growth and same growth for ZTE and all the other customers we expect them to go down.

Daniel A. Berenbaum – MKM Partners LLC

But, is that year-over-year in Q3 specifically, so I mean it seems like ZTE is going to be down sequentially and year-over-year, but would Cisco be up on a year-over-year basis even though it’s down sequentially for Q3?

Dror Israel

In Q3, I don’t really know if it’s going to be a year-over-year growth compared to Q3 ‘11, I think that’s what you mean, maybe not.

Daniel A. Berenbaum – MKM Partners LLC

Okay. And then given the gross margin guidance, gross margin seems pretty solid, given the weak revenue I would expect there to be some sort of pressure on your pricing which could ultimately impact gross margin. Are you seeing any pressure on pricing, and why or why not?

Dror Israel

No, not at all, we don’t see any pressure on pricing. I think it’s setup for years ahead based on time and volumes. So, no we are not seeing pressure on pricing.

Daniel A. Berenbaum – MKM Partners LLC

Okay. And then maybe just last question, can you comment on the size of your available market with your guidance down significantly year-over-year at least in isolation for Q3 and even down for the full year 2012. How much of this is related to the market? You guys talk about the TAM in terms of the number of high-speed Ethernet ports for edge routing, is there something wrong with that TAM – we’re not seeing the 10-Gigabit Ethernet cycle the way we thought it was going to be, can you help me understand the dynamics there?

Eli Fruchter

I think that we are looking at the situation here, where customer – we’re actually seeing in the simplest terms, a six months delay. That’s the best way to look at this and that delay is caused by customers that have not yet finished development of the NP-4 and we mentioned three larger one, but we have, I think around 20 add-on customers that are now bidding products with NP-4 that are smaller ones. And I believe that they will all enter production until the third.

Okay, I think that the delay, the six months delay is currently the combination of those customers using more time to build their product. Some of them did not use the NP-3 and they had to fully develop from scratch and that takes more time. Cisco and ZTE both used the NP-3, so they have a lot of support ready and they just need to introduce new line cards, but with the same features with higher propensity where other customers that are mainly using it for the first time, they have to develop all the features on our chip and that takes more time.

So, I think that we are not seeing a change in what we said before. We are seeing a delay to what we said before.

Daniel A. Berenbaum – MKM Partners LLC

And in the case where the for the edge router TAM, the edge router market itself is still growing but those customers are still using their own internal products to fulfill demand?

Eli Fruchter

Exactly, exactly. So when we are, we need those customers to increase our market share in edge routing and right now, they are selling the older products and they utilize that thing really see those both and our market share will grow.

Daniel A. Berenbaum – MKM Partners LLC

Okay. Thanks very much.

Operator

The next question is from Joseph Wolf from Barclays Capital. Please go ahead.

Joseph Wolf – Barclays Capital

Hi. I just wanted to go through a couple of product questions. In the fiscal commentary you mentioned NP-4 and NP-5 and then you talked about NP-5 sampling and in the press release you talked about being ZTE. So when you say substantially or can we now infer that Cisco was looking at the NP-5 already. That’s my first part of question. The other question is, you mentioned the ZTE is taking the NP-4L, could you go into a little bit more detail on the differences there and how you look at that product developing really on sampling production and if you look at that mix may be a year from now in the NP-4 build, what is the other part and how should we be thinking about that?

Eli Fruchter

Okay, thank you, Joseph. So I really cannot name customers that are designing NP-4 – NP-5 now, but I can tell you in general customers that are already in production with NP-4, designed already with NP-5. But they cannot name themselves, but I think it will repeat to conclude.

Then regarding the NP-4L, so what we’re seeing that the product line NP-4 with the lower performance is needed and lower price points and that part goes more towards the access, closer toward the access point, the valuation point. The NP-4 did a full performance closely with the routing. So it somewhere between edge routing and access, more towards access and then you need low performance and lower pricing. So we have NP-4L that we sell at lower price and it provides low performance. And that’s what we have won at ZTE. And we’re working on other projects as well with NP-4L and we hope to win similar projects at other customers.

Joseph Wolf – Barclays Capital

Can you just, what kind of lower performance, is that – the NP-4 I assume is done a speed level performance. What is it, is it reduced number of chips, is it a, what is, what are we giving up?

Eli Fruchter

It’s half of the processing power.

Joseph Wolf – Barclays Capital

Okay. And the ASR 5000, ASR 9000 and the other Cisco product going to production this year, those are straight NP-4?

Eli Fruchter

Yes.

Joseph Wolf – Barclays Capital

Okay, great. Okay, thank you.

Eli Fruchter

Thank you, Joseph.

Operator

Your next question is from Daniel Meron of RBC Capital Markets. Please go ahead.

Daniel Meron – RBC Capital Markets

Hi, Eli and Dror. A couple of questions, first, I understand that things were delayed for the next six months, but as we look at the big picture opportunity, do you have any changes in the overall market size potential and how you fit in? And also, is there a way to compare the development time of your customers now, Tellabs, Huawei and Ericsson versus this time length that it took to develop it with ZTE and Cisco, why is it taking longer – I understand that there is different needs because of the prior experience that they had with NP-3, but is it longer or is it about the same, when all said and done? Thank you.

Eli Fruchter

Hi, Daniel. So the main reason why it takes longer for customers that did not use our (inaudible), is because they don’t – let’s look at it the other way, the customers that used our chip was asked to do with the new chip, so if they use the NP-3, they take the NP-4, they have don’t need to change the NP-3 software significantly. They do some adjustments and it will run on the NP-4. So all the features that already exists on the platform will move from NP-3 to NP-4 pretty quickly.

When the customer is using the NP-4 for the first time and did not add or did not use the NP-3, the customer like us will need to develop all the features for the platform on the NP-4 for the first time. And that takes more time, software development and that’s the main effort that exist and that’s why we always say that customers that work with us for more than one generation they make a huge investment with us and they are the ones that are likely to continue with us.

And that’s why I’m saying that customers that use the NP-3 and now the NP-4 and once they finished the NP-4 development, they’re likely to use the NP-5 and that’s what we see with the customers who have already finished the NP-4 development. And NP-5 will also take them a faster than people that did not use the NP-4, okay? So hopefully when people will move to NP-5 they will be more than and the move to NP-5 will be quicker.

Daniel Meron – RBC Capital Markets

And as far as the market opportunity, I mean I know that we’re moving as far as some, but as the overall size relates to that, I mean shifting around, but how do you think that we can look at it? Do you think that the NP-4 cycle will peak in 2015 as you thought before or is it going to be delayed even further?

Eli Fruchter

No, I don’t think that it will be delayed further. I think that it will peak in 2015. I think the transits in production will eventually decrease especially with the ones that will start (inaudible). So if Cisco enter production in Q4 of last year, then that certainly will be 15 and that’s my best guess, I would say, that will get into the peak.

Daniel Meron – RBC Capital Markets

Okay. And moving real quickly to the new Kiryat Gat product that you will be announcing in about a month, so I assumed, so as you look at that product could there be any delays like that like you have experienced with the NP as far software design, et cetera, around that. And how do you think about the timing of that or how does that product suppose to ramp into the market? Thank you.

Eli Fruchter

So, the product Kiryat Gat as I said will be announced next month and normally we announce the products about the year before take out, so that means that we expect samples at the end of next year and that’s very aggressive and then we’ll do our best to meet that timeline. And we are making very good progress, we are investing more money to the product, it’s already 40% of our R&D expenses and we expect it be 50% by year end. We see more and more customers and we get excellent feedbacks and we feel that we are doing something that will have a big impact on networking chips, and if we sample it at the end of next year, I assume that it will take another year for testing and then it will go to production. So we are not talking about production before 2015.

Daniel Meron – RBC Capital Markets

Got it.

Eli Fruchter

Okay. Thank you.

Operator

The next question is from Jay Srivatsa of Chardan Capital Markets. Please go ahead.

Jay Srivatsa – Chardan Capital Markets LLC

Yeah, thanks for taking my question. Eli, if I look at comments from the service providers, it appears most of them, whatever investments they’re making seems to be directed more to the wireless side, specifically looking at LTE in the U.S. and then 3G in China. Are you concerned that the six months delay that you alluded to could be longer and that investments in the wireline space might get pushed some more?

Eli Fruchter

Hi Jay. Thank you for the questions. I agree with you that most of the service provider investments are now done in wireless and not wireline. The indications that we get from our customers is that it will resume next year, early next year and that’s why we are saying that we expect a delay of six months. And obviously if it takes longer, then we will see longer delays. I believe that the carriers cannot halt investments in wireline products for too long because then it creates a bottleneck and the networks will not function well. So I think that those investments will resume, and right now, I think that it will resume at the end of the year.

Jay Srivatsa – Chardan Capital Markets LLC

All right. Competitively, at least a couple of other companies have thrown their hat into the ring in terms of developing solutions in the carrier internet space. As you speak with your customers, are you getting indications that they might be looking at alternative solutions or do you feel pretty secure about your position with your existing customers as it relates to NP-4 and NP-5 coming up?

Eli Fruchter

We feel very comfortable with our customers and the way they looked at NP-4 and NP-5. And actually I think that we will actually strengthen our position in that market although there are some new entities from Broadcom that we saw some time ago and from where that required accelerated. We do see them more in transport which is not a strong space for us but not in routing. And I feel that looking forward the gap will actually increase and not decrease.

Jay Srivatsa – Chardan Capital Markets LLC

Okay. Last question on the NP side, you haven’t talked much about it. Can you give us an update on where things are on the NP market and are you seeing any traction, any meaningful traction for those solutions.

Eli Fruchter

So NP is targeting access. We see some wins, we see some success but we do see the NP-4L getting into that space as I described before. And that’s because the speed that’s required in access is actually increasing. So I don’t think that we can build, we can continue and look at NPA as a product line that goes through access and the NP goes to the network or the routers, but the NP especially the NP-4L is really starting to target access bottoms with, that’s what we see.

Jay Srivatsa Chardan Capital Markets LLC

Thank you.

Eli Fruchter

Thank you, Jay.

Operator

The next question is from Paul McWilliams of Next Inning Technology Research. Please go ahead.

Paul McWilliams – Next Inning Technology Research

Hi guys thanks for taking my call. Two questions, what is the factor for Cisco if we’re to convert its royalty to a normal direct to customer revenue stream?

Eli Fruchter

I think you can use the double the number that we provide for Cisco.

Paul McWilliams – Next Inning Technology Research

Okay. Now I realized that Cisco is reported in the rear, so what shipment months from Marvell to Cisco are reported as Q3 revenue?

Eli Fruchter

It will be a June, July and August.

Paul McWilliams – Next Inning Technology Research

Okay. Now if I look at your comment about 2012 possibly being less than 2011, and I didn’t memorize exactly what words you said there. It would allude to me that you are pretty confident that it will be less but possibly not much less. Can you give me some clarification on that?

Dror Israel

Yes, look we guided for $8 million to $10 million revenues in Q3 which is significantly down.

Paul McWilliams – Next Inning Technology Research

Okay.

Dror Israel

So the revenues that we generated for the first six months already now get above $30 million. So, which means that if we want to equal last year we’ll have to make numbers that at this point look unreachable. Now again as Eli mentioned and still we’re one month into the Q4 and like to total, we will also have a really good visibility, how Q4 is going to end, but we don’t expect to have this kind of let’s say, optimistic expectation for Q4 and that’s why we assume that we will end the year lower than 2011.

Paul McWilliams – Next Inning Technology Research

Okay. Is there a good potential that it will be significantly lower than 2011?

Dror Israel

Anything both of end of this flow, once again it will depend in large part on carrier’s spending getting better, especially in edge routing and on our NP-4 customers moving to production. We don’t really know at this point and we’ll have to take the conservative sides.

Paul McWilliams – Next Inning Technology Research

Okay. End marketwise what percentage of your NP sales are driven by carrier, is that a 100%, 90%?

Dror Israel

Above 90%.

Paul McWilliams – Next Inning Technology Research

Okay. Was the balance coming from enterprise?

Dror Israel

Not only enterprise, but let’s say more access kind of boxes and wireless backhaul and these kind of.

Eli Fruchter

But it’s also some enterprise things like load balancing, which we see some security boxes where chips will be used as an accelerator for Intel CPUs or multi-core. And so it’s really very, very many decent applications let’s say that we made the remaining 10%.

Paul McWilliams – Next Inning Technology Research

How many total NP-4 designs do you have now?

Eli Fruchter

We have over 20 customers. I would say close to 100 designs.

Paul McWilliams – Next Inning Technology Research

Close to a 100 designs?

Eli Fruchter

Yeah, around that number I would say.

Dror Israel

Altogether.

Eli Fruchter

Altogether.

Paul McWilliams – Next Inning Technology Research

Yes. So active customers in production in 2012 NP-3 plus NP-4, how many do you think you will have?

Eli Fruchter

Probably around 30.

Paul McWilliams – Next Inning Technology Research

How many of those will be NP-4?

Eli Fruchter

As I said before, I think NP-4 will be above 20.

Dror Israel

But maybe in terms of NP-4 based platform we currently have only two NP-4 based platforms in production and coming from Cisco and ZTE. And we expect additional platforms to move to production from Cisco and ZTE this year together with premium customers, Huawei, Ericsson and Tellabs that will add more platforms so altogether we can be at a position that we may have about 10 platforms using NP-4 by the end of the year up from two right now. And with that we should always remember that the ASR 9000 is by far the most important platform. So, it’s not that all of them can have the same kind of revenue contribution.

Paul McWilliams – Next Inning Technology Research

Of course. Now going back to that, how may NP-4 customers versus platforms do you expect in production at the end of this year? I want to make sure I’m clear?

Eli Fruchter

Well I think that the question understand what you’re trying to achieve, but please remember that not all customers are equal and not all platforms are equal. We can’t sell a customer 100 chips a year and we can’t sell another customer under 1,000 chips a year.

Paul McWilliams – Next Inning Technology Research

No. I…

Eli Fruchter

So, I think that the number of platforms or design wins is not really going to help you understand our business. We think that’s why Dror focused on the five customers that we feel should make most of our revenues and all others could make probably 20%, 25%.

Paul McWilliams – Next Inning Technology Research

Yeah, I understand that Eli. What I’m trying to get to here is to better understand where customers are within the software development process?

Eli Fruchter

And so, it’s really, as I said before customers that use our previous generations are more advanced than customers that are using the NP-4 for the first time are less advanced, but most customers at the group, the 30 customers in total, most of them I would say, use our previous generation. They did use our previous generation, and but they are not going to have a strong impact on our revenues. So, even if they can go to production sooner, that’s not going to make a huge difference.

Paul McWilliams – Next Inning Technology Research

Okay. Are any of the NP-4 customers having difficulties beyond what would normally be expected in their software development cycle?

Eli Fruchter

I don’t think that it’s difficulties that are beyond what’s you would expect and it’s not, remember it’s, normally it’s a new platform and it’s not just fast, in the new platform there are many other chips and a lot of software development, it is not just EZchip related. And in some cases the platform is delayed not because of EZchip. So, in some cases it takes more time with that, but it also takes more time with other chips.

Paul McWilliams – Next Inning Technology Research

Were these platforms delayed or for whatever reason they are delayed, the carrier qualification cycle, does that still sit in front of the platform?

Eli Fruchter

Normally, they would start that qualification before the product goes to production, if they have the time to do it. So, they don’t need all the features on a new product to be available before they can qualify it, so I would say that qualification can start earlier, but in some cases it could start when the product is really available and starts production, that’s also a possibility.

Paul McWilliams – Next Inning Technology Research

What I’m trying to get to here is some of this delay is development delays, some of this delay is macro economic delay so on, so I would think that these suppliers or your customers would have an opportunity to get into the qualification cycle with their customer during this delay period, is that the right way to look at it?

Eli Fruchter

Can you repeat?

Paul McWilliams – Next Inning Technology Research

Okay, platforms have been delayed for whatever reason, so does that delay the qualification cycle or are they going ahead in qualifying during this soft period their new platforms?

Eli Fruchter

Yes, I answered that before, I answer this, in a general way, I think that in some cases that the qualifications can start before the platform is complete and in some cases not and they cannot tell, I don’t know customers by customers exactly where it stands in the qualification process. Our customers are not sharing it with us, so we don’t know, we are not part of it, we understand it. It’s entirely our customers that are doing it.

Paul McWilliams – Next Inning Technology Research

I understood. I got just a couple of quick bullets here to finish off. Have you lost any designs?

Eli Fruchter

No.

Paul McWilliams – Next Inning Technology Research

Okay. In your presentations you provided the…

Eli Fruchter

Again, I want to be careful when I’m saying we didn’t lose designs, we didn’t lose designs in routers. We do in transport we win some and we lose some. It has always been like this. So we are not in access, we win some lose more. So it depends where, but edge routing is more than 90% of what we do and we did not lose them.

Paul McWilliams – Next Inning Technology Research

That was my question, I’m sorry I should have qualified that. So none of the edge router designs that you’ve talked about which are the big revenue drivers that go on as 2015 have been lost?

Eli Fruchter

Right.

Paul McWilliams – Next Inning Technology Research

Okay, now for the 2015 you’ve talked 2X number of platforms and 2X the price NP-4 versus NP-3, which kind of gives us the 4X factor on the 2011 revenue. Is that still a valid way to look at modeling 2015 revenue potential?

Dror Israel

Yeah, actually we adjusted it a little bit now in your presentation, but not now I think its one or two quarters ago, and we measure to 2011 versus 2016 and we adjusted numbers a little bit, but the bottom line is the same, we still expect the market for us to grow in such a way that we can potentially increase our revenues full time that’s correct.

Paul McWilliams – Next Inning Technology Research

Okay, will the KG product as we all call it because I don’t pronounced yet got very well, will it leverage at all any of the NP-4 software?

Eli Fruchter

I cannot answer that right now.

Paul McWilliams – Next Inning Technology Research

Okay.

Eli Fruchter

If we tell too much about it and I think you will know a lot in one month.

Paul McWilliams – Next Inning Technology Research

Okay. Will you do a presentation at the October when will you on that product?

Eli Fruchter

This is something that we are considering and probably will.

Paul McWilliams – Next Inning Technology Research

Okay. Last question here, how will the trends of virtualization impact the EZchip, will it be favorable, unfavorable?

Eli Fruchter

I think that it has to do more with management and I think that it should not have an effect either way. I think that when you look at the virtualization it will require the boxes to have more intelligent count and that will be in our favor when you compare NPUs to hardwire feature phones. And so I think that it present virtualization will be to have boxes that are smarter and when it took smarter then I think that we can benefit from it.

Paul McWilliams – Next Inning Technology Research

Okay, so at the bottom line would be a potential net benefit for EZchip versus a threat?

Eli Fruchter

Yeah, it’s not a threat for sure.

Paul McWilliams – Next Inning Technology Research

Okay. Thank you very much for your time.

Eli Fruchter

Thank you, Paul.

Operator

The next question is from Sundeep Bajikar of Jefferies Capital. Please go ahead.

Sundeep Bajikar – Jefferies & Co.

Hi, guys, thanks for taking my question. Can you remind us what the value proposition is for customers to transition to NP-4, perhaps in terms of cost per port, how much lower do you think cost per port is with NP-4, compared to the older products and if that cost is lower why wouldn’t your customers have a strong incentive to speed up their design efforts with NP-4 particularly at a time when carrier investments might actually be softer?

Eli Fruchter

I think that customers what they are trying to do, is they’re trying to lower the price of both by increasing the port density. And by moving from NP-3 to NP-4 and then from NP-4 to NP-5 actually, the price of the chip increases, so we get more, but also the port density increases in such a way that the price per port is lower. So, actually our customers are lowering the price per port and are offering line cards with higher port densities. And if you look at 10-gigabit ports, you can see it in the presentation that we had on our web you can see that the number of 10-gigabit Ethernet port in edge routing is expected to grow from about 1 million also to more than 7 million by 2016, that’s a significant growth. So the customers are trying to increase the port density on the line cards to be able to provide their customers with a better solution.

Sundeep Bajikar – Jefferies & Co.

Okay. I understand that. I guess the question is, why isn’t that translating to a faster ramp for NP-4? And related to that, are there any other changes that are required on the infrastructure side to enable faster adoption or at least incentivize your customers to transition to NP-4 faster?

Eli Fruchter

So, as I said before, the transition depends, it’s more software than hardware. So customers that have already worked through that from NP-3 the transition is pretty fast because there is no software or minimal I would say software investment. And when and before is being used, the first time and it replaces something, which is internal or maybe another older network processor technology or something like this, then the software must be written, features must be developed and that takes more time. So it’s limited by software and not by hardware.

Sundeep Bajikar – Jefferies & Co.

Okay. Thanks for the clarification. One big picture question, I think just to circle back on that. So industry forecast for growth in carrier Ethernet are still quite optimistic in spite of the global concerns that everybody has on the economy. How long do you think carriers can grow without investing in carrier Ethernet in a big way or in other words how critical do you think the bandwidth bottleneck is today in the metro area network? Just looking for a framework to get more comfortable around timing of the next round?

Eli Fruchter

Right, so I think this is based on what they use from our customers, they feel that those investments in carrier Ethernet specifically in wireline will resume at the end of the year. So we’ll see growth in that next year. But obviously time will tell and we’ll have to wait and see if that really happens. I personally think that, they cannot halt the investments in wireline for too long, the project will start creating the bottleneck.

Sundeep Bajikar – Jefferies & Co.

Okay, thanks so much.

Eli Fruchter

Thank you.

Operator

The next question is a follow-up question from Daniel Berenbaum of MKM Partners. Please go ahead.

Daniel A. Berenbaum – MKM Partners LLC

Yeah. Hi, guys, thanks. Not to beat the dead horse, but coming back to the two customers that are ramping NP-4, I just want to make sure I understand this since they’re both being guided down pretty significantly for Q3, how much of the guide down, can you talk about is related to NP-4 slowness at those customers or is the guide down mostly related to NP-3 with – and will NP-4 be up sequentially for those customers?

Eli Fruchter

I think that Daniel, what we said about those two customers is that we think that they will feel pretty comfortable that they will grow either year-over-year and they will grow on NP-3 year-over-year pretty significant – on NP-4 sorry pretty significantly year-over-year but we shouldn’t take one quarter and try to draw conclusions from that quarter, so they will grow year-over-year, and Juniper will decline over year-over-year. And the 300 customers the big ones need to go to production and that is expected to happen until the end of the year and we think that then we will see growth resume in next year. That’s a very simple way to describe where we are and trying to dig deeper into the first quarter, I don’t think that it will get you anything, I really don’t.

Daniel A. Berenbaum – MKM Partners LLC

Okay, but then at the risk if it not gaining anything just to try to understand your ZTE, I mean ZTE last year saw revenue in the quarter oscillate between $300,000 and almost $4 million. Do you expect that those type of oscillations to continue in other words should we, when we think about just modeling ZTE moving forward and should be bake in every third quarter as a sub $500,000 quarter?

Dror Israel

You know what, I wish I knew really, I wish I knew. We can see as you said, we can see a $4 million quarter and we can see a $400,000 quarter and I don’t even think they know because they will get an order from China Telecom for instance, and they have to deliver it and then they place a order with us. They even cannot focus it very well so this is the type of surprises that we get from ZTE and the way they explain it is, as we said the carriers in China are not buying on a regular basis. They buy based on projects.

Daniel A. Berenbaum – MKM Partners LLC

Okay. Fair enough. Thanks very much.

Dror Israel

You’re very welcome.

Operator

There are no further questions at this time. Before I turn the call over to Mr. Fruchter for the concluding statement, I would like to remind participants that a replay of this call will be available on the company website at www.ezchip.com. Mr. Fruchter would you like to make your concluding statement?

Eli Fruchter

Yes operator. Thank you everyone for joining us today. I hope to deliver a better news in the future calls. Thank you.

Operator

Thank you. This concludes the EZchip second quarter 2012 results conference call. Thank you for your participation. You may go ahead and disconnect.

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