PMC-Sierra Inc. Q2 2008 Earnings Call Transcript

PMC-Sierra Inc. (PMCS)

Q2 2008 Earnings Call

July 17, 2008 4:30 pm ET

Executives

Gregory Lang – President and Chief Executive Officer

Michael Zellner – Vice President and Chief Financial Officer

Colin Harris – Chief Operating Officer and Vice President

David Climie – Vice President, Marketing and Communications

Analysts

Romit Shah - Lehman Brothers

Sandy Harrison - Signal Hill

Allan Mishan - Oppenheimer

Ruben Roy - Pacific Crest

Shawn Webster - JPMorgan

James Schneider - Goldman Sachs.

Presentation

Operator

Good day and welcome to the PMC-Sierra Q2 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.

David Climie

Thank you. Good afternoon, everyone, and thank you for attending our investor conference call. With us on the call today is Greg Lang, President and CEO; and Mike Zellner, Vice President and CFO. We also have Colin Harris, our Chief Operating Officer and VP General Manager on the call as well.

Please note that our Second Quarter 2008 Earnings Release was disseminated today via Business Wire after market close, and a copy of the release can be downloaded from our website.

Before we begin I’d 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 that are detailed in the company’s Securities and Exchange Commission filings.

Actual result 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 you’re asking a question during the Q&A session of today’s call, we request that you will limit yourself to one question, and if you’d 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.

Michael Zellner

Thanks, Dave. I’ll review our second quarter 2008 results and financial positions and then turn the call over to Greg to discuss our business activity in detail.

Q2 was another strong quarter for PMC-Sierra with revenues of $139.8 million, representing an increase of $14.8 million or 11.8% versus Q1 and our highest revenue quarter since Q4 2000.

The increase in revenue was primarily the result of improved activity in our fiber-to-the-home and wireline communications business. Our terms business, meaning those orders booked and shipped within in the same quarter, were 25% of revenue in Q2 compared with 24% in Q1.

In Q2 no customer accounted for more than 10% of revenue. Our top two customers, Hewlett-Packard and Cisco, were just below 10%.

By region, Asia continued to generate the strongest results in the quarter with the geographic breakdown as follows: China 31%; Japan 17%; other Asia 25%; North America 21%; Europe and Other at 6%.

Quarter over quarter, revenue growth was strongest in China, which again was 31% of company revenue, up from 24% in Q1.

On a non-GAAP basis, gross margins in Q2 declined slightly to 65.2% versus 65.6% in Q1. On a non-GAAP basis, operating expenses were up $2.4 million to $57.2 million in Q2 versus $54.8 million in Q1.

Operating expenses were higher in Q2 due to our annual increase in employee salaries, along with higher costs associated with takeouts in the quarter.

Breaking down operating expenses, non-GAAP R&D was $36.8 million in Q2 versus $34.1 million in Q1. Non-GAAP SG&A was $20.5 million in Q2 versus $20.7 million in Q1.

In Q2 non-GAAP operating income before income taxes was $33.9 million or 24% of sales, which aligns with our targeted operating margin levels of 20% to 25%.

Net interest income of $1.4 million in Q2 was down $800,000 from Q1 due to reduced cash balances with the repurchase of our convertible note in March of 2008 and lower yield on investments in general.

Our non-GAAP effective tax rate was 15% for the quarter, down from 18% in Q1. This was mainly due to a change in our foreign income and product mix during Q2.

Although it’s difficult to predict quarterly tax rates due to the impact of our FIN 48 position on foreign earnings, we expect the non-GAAP effective tax rate to be in the high teens to low 20s for the third quarter depending of course on product and foreign income mix.

Non-GAAP profits after tax for Q2 were $29.7 million or $0.13 on a per-share diluted basis. For a detailed reconciliation between GAAP and non-GAAP results, please see our press release issued today.

Q2 GAAP net income per share was $0.61 on a diluted basis. The primary reconciling items for Q2 are as follows:

Stock option expense or FAS 123R of $7.4 million;

Amortization of intangible assets, $9.8 million;

Net unrealized foreign exchange loss of $800,000 related to our foreign denominated FIN 48 liabilities;

Restructuring charges of $200,000;

$1.3 million income tax provision related to the non-GAAP adjustments just mentioned;

And an adjustment to the accrual for unrecognized tax benefit of $124.3 million.

During the quarter the company reached a settlement on several ongoing foreign tax matters related to prior years. As a part of the settlement, the company agreed to a cash payment of $18 million and utilized $38.1 million in investment tax credits.

As a result, we recorded an adjustment for an unrealized tax benefit of $124.3 million. Excluding this adjustment, Q2 diluted GAAP net earnings per share was a positive $0.06.

Turning to the balance sheet, we entered the quarter with $322.3 million cash and cash equivalents. Free cash and cash equivalents, net of our convertible notes increased $36.7 million to $195.3 million, up from $158.6 million at Q1.

The primary reasons for the increase in the company’s net cash positions were as follows: positive non-GAAP cash flow from operations of $34.3 million; cash received from stock issuance of $4.2 million, offset by $2.1 million associated with expenditures on capital and intellectual property.

Accounts receivable decreased $600,000 to $45 million, which reflects 29 days sales outstanding based on quarterly sales volumes. Our net inventory at the end of Q2 was $37.9 million, an increase of $2 million up from prior quarters. However, net inventory turns on an annualized basis were 5.2, favorable to the prior quarter’s 4.8.

I will now turn the call over to Greg for his briefing.

Gregory Lang

Thanks Mike. PMC delivered excellent top- and bottom-line growth in Q2 2008, with all major product groups showing improvement in the quarter. Revenue in Q2 grew 34% year-over-year to $140 million, which was the highest quarterly revenue in eight years and speaks highly of the positive growth trends we’re experiencing in our communications and enterprise storage business.

In addition, wireline infrastructure improved in Q2 after a slow start in the first quarter of this year. We’ve experienced solid bookings during the second quarter, resulting in overall book-to-bill exceeding 1.0. We have a good backlog position going into Q3.

Total design wins for the company improved again in the second quarter and were the highest they’ve been in the last four quarters. As we indicated during our previous call, we’re not seeing any broad or major supply chain inventory issues emerging in markets that we serve. Inventory turns appear to be at near-model levels. We believe our demand is being driven by end market consumption levels.

During Q2 the company generated non-GAAP operating income of $33.9 million compared to $7.7 million in the second quarter one year ago, which is more that a four-fold increase in 12 months and also the highest in 30 quarters.

With a non-GAAP operating income of 24% in the second quarter, that puts us near the high end of our target business model range of 20% to 25%. This represents excellent progress over the past year, but we continue to focus on improving our operating results, given the potential operating leverage that I see in our business model.

Now we’ll comment a bit by end market segments. In the fiber-to-the home area, EPON deployment Asia continues to expand and we saw our business rapidly accelerate in the second quarter. China carriers expanded their EPON FTTH trials primarily in China Telecom’s southern provinces. Over time we believe this will expand to the northern provinces in China Netcom as well.

In addition, the Japanese central office build out continued, with improving orders for OLTs due to the parallel, next-generation network upgrades undertaken by NTT.

Also in Korea, we experienced improved Q2 shipments, as regulatory policies are being resolved in the market in preparation for the new IPTV services in the fall, which will both help drive addition high bandwidth demand and FTTH subscriber connections.

While we have a good backlog going into the third quarter for FTTH, we are being a bit conservative in our Q3 forecast at this time, which we believe is a prudent approach after our red-hot Q2.

After visiting our major carrier and OEM customers in Japan, Korea, and China in the past seven weeks, I’m impressed by the interest and engagement level for this new broadband technology.

Once again, Asian carriers are leading the next generation of broadband deployment just as they did with DSL. We remain very positive on this business over time, as we are the world leader in EPON FTTH devices.

We will be introducing our next-generation GPON device as we move into the summer time period. We were also successful at demonstrating the first complete 10 Gig EPON solution in Beijing last month, featuring a 10 Gig OLT and 10 Gig ONU.

We received strong feedback from many of our OEM customers and carrier partners with regard to this leading 10 Gig platform, as carriers deploying 1 Gig EPON solutions are already looking at higher capacity to deployment and aggregation capabilities with 10 Gig EPON solutions.

In the wireline infrastructure business, we saw a steady recovery in shipments in Q2, and we’re expecting that to continue in the second half. Initially we thought the recently announced China carrier consolidation, where six carriers were merging into three larger carriers, would cool demand for metro equipment through their integration period.

But we’re seeing the opposite, with increases in demand and expedite for base stations, base station controllers, and backhaul infrastructures. It appears to us that the three large carriers are moving ahead aggressively to separate their networks and finally start deployment of 3G wireless networks.

During the second quarter, we secured architecture design wins with two top-tier OEMs in both SDH and T1/E1 platforms. We expect these wins to enable us to further penetrate the U.S. market for video overlay architectures, as well as into new wireline markets such as India and Russia.

In general, the market outlook for our technology is promising. Voice additions are continuing in third-world countries, and we’re benefiting from growth in voice aggregation boxes through our T1/E1 and CHESS chip set solution.

More significantly, the continued expansion of video traffic in developing countries is expected to bring continued demand for network carrier upgrades using equipment that contains even more PMC content.

In our enterprise storage business, we see the worldwide market remaining healthy relative to macroeconomic concerns. The amount of digital information being created and replicated continues to increase at more than 60% in compound annual growth rate, and as a result storage capacity upgrades and information management solutions remain a spending priority for corporate IT budgets.

PMC is enabling our customers’ transition from 4 Gig to 8 Gig fiber channel, as well as the move from 3 Gig SAS to 6 Gig SAS, where we have focused much of our design efforts over the past two years and have greatly expanded our product line.

Our customers’ 6 Gig SAS and 8 Gig fiber channel system developments are progressing into the qualification phase, with volume production ramps expected to begin in the first quarter of 2009.

The second quarter of this year was another solid quarter of design wins in the enterprise storage arena as well. Our team achieved design wins with our 6 Gig expander product family and switches with a leading Tier 1 storage customer for their entire platform.

Our momentum continues as our tracking of design wins to date indicates that PMC has won approximately 75% of Tier 1 designs awarded, and there are a number that are still pending.

With regards to our SRC or SAS RAID-on-Chip controller for 6 Gig in the server market, this one is designed as the HP’s next-generation ProLiant platform, and we continue to work toward the same schedule as we talked about before with expected production ramps starting in the first quarter of 2009 timeframe.

In addition we started working with our new storage OEM partner, IBM. As we announced a couple of months ago, we’ve entered into a multi-year agreement with IBM for joint development of RAID technology.

While PMC is still adding some new engineers as part of our commitment to the partnership, we’re underway developing innovative RAID solutions for next-generation 6 Gig enterprise servers and storage systems. We believe the partnership will provide the opportunity for further growth in the storage business in late 2009 and early 2010.

Also, we had successful interoperability testing of our 6 Gigabit-per-second end-to-end SAS chip sets with both Hitachi and Seagate 6 Gig SAS prototype hard disks. Overall we remain very positive on this business, as the market transitions from 3 Gig SAS to 6 Gig SAS early next year.

In our microprocessor business, we experienced a modest increase in Q2, primarily driven by activity in the laser printer market. We benefited from growth in our system-on-chip design wins in North America, as well as some improved activity in Japan during the second quarter.

We’re supplying into the mid- to high-end color and multi-function printer markets, which is growing as many OEMs are attractively pricing this equipment versus monochrome solutions.

In the area of network-attached storage, our NAS solutions are being demonstrated for integration with IP video surveillance network systems. This is a unique opportunity in a high-growth segment, and we are working with several Tier 1 customers on an early stage development in this area.

Now for the outlook. Based on our backlog and bookings to date, as well as expected levels of capital spending in the end markets, we currently anticipate PMC-Sierra’s revenue in the third quarter of 2008 to be in the range of $136 to $141 million.

This outlook considers the business activity levels that we’re seeing today in each of our areas we serve, Q3 seasonality, as well as macroeconomic and regional trends affecting those markets.

As you all know, I’ve been on an aggressive learning curve this quarter. After visiting customer and company sites across North America, Europe, Israel, China, Japan, Korea, and Taiwan in my first two months, I feel very positive about our market position, our customer relationships, the core technical competence of the company, and our growth prospects.

The digitization of media and applications as common as YouTube and as exciting as IP-based HDTV will drive substantial infrastructure upgrades for the several years to come.

I’m excited to join PMC-Sierra and the team at a time that it is so well-positioned to benefit from the next round of internet infrastructure build-out in access, in metro infrastructure, and in storage, driven by the immense bandwidth requirements of video.

I will now hand the call back over to Mike for more details on our outlook for the third quarter of this year.

Michael Zellner

Thanks, Greg. I will now provide more information about our Q3 outlook. Judged, shipped, and shippable backlog at the beginning of Q3 was approximately $103 million. As of today, judged backlog including shipped plus shippable is approximately $120 million.

Based on this information, considering current levels of demand and general uncertainties as to the booking rates throughout the balance of the quarter, we estimate that the potential revenue for PMC-Sierra’s Q3 is in the range of $136 to $141 million.

On a non-GAAP operating basis, we expect our overall gross margin percentages in Q3 to remain flat to slightly up compared to Q2, slightly up being in the range of say 50 basis points.

We expect non-GAAP Q3 operating expenses to be approximately flat to up $1 million compared to Q2 levels due to additional resources associated with our IBM RAID partnership.

We are substantially hedged on our Canadian dollar operating expenses at roughly par throughout Q4. 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 will be in the high teens to low 20s for the third quarter. As a reminder, the effective tax rate can be impacted by a number of variables associated with our FIN 48 liabilities, including but not limited to a change in foreign income and product mix.

Regarding share count, we ended Q2 with a basic count of 221 million and a diluted count of 225 million. Our basic share count is expected to be between 222 and 223 million in Q3, and our diluted share count is expected to be between 227 and 228 million.

For the third quarter of 2008, we planned for the following significant GAAP to non-GAAP reconciling items: first amortization of purchased accounting costs associated with past business acquisitions; stock option expense as required under FAS 123R; and finally FX gains or loss and interest on our FIN 48 liabilities.

Additional non-reoccurring items associated with restructuring or other costs, positive or negative, are always possible.

With that, Operator, we will open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today comes from James Schneider - Goldman Sachs.

James Schneider - Goldman Sachs.

Good afternoon and thanks for taking my question. If you look at China as an end market, I think you touched on some of the speculation around wireless. But if you look at the wireline side and fiber-to-the-home, what’s your expectation about the build-outs there in the back half of the year and whether you see any slowing due to any of the consolidation or other government factors out there?

Gregory Lang

I mentioned a little bit of this in the prepared portion of the call. But I would break this probably into two categories. One is in the wireless and some of the wireline backhaul piece, and then the fiber-to-the-home, I think is a little bit separate. In both of those cases, we’re seeing strength as opposed to weakness or any kind of softness right now.

I think when the carrier consolidation was announced, many of us, including ourselves, thought that there perhaps would be a pause while they went through some integration, planned out their new network strategy, et cetera, but thought that we’d see some strength in 2009.

But what’s happened is we’ve just seen an acceleration of demand, in particular on the wireless front. For example China Telecom is really probably pushing the most aggressively ahead.

But they’ve basically have already issued RFQs to expand their CMA network that they just acquired from China Unicom. Also China Mobile is busy trying to basically build out their own backbone network so they can become independent from China Telecom.

So the spirit of this carrier consolidation was really to make really a strong second competitor to China Mobile in the market. So we’re seeing the resulting spending from actually putting some of that additional infrastructure in place in China Telecom, as well as kind of pulling apart the two networks in the China Mobile’s case.

So we’re seeing strength, and we’re seeing it not only in the wireless space, but also in the backbone part of the network, and the backhaul for that wireless traffic. So that’s all very positive.

We saw an uptick in our wireline business this last quarter. We expect to see that again in the September quarter, heavily driven by these activities in China.

Now the second part of your question is on the fiber-to-the-home front. I don’t think that this consolidation has had much of an impact on that. We’ve seen trials going on, as I mentioned, in the southern parts of China. Those seem to be expanding quickly. The growth last quarter was substantial, and we expect to see another very solid quarter on FTTH as well, as they look at deploying more bandwidth in their network.

They have a lot infrastructure that doesn’t exist yet that they need to put into place. If you’re trading off the difference between putting new infrastructure in with copper versus FTTH-type of solution, FTTH is going to be the obvious choice.

So we think there’s a good long growth path in the China market in the fiber-to-the-home area as well.

James Schneider - Goldman Sachs.

Could you potentially comment on the fiber-to-the-home outlook for Korea and Japan in the back half?

Gregory Lang

Let me talk about Korea first. They have an IPTV service that I think is going to be released sometime in the September or fall timeframe. I think there’s preparation for that, partially due to they expect a lot of subscribers to pick up on that. Unless it has a disappointing result or a disappointing roll-out, I think the demand for the FTTH should remain healthy in Korea, barring any other kind of issues.

The other thing, the second major carrier there, Hanaro, has not started deployments yet in any meaningful way. We expect them to start this fall in conjunction with this IPTV service. I think the business there is poised to have a good healthy second half of the year.

In the Japan market, the comment that I made earlier, which is driving some of the revenue upside right now, is they’re deploying kind of a parallel next-generation network, and that will probably continue through the first quarter of next year as far as we can tell. That should keep a good healthy flow of OLT-type of business for us, in addition to the normal subscriber additions on the base business as well.

So I think in all three of the markets that we’re talking about, it appears for the back half of the year they should remain healthy, as far as we can see right now.

James Schneider - Goldman Sachs.

Thanks very much.

Operator

Our next question today comes from Shawn Webster - JPMorgan.

Shawn Webster - JPMorgan

Thank you. Can you tell us the turn’s requirement for Q3?

Michael Zellner

I gave two references. One was starting the quarter and then at the time of the call. So the interim turns to that point were 16.9; call it 17. And from here to the end of the quarter, it’s about 18.5.

Shawn Webster - JPMorgan

Okay, so at the start of the quarter, that’s 17%.

Michael Zellner

It’s about 24% to 27%, in percentage terms, depending on the profile based on our range.

Shawn Webster - JPMorgan

Thanks. How is your linearity during the quarter? I think you talked about wireline being up in Q3. Can you give us the puts and takes to get to your flattish or slightly down Q3 from a segment perspective?

Michael Zellner

We really haven’t talked too much about linearity within the quarter. So we haven’t gone into that in a lot of detail in the past. I don’t think we should. There are obviously different things that can affect that that can be unique in a particular quarter. But we haven’t talked about it in the past. So I’d like to leave that one, I think.

Shawn Webster - JPMorgan

Okay, how about the segment color for Q3? What’s going to be up, down, sideways?

Gregory Lang

Market segment-wise we expect another good quarter in the communications part of our segment. We’re actually thinking that the wireline portion of that communications segment will be up, and we expect the FTTH part will be down a bit, but not much. Again that was a little bit of conservatism on our part given how strong last quarter was.

On the enterprise side, we’re expecting that to be flattish to down a bit. That one is really more of a function of, we have an enterprise storage customer that’s working off a little bit of inventory. So we think that’s a one-quarter little dip and can come back to us in the fourth quarter.

Shawn Webster - JPMorgan

My last question is, can you help us reconcile the sequential change in your gross margin percent?

Michael Zellner

Again it’s less than a full percent. It’s not huge. Obviously mix can impact that pretty dramatically depending on the product line that we’re talking about. So it’s not a huge difference we’re talking about; certainly less than 1%.

Shawn Webster - JPMorgan

Okay, thank you.

Operator

Our next question comes from Ruben Roy - Pacific Crest.

Ruben Roy - Pacific Crest

Thanks. Greg, in terms of the EPON build-out in China, can you talk about the equipment that’s actually being rolled out in China Telecom now? I would think that you’re the primary supplier. Are there multiple manufacturers going out there?

And then eventually when China Netcom starts, are you a primary supplier? From where you can tell, any equipment that will be going out in China Netcom? Thanks.

Gregory Lang

Today the primary equipment that’s going out, actually I believe all of the equipment that’s going out in production in any kind of volume is EPON equipment. As you identified, we are clearly the market leader there.

We’re basically the core provider to the folks that have won the equipment business. We expect that to continue when the next round rolls out. So I think that our position there is strong, in excess of half of that market. We expect to continue to aggressively compete for that.

Ruben Roy - Pacific Crest

Okay. Then on the GPON device you talked about coming out later this summer, what’s the typical timing from when the device is in your customers’ hands till when design wins are awarded and then revenues might start rolling in? We saw British telecoms talk about an extensive fiber initiative. Is there a chance that we could see PMCS playing into that initiative?

Gregory Lang

The answer to that question really depends on the stage of qualification of the actual technology. For example, people have talked about GPON for a long time, but there really isn’t a lot of volume that’s shipping today. So in our GPON business, we’ll be ready for production shipments on the ONU side, for example, by the end of the year; perhaps earlier in the fourth quarter.

To the extent business ramps up in that timeframe, we’ll be ready for the revenue. But I think for us it’ll probably be in the first quarter of next year before we see GPON revenue, given that we’re just starting to sample the ONU part right now.

As you know, we focused on the EPON market and have done extremely well there. We’ve just recently come out with our GPON solution and are working to earn our business in that arena. I think we’ll start to see some revenue in the first part of next year.

Ruben Roy - Pacific Crest

Great. Thank you.

Operator

Our next question today comes from Allan Mishan - Oppenheimer.

Allan Mishan - Oppenheimer

Nice job. Quick clarification: were all four of the businesses up sequentially in the quarter?

Gregory Lang

Yes, they were, but the enterprise side was up very, very slightly or small. The growth quarter-to-quarter was on the communications side. That was really the driver of most of the growth.

Allan Mishan - Oppenheimer

Okay, great. And then is the fiber-to-the-home business now larger than the microprocessor business?

Michael Zellner

Give me a second and I’ll tell you that.

Gregory Lang

We’re getting close. It’s a one-quarter thing. I’d like to see through more quarters, but we’re just double-checking right now.

Allan Mishan - Oppenheimer

Okay.

Gregory Lang

Do you have anything else, Allan?

Allan Mishan - Oppenheimer

Yes, my last question would be, what are the nature of these trials that you’re seeing right now? Are these hundreds of thousands of units? How extensive are they, being that they’re driving real revenue for you? Are they really trials, or are they deployments? Or how could you characterize them?

Gregory Lang

Clearly in Japan and Korea they are deployments; they’re not trials. I think they’re in varying degrees. I would call it an early stage roll-out in China; early stage where they’re doing a limited roll-out where they can make sure the network works.

But just to put it in perspective, last quarter our China business was more substantial than the Korea business. So that gives you the idea of the size of the “early deployment in China.” So it’s moving along quite well.

Michael Zellner

So let me answer your question. Fiber is about 106% of the microprocessor. So they’re about the same, actually.

Allan Mishan - Oppenheimer

Okay, so slightly larger than microprocessor.

Michael Zellner

Slightly, yes.

Allan Mishan - Oppenheimer

Okay, thanks very much.

Operator

Our next question comes from Sandy Harrison - Signal Hill.

Sandy Harrison - Signal Hill

Thanks. Good afternoon. Just a quick clarification, Mike, if I could, or some comments, too, that Greg had on the prior question – that you had said that you wanted to see another quarter or two from fiber-to-the-home before you thought that it was a change in direction, as far as being larger than MPU. Or is that an anomaly; you expect it’ll come back in going forward?

Gregory Lang

No. What I was really trying to say is, last quarter was a very strong, very solid growth on the fiber-to-the-home front. I’d like to see that continue before we say the business is bigger. It is going to continue. This quarter that we’re forecasting right now is still substantial and in that same ball park as the size that Mike just mentioned.

Sandy Harrison - Signal Hill

Okay, thanks for that. And then also you talked a lot in your prepared remarks, Greg, about a number of projects that are going to be ramping beginning of 2009 and throughout 2009 with a number of other projects layering in throughout the year with work on IBM coming in at the back half of the year.

I get the sense that that’s not been a change at all. And so with the macro-environmental challenge backdrop, it doesn’t sound like anything’s changed as far as your views on that. What else do we have for the rest of 2008 to look to from a growth prospect before we go into the extended growth in 2009?

Gregory Lang

Just to comment or a clarification on the 2009 growth: what I was really referring to there is there are two major transitions happening in the storage market, both of which we’re extremely well positioned for it and better positioned than the prior generation.

One is the beginning of a transition from 4 Gig fiber channel to 8 Gig fiber channel. That gives us an ASP uplift. We also think we’ll see somewhat of a share uplift in that space, even though we’re already number one in that arena.

The second one, which is actually more important for us from a growth perspective, is actually on the 6 Gig SAS side, which we did see that also starting to kick in, at least for the server side in the first quarter.

The equipment side will probably follow a quarter after. But here again our share position is substantially improved in the SAS space in general. As people move to 6 Gig platforms next year, we should see very healthy revenue growth associated with that.

I don’t think that transition is going to be hugely impacted by macro issues because people are going to move to the higher balance solution. On the server side it’s timed with Tylersburg, and on the equipment side it’s timed with the next-generation platform. There’s a lot of reasons for those to come out. I think this transition is one that looks like it’s in good shape with or without the macroeconomic issues.

The second part of your question I think was, ‘okay, so that sounds great this quarter and the fourth quarter; what are we seeing as potential growth drivers here?’ I think the things that we’ve talked about are the things that I’ll come back to is right now, the China market has absolutely picked up with this consolidation complete, and that will drive growth for us in the back half of the year.

Not clear how much in the fourth quarter, but I think it’s going to remain healthy and strong because the infrastructure that’s required there is not a one-quarter pop type of thing.

The second place that I think that we have some growth potential is going to be in the FTTH business. We’re very, very early in this technology; very early. So the potential for continued growth there I think is good.

The timing of it and the lumpiness of it is really the only question here. It’s not a question of if; it’s a question of when and how big can it get. So I think that’s another area that we could see continued growth in the back half of the year.

And last but not least, in the fourth quarter, we also could see some of the early stage of that 6 Gig SAS on the server side start to add in a little bit since some of those platforms shipping in the first quarter will need to get built or at least the pipeline filled with parts in the latter half of Q4.

So those are the areas that I would point to as the major growth areas.

Sandy Harrison - Signal Hill

Do you need any ecosystem partners to come online or to drive any of the transitions that you’ve highlighted here, or is a lot of this just the market making its way towards that direction?

Gregory Lang

I think the ecosystem is pretty well hardened. The discs are in place and the pieces are in place. The RAID stacks are getting ported. It’s in very good shape.

Sandy Harrison - Signal Hill

Got you. Okay, and then the last thing is, looking at the turned business you have had historically and then looking where your backlog is currently today versus the beginning of the quarter, it looks like you’re pretty well on your way.

So that would suggest that being three weeks into the quarter with a substantial amount of your needed turns business at least coming into the end of the backlog, it sounds as though you’re looking at a conservative August timeframe and not a lot of high expectations for September. Is that a fair characterization, or do you see something else out there?

Gregory Lang

If you just look at the simple math between last quarter and this quarter, we’re actually a couple percentage points behind where we were last quarter. But the flip side of that is we’re at or ahead of where we were in the four quarters prior to that. So based on history and our progress to date, we feel confident with the numbers that we have here.

I think to your point, ‘is there a potential upside?’ I think the answer is potentially yes. We’ll have to see how the summer unfolds. As you know, August can be a sleepy month for bookings. But if things continue to be strong, we could see some strength here. But we think this is a reasonable outlook, given our current backlog and understanding of the end-market trends that are out there.

Sandy Harrison - Signal Hill

Then not as good as last quarter, but better than others. So with that in mind, got more conservative than out there.

Gregory Lang

Yes.

Sandy Harrison - Signal Hill

Okay, thanks.

Operator

Our next question today comes from Romit Shah - Lehman Brothers.

Romit Shah - Lehman Brothers

Yes, thanks for taking my question. You mentioned there was storage customer that’s working down some inventory. Did that have an impact on your numbers for Q2, or is that something you’ve noticed more recently?

Michael Zellner

It had an impact to the effect that when we saw it, collectively we tapered down the shipments. So I guess you can say, yes, that we’re a little less than it would have been, but it wouldn’t have been wise to continue to pump products into a place that was already full.

Romit Shah - Lehman Brothers

Okay, and on this enterprise segment, would you characterize this issue with this customer as being specific to one, or are you seeing a lower level of activity with some of your other key source customers?

Michael Zellner

No, I just think it’s one anomaly type of thing; I’ll call it normal ups and downs in the supply chain side. I don’t see any underlying systematic issue there at all.

Romit Shah - Lehman Brothers

All right, terrific. Thank you.

Operator

There are no further questions at this time. Please continue.

David Climie

Okay. Thank you, Joshua. If there are no additional calls coming in at this time, then we’d like to thank you for attending our conference call today. We will be scheduling our third quarter 2008 earnings release for the second quarter of October. At that time we’ll be reviewing the quarterly results and providing our outlook for the Q4 2008 time period.

So thank you, and that ends today’s call.

Operator

Thank you. Ladies and gentlemen, this does conclude your call for today. We thank you for your participation. You may now disconnect your lines, and have a great rest of the day.

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