NetLogic Microsystems Inc. Q407 Earnings Call Transcript

| About: NetLogic Microsystems, (NETL)
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NetLogic Microsystems (NASDAQ:NETL) Q4 2007 Earnings Call January 29, 2008 5:00 PM ET

Executives

Leslie Green – Investor Relations

Mike Tate – VP and CFO

Ron Jankov - President and CEO

Analysts

Adam Benjamin - Jefferies & Co.

Allan Mishan – Oppenheimer

Nick Aberle - Caris & Company

Kevin Cassidy - Thomas Weisel Partner

Romit Shah - Lehman Brothers

Reuben Roy – Pacific Crest Securities

Cody Acree - Stifel Nicolaus & Company, Inc.

Sandy Harrison – Signal Hill

Arnab Chanda – Deutsche Bank Securities

Operator

Welcome to the NetLogic Microsystems Fourth Quarter and Fiscal Year 2007 Financial Results Conference Call. Leading the call today are Mr. Ron Jankov, President and Chief Executive Officer and Mr. Mike Tate, Vice President and Chief Financial Officer.

(Operator Instructions)

I would now like to turn the presentation over to your host for today, Ms. Leslie Green, Investor Relations for NetLogic Microsystems. Please proceed, ma’am.

Leslie Green

Please note that our fourth quarter and 2007 yearend results were disseminated by Business Wire after market closed today and a copy of the release can be downloaded from our website at netlogicmicro.com.

Before we get started with our financial results for the Fourth Quarter, I would like to point out that during the course of this conference call, we will be making forward-looking statements that are based on certain assumptions and expectations of future events that are subject to a number of risks and uncertainties and actual results may differ materially. For a discussion of such risks and uncertainties, please see today’s earnings release. The risk factors in our Form 10-K filed on March 2, 2007 as well as other reports that the Company files from time to time with the SEC. All forward-looking statements are qualified in their entirety by this cautionary statement and the Company undertakes no obligations to publicly update forward-looking statements for any reason except as required by law even as new information becomes available or other events occur in the future.

Also on the call, we will be making reference to non-GAAP financial measures, a reconciliation of non-GAAP to GAAP financial information is in today’s earning’s release. The reconciling items between GAAP and non-GAAP are stock based compensation, amortization of intangible assets, in process research and development charge, fair value adjustment to inventory required, a deferred tax asset valuation allowance release and a tax effect of an inter-company license agreement. These items have been removed from the cost of revenue, operating expenses and provisions for income tax line items to the non-GAAP reporting. I will now turn the call over to Mike Tate to discuss our Fourth Quarter and Fiscal Year results.

Mike Tate

Today we reported that revenue for the Fourth Quarter of 2007 was $32.3 million, which came in ahead of our prior guidance of $32 million. Q4 revenues grew 17% sequentially from $27.5 million for the third quarter of 2007.

Revenue from Cisco Systems, our largest customer was approximately $15.8 million or 49% of our total revenues compared with $12.2 million or 44% of our total revenues for Q3. This was consistent with our expectations and reflects the final impact of our transition to Cisco’s vendor managed inventory program, which was positively offset by the initial production shipments of our NL8000 as well as a full quarter of revenues from the network search engine products we acquired from Cypress last August.

Revenue from Alcatel-Lucent for Q4 was $3.1 million or 10% of our revenues compared with $3.8 million or 14% of our revenues in Q3. The decline in revenues from Alcatel-Lucent was largely due to what was in a usually strong Q3 coupled with what believe was a work on our inventory levels.

During the Fourth Quarter, we also successfully closed our acquisition of Aeluros. Fourth quarter shipments of our 10-Gigabit physical layer products represented a partial quarter as we closed the transaction on October 24. We were pleased with the partial quarter of shipments which were in line with our expectations. Also during Q4, as previously discussed, we experienced some near term softness in our knowledge-based processor revenues in China and for the cable infrastructure.

Excluding stock-based compensation expense, the fair value adjustment related to inventory acquired from Cypress and Aeluros and the amortization of the tangible assets, our non-GAAP gross margin was 65.6% for Q4. There is a complete reconciliation between GAAP and non-GAAP gross margins in today’s earnings release.

Our Q4 non-GAAP gross margin was consistent with our guided range of 65% to 66%. Q4 GAAP operating expenses were $21.1 million which included $5 million for stock-based compensation, $1.6 million charge for in-process R&D related to the Aeluros acquisition and a $0.3 million for the amortization of intangible assets. This compares with GAAP operating expenses of $15.9 million for the third quarter of 2007 which included approximately $3.9 million for stock-based compensation. Non-GAAP operating expenses during Q4 were $14.2 million compared to our guidance of $14 million. Non-GAAP R&D expenses were $10.1 million for Q4 as compared with $8.4 million for Q3. The large sequential increase was primarily due to the additional R&D expenses from the acquisition of Aeluros.

R&D expenses was also slightly higher than our guidance of $9.9 million given the high level of project development expenses with our two new 55-nm parts. Non-GAAP SG&A expenses excluding stock-based compensation and the amortization of intangible assets were $4.1 million for Q4 as compared to $3.6 million for Q3 and were in line with our prior guidance.

Our Q4 tax provision was approximately $38,000.00 which was favorable to our guidance of $200,000.00. On a GAAP basis, our Q4 net loss was $4.8 million or $0.23 per diluted share compared with a net income of $3.5 million or $0.16 per share for Q3. Non-GAAP net income for Q4 was $7.6 million or $0.33 per share compared with $7.7 million or $0.34 per share for Q3 2007 and was in line with our prior guidance.

We have fully diluted shares of $21.1 million on a GAAP basis and $22.8 million on a non-GAAP basis.

With respect to the balance sheet, cash and short term investments at the end of Q4 were $57.0 million compared with $99.8 million at the end of the prior quarter. The decline in our cash reflected our $57 million acquisition of Aeluros and was partially offset by the continued positive cash flow from operations.

Our accounts receivable increased to $14.8 million with our day sales outstanding of 42. The fourth quarter net inventory was $12.9 million compared with $12.1 million at the end of Q3. And now turning to the results for fiscal year 2007.

Total revenue for fiscal 2007 was $109.0 million. This was an increase of 12.6% over the $96.8 million for fiscal 2006. Our fiscal 2007 GAAP gross profit was 59% compared with 62% for fiscal 2006. Non-GAAP gross profit for 2007 which included stock-based compensation, amortization of intangible assets in the effect of a fair value adjustment to inventory acquired from acquisitions was 65.8% as compared with 64.9% for 2006. GAAP operating expenses for 2007 were $66.5 million compared with $62.7 million for fiscal 2006. Non-GAAP operating expenses excluding stock based compensation, in-process research and development charges and the amortization of intangible assets were $49.3 million for 2007 compared with $40.7 million for 2006.

Our non-GAAP research and development expenses increased to $35.2 million for 2007 from $29.1 million for 2006. Non-GAAP SG&A expenses increased to $14.1 million from $11.6 million in 2006. Net income in accordance with GAAP for 2007 was $2.6 million or $0.12 per share. This compares to a GAAP net income of $592,000.00 or $0.03 per share for fiscal 2006.

Non-GAAP net income was $26.7 million or $1.20 per share, compared with non-GAAP net income of $25.5 million or $1.18 per share for 2006.

This concludes my review of the quarterly and fiscal yearend results and now, I would like to turn the call over to Ron.

Ron Jankov

Our strong Q4 concluded what was another solid year for us with our diversifying customer base; we are witnessing first hand a transition of the network. This transformation is occurring at a rapid pace across many different end-markets including enterprise switches and routers, telecom equipment, cable infrastructure and now the advanced mobile wireless infrastructure.

Throughout these markets, our customers are working aggressively to employ next generation equipment that can handle the complexity and speed of tomorrow’s network traffic.

The complexity and increase bandwidth of this traffic is requiring much more advanced innovative technology. As a result, the design opportunities for our technology are growing and our customers are pushing us to deliver even faster and more complex devices. I am very proud to report that our team has responded to this tremendous opportunity with near flawless execution and the fourth quarter was an extraordinary example of this.

During the fourth quarter, we received samples with first pass silicon success of two separate and new products designed and developed on TSMC’s industry leading 55-nm node. These two new devices are some of the most complex and difficult chips so far attempted on this advanced technology node. We have delivered these two different products to our customers on time and ready for production with first pass silicon. By aggressively moving to 55-nm, we are able to provide sturdy performance and significantly lower power consumption with a chip size that is 18% smaller than what can be achieved with the standard 65-nm node.

Additionally, during the quarter, we also achieved first pass silicon success on a new advanced 10 Gigabit Ethernet SFP-plus product with advanced EDC technology. The feature of the industry’s lowest power consumption and smallest package footprint while maintaining the most comprehensive support for SR, LR, LRM and SFP plus copper nodes. Also, this new device provides ultra low latency for high performance data center applications. This advanced solution is enabling breakthroughs by our customers in 10 Gigabit port disk density, which continues to be an important requirement in a data center where power, space, latency and flexibility are critical metrics for success.

Our ability to support multiple modes of operation in the smallest footprint and lowest power consumption enables our customers to leverage a common solution across different cabling environments and reach. This innovative SFP plus technology with DDC has been very well received and is already shipping an initial volume production. Here again, the flawless execution of the Aeluros engineering team has allowed us to rapidly bring these innovations to our customers enabling them to be first in the market with the most flexible, cost-effective and highest density, multi-10 Gigabit equipment.

I am confident in saying that in the case of all three of these new devices, our engineering team has pushed the technology limits significantly beyond what even the largest semiconductor company has attempted in 2007. It is difficult to overstate how remarkable it is to have achieved first-pass success with these three complex products. These technical achievements have not gone unnoticed by our customers as our strong track record of execution and delivery is opening up further opportunities that strengthen our relationship as a strategic technology partner.

One of the new 55-nm parts is the NL9000 which we announced yesterday. As our customers introduce equipment with higher bandwidth, increased complexity in more knowledge-based processors for a system, power is becoming more important than ever before. As the leader in low-power knowledge-based processors, this is a trend that plays into our strength and has given us the opportunity to further pull ahead of our competition. We are doing so with the introduction of the NL9000, industry’s first fifth generation knowledge-based processor which combines not only superior performance, but superior power management as well.

The NL9000 is a significant engineering achievement as it is the first ever hybrid knowledge-based processor combined with massively parallel high-performance capabilities of knowledge-based processing with the power efficiency and flexibility of our advanced Sahasra algorithmic technology. The NL9000 also offers an advanced feature set ideally suited for our customers next generation IPv6 systems that achieves power savings of up to five times compared with non-hybrid solutions. This represents an important milestone for the industry as our customers strive to meet stringent low-power requirements for next generation advanced telecommunications computing architecture in high-density data center systems.

The NL9000 integrates our innovative Sahasra algorithmic engine, which is already production proven across many leading carrier networks and has been under continued development for over seven years providing customers with the ability to dramatically lower the power of search processing while expanding the effect of processing power. In addition, the NL9000 processor incorporates a number of industry firsts and ground breaking innovations, such as intelligent load balancing engine, a ranging coding engine and a fifth generation I/O design that delivers 64Gbps of raw chip-to-chip interconnect bandwidth, which is 60% greater than previous generations of knowledge-based processors. Also, when coupled with the integrated intelligent load balancing engine, our customers can achieve up to 100Gbps of effective bandwidth to support the most performance demanding switches and routing applications.

We are experiencing tremendous development activity for this device, given that it is the first and only fifth-generation product in the market and that this technology uniquely meets the high performance requirements of our customer’s next generation systems. In fact, we earned five design wins in the fourth quarter even prior to receiving first Silicon. We believe that these wins demonstrate the confidence our customers have and our ability to deliver first Silicon and also the eagerness of the market to have access to this fifth-generation technology.

Now turning to our current business, first, 2007 was an important transition year for our business with our largest customer, Cisco Systems. After 2-1/2 years of very strong growth beginning in 2004, the pace of new product ramps with Cisco slowed from the second half of 2006 through 2007. And currently, Cisco’s contract manufacturers adopted lean initiatives and we moved for the first time to a vendor managed inventory program with Cisco, but the lack of revenue growth at Cisco as a result of these factors belie a tremendous amount of continued success in our relationship with Cisco. Throughout 2007, we achieved a record number of design wins for our most advanced products nearly doubling our pipeline at Cisco and setting the stage for our next significant product ramp cycle that has just started in Q4 with a volume of production ramp of two NL8000 design wins.

Many designs now point to go to volume production over the next year and a half are particularly exciting because of the expanding number of new business units and end- applications at Cisco that we have not previously penetrated, including Metro, Edge, Access Aggregation, Edge and core routing, mainstream switching, data center switching and desktop switching.

Our commitment to continuing to innovate and support the products and applications that are strategically important to Cisco has allowed us to further strengthen our relationship and explore new opportunities. As a result, we believe that we are now poised for a period of renewed long-term growth with Cisco as the many new designs we have been winning going to full volume production.

Just as we have experienced a number of diverse design opportunities within Cisco, outside of Cisco we continue to enjoy strong adoption of our technology across many customers and end markets that will continue to enable us to diversify our revenue streams, as well as expand our camp.

In 2007 we enjoyed a tremendous year of growth for our non-Cisco revenues. With our leading edge product portfolio, coupled with our aggressive roadmap, we are positioned as a leader for many exciting emerging applications, such as IPTV, 10 Gigabyte Ethernet, cable infrastructure and mobile wireless infrastructure. Driven by the increasing number of internet connected devices and the explosive growth in voice and video delivered to these devices, demands for advanced knowledge-based processors is growing and in many cases our products are being designed into areas that did not require knowledge-based processors before.

In 2007, we saw a particularly strong growth in IPTV applications for customers such as Alcatel-Lucent, Juniper Networks and Huawei.

Revenues from Alcatel-Lucent grew by 36% in 2007 from 2006 and revenues from Juniper group by almost 200% in the same period. While some of the inventory balancing at Huawei resulted in slower Fourth Quarter revenues, for the overall year, revenues from Huawei were up 76% from the prior year. What is also exciting is that even with this strong increase in our IPTV revenue, the adoption of this technology is still in its infancy worldwide. As it grows, we believe that our NL7000 and our just introduced NL9000 will continue to give us a strong competitive advantage that is ideally suited for IPTV is for a unique set of instructions specifically designed to take full advantage of the parallel processing architecture when handling IPv6 packets.

The high bandwidth and quality of service requirements for video will continue to drive the need for the most advanced knowledge-based processors in IPTV equipment. We continue to have tremendous success and win virtually every design we target, as there is still no competitive equivalent to the NL7000.

Also, the advanced IPv6 functionality, which is distinguishing the NL7000 has been incorporated into our fifth-generation NL9000, putting us now two generations ahead in serving this key IPTV segment.

Another encouraging development in 2007, with the beginning of meaningful adoption of 10 Gigabit Ethernet, this market has predicted to see strong growth over the next several years, given the ever-increasing need for higher bandwidth in the enterprise and data-center networks, driven by video and virtualization applications. We are now positioned to enjoy growth in 10 Gigabit Ethernet with the increased volumes of our knowledge-based processors, as well as from our newly acquired Physical Layer products.

During Q4, we successfully closed our acquisition of Aeluros. We are very pleased to have such a talented group to join the NetLogic Microsystems family. Their execution today has been stellar as the 10 Gigabyte Ethernet Physical Layer products that we now offer holding market leading position in next generation X2 module technology and provide an exciting product portfolio and roadmap for the emerging SFP-plus opportunities with the industry’s best power and smallest form factor.

Additionally, this world-class group of engineers will further enhance our ability to integrate even higher performance and lower power I/O into our next generation knowledge-based processors and deep packet inspection solutions. This comes in a time when I/O functionality and performance is becoming a critical bottleneck in system performance in our customer’s next generation design.

With the integration of such a high-speed, low-power I/Os, we will further distinguish our offering from our competition and allow our customers to achieve new levels of system performance and functionality.

Now, moving to cable infrastructure, our revenues in the cable infrastructure area of our business were expectedly softer in the Fourth Quarter. We saw a strong growth in this area in 2007 as a whole, driven by the growth and demand for Voice over IP and video on demand. We continue to be excited about our opportunities for growth from cable infrastructure given the increased complexity of the CMTS equipment in the upcoming transition to Docsis 3.0.

The cable service providers continue to face competition from IPTV and as a result, we expect them to continue to upgrade their infrastructure equipment with solutions incorporating our technology. Although most of our cable revenues have been with Aeluros to date, we expect that new opportunities with Motorola and Cisco will also contribute to our growth in this exciting end-market as well.

The mobile wireless infrastructure also continues to be a new growth market for our solutions, driven by the proliferation of video phones coupled with carrier deployment of mobile IP services and a host of new applications for the cell phone, Legacy circuit based networks are being migrated to a converged IP platform, which can support high bandwidth, high quality video, as well as packetized voice, music and data.

By the end of 2007, we had achieved design wins for equipment that are sold into the many of the leading carriers worldwide with considerable future opportunities. Additionally, the proliferation of mobile wireless devices connected to the internet is accelerating the depletion of IPv4 addresses. As a result we are seeing our customers aggressively adopt our designs for high performance support of IPv6 packet, which are larger and more complex compared with IPv4 packets and need higher end knowledge-based processors.

As the technology’s leader in the market, this is yet another trend that highlights our strength and further separates us from our competition. We expect our revenue from the mobile wireless infrastructure market to begin ramping in the second half of 2008 and our continued design win success is building a healthy pipeline for long-term future growth.

2007 was also an important year for continued investment in our Layer 7 deep packet inspection technology. During the year we delivered our newest NLS1000 five-layer 7 content processor featuring a high speed PCI express interface. It also announced the availability of production-ready Layer 7 software suite for the NETL7 processor that significantly reduces the amount of time and engineering resources required by us and our customers to product type solutions incorporating our NETL7 processors.

As we move into 2008, we are hard at work on broadening our product portfolio to expand the reach of our technology, to have solutions ranging from the highest performance 10 Gigabit hardwired solutions to a high volume mainstream enterprise applications. The number of design opportunities continues to increase, given the growing interest to incorporate deep packet inspection technology in many points of the network.

We look forward to giving more specific updates during the course of the year.

Finally, during 2007, our customers and merchant switch partners continue to make progress in the development of their new Layer 3 desktop switches incorporating our NETLite network search engine technology. We have quite a number of programs under development where our customers are offering much more advanced Layer 3 functionality in our high-volume switch product family.

Given the increased level of Layer 3 functionality they incorporated in these systems, our network search engines are being utilized in this high volume segment for the first time. This technology trend is another example of expanding camp for our technology throughout the network. As our switch partners are bidding to deliver their new advanced packet processors to our customers, we are seeing a measurable pickup in design activity, and during Q1, we expect to close a record number of NETLite design wins.

In closing, we are entering 2008 with the strongest competitive position we have ever held. With the success of two 55-nm parts, including the fifth-generation NL9000 and breakthroughs in 10-Gigabit technology, we are poised to secure a record number of design wins this year. The revenue growth that we are forecasting in Q1 as well as for the remainder of 2008 and into 2009, we are much less dependent on general economic growth and the growth of our customers, but rather will be much more driven by the record number of new programs which will ramp into production.

The breadth and diversity of these programs, are evidence of the transformation of the network that is underway in the growing address of the market for our expanding portfolio with add solutions. Also, as a result of our tremendous execution over the last several years, we are positioned to also enjoy market share gains at our existing customers as we ramp beyond our traditional base of high end switching into many new diverse applications such as mainstream switching, data center switching, desktop switching, Metro, Edge and aggregation as well as core and high-end edge routing.

At this point I will turn the call back over to Mike to discuss guidance for the First Quarter and will open up the call for your questions.

Mike Tate

Although we are mindful of the current volatile economic backdrop, as we look to Q1, we are encouraged as we believe our customers are starting the year with relatively low levels of inventory. Having just implemented the vendor manage inventory program with Cisco, we are now shipping products to Cisco at essentially a-just-in-time basis. Also in Q4, we saw a good work down of the inventory balances in China, cable infrastructure in European Telecom. This view is further supported by our customer’s forecast, bookings and backlog position.

We entered Q1, with healthy backlog and solid ordering patterns across our customer base and end markets. Revenue with Cisco in Q1 is expected to grow as a result of our revenue diversification and the continued volume ramp of our initial Gen-4 design wins. Outside of Cisco we expect another solid quarter from our 10 Gigabit Ethernet by-products as well as broad contribution from our other knowledge-based processor customers as they also ramp new designs into production.

As a result we expect our first quarter 2008 revenues to increase to $33.8 million representing an approximate 5% sequential growth from Q4. We expect our non-GAAP gross margins to be approximately 65%, consistent with out long-term model. We expect non-GAAP operating expenses will increase to approximately $14.5 million with non-GAAP R&D expenses expected to be approximately $10.3 million and non-GAAP SG&A of $4.2 million.

Also, we expect Q1 interest income to be approximately $500,000.00. The decrease reflects a lower average cash balance of Q1 as well as the decline in market’s interest rates. We expect our tax expense for Q1 to be approximately 5% of our non-GAAP income before taxes. We expect non-GAAP EPS for the First Quarter to be $0.33 per share. We expect our GAAP EPS for the first quarter to be a loss of $0.02.

This includes an estimated $5 million for stock based compensation, $3.3 million in the amortization of intangible assets and $0.5 million in a fair value adjustment for acquired inventory.

Finally, we expect our GAAP share account to be approximately $21.4 million and the non-GAAP share account to be approximately $23 million in Q1.

This concludes our prepared remarks for the call and now we are happy to take questions.

Question and Answer Session

Operator

(Operator instructions)

Your first question comes from Adam Benjamin from Jefferies & Co., please proceed.

Adam Benjamin - Jefferies & Co.

Just a couple of questions, first on Cisco, you have been talking for some time that you did not expect to see the organic business at Cisco to grow with those new product ramps until Q1 timeframe. You have given what you just reported in Q4, did that actually grow sequentially excluding the acquisition of the Cypress business?

Mike Tate

We are not going to specifically break up the Cypress transaction in Q4. We had three different moving parts, we have won the final move to the vendor manage inventory program, which was effectively worked down for about a week or so revenues, but then we did have the successful launch of two new programs for mainstream switching, which is with our NL8000 and then a Full Quarter of the Cypress, so all that combined contributed a very solid quarter for Cisco where they grew to represent 49% of our revenues.

Looking into Q1 now, we have a full quarter of the product launch with the NL8000 and also, the increasing volumes associated with that. So that gives us comfort that Cisco will continue to grow and what is great about the position right now is, we entered the year with the strongest pipeline of designs that we have ever had with Cisco and with that, we have a nice view of Cisco growing throughout ’08 as those products launch into production.

Also, what is nice about these designs is they are very diverse where we are getting exposure to a lot of new business units that we never serviced before and a lot of new end applications. So as our revenues grow with Cisco, our diversification within Cisco is also playing out.

I would just add to that also that the uptake from our Gen-4 products is both for Q4 and Q1, it was a little bit better than expected; it is a little bit larger and happening on time, so that was a pleasant surprise.

Adam Benjamin - Jefferies & Co.

On the non-Cisco business, I think, for the year was about 40% year-over-year growth.

You guys care to talk about what you think what is realistic. I mean you know have several new customers ramping, so it is not a year-over-year compare that topples, but can you talk about what you think, given what you are seeing right now and your design wins and the projective ramp of those wins?

Mike Tate

2007 was a great year for the non-Cisco revenue growth. It was really, kind of the emergence of Juniper for example as a large costumer for us and saw a good growth from Foundry and Huawei and Alcatel as well. Those trends continue into ’08. We are really seeing a transformation of the network, where they are including knowledge-based processors into more and more equipments at different points of the network. So, we obviously built up a nice base level of revenue in ’07. That base grows, but then, we will start to see new applications and as we move to the area of new customers as well. We are very excited about the gross prospects of the company, in particular, the diversification of our revenue so, if you look at NetLogic, the growth that we have in front of us is really the expansion of our TAM versus the growth of our end customers or us really gaining share in an existing market and the design activity that we are faced right now is probably the most active it has ever been just because there is a lot of work to transform the network and move to the new generation boxes.

Adam Benjamin - Jefferies & Co.

Great, just one more question on gross margin. You guys keep introducing a new products at lower process geometries. At some point, do you start seeing your gross margin trend up into the higher 60’s. Is that realistic?

Mike Tate

We still say long term, 65% is a model we could think of. Clearly you are being at the leading geometries, you know, just to say a die-size advantage versus the competition that will ultimately help translate to good margins. But, it kind of helps to protect our model versus seeing our model expand much beyond 65%. 65% is a pretty attractive gross margin right now.

Operator

And, our next question from Arnab Chanda from Deutsche Bank, please proceed.

Arnab Chanda – Deutsche Bank Securities

Couple of questions, one, Mike, could you tackle over about in Q4 and Q1 that the 10-Gig business and your kind of desktop switching segments contributed, then I have a couple of follow-ups.

Mike Tate

For the 10-Gig side, we will not specifically give the numbers, but we close the Aeluros transaction at the end of October. In Q3 the company has a stand-alone company earned about $3 million of revenue. So, that was kind of a run rate going into Q4. Q4 is a partial quarter of that run rate. The business is doing well and it is growing, we are seeing the 10-Gigabit Ethernet market markets continue to adopt the 10-Gigabit. And, when within 10-Gigabit market, you are seeing the transition from Legacy, XENPAK modules, then to X2 and NetLogic has a leading share position in X2. And so as that transition takes place, we project to see the growth revenues. Also, we are seeing the initial volumes for SFP-plus as well. So, those all combine, we are pleased with the prospects for growth of the 10-Gigabit revenues.

Desktop switching in particular for NETlite. We are still seeing modest growth there, where the next wave of growth will as our silicon partners come out with their new packet processors, which they are successfully doing right now and launch those programs to volume with our costumers in the second half of the year.

Arnab Chanda – Deutsche Bank Securities

I have a question for Ron, could you talk a little bit about sort of what timeframe you expect of your Layer 4 through Layer 7 products, as well as the NETlite family. NETL7 and NETlite family, what timeframe do you see that showing some revenues and what the metrics are. Is it by end-market or the customers that we can do to track that?

Ron Jankov

I will start with the NETlite; we did generate a significant amount of business in NETlite last year. We built that business up and it is continuing to grow in the current quarter and we will see growth throughout 2008. As Mike mentioned, a big uptick will happen when the two big switch partners Broadcom and Marvel are in high volume production with their new switches which are out in the customer base now.

Basically the very positive development that these new chips are out which has accelerated activity and when those ramp to production because they control so much market share in the desktop switching area, so we look forward to that. I do not know exactly how long it will take to go from the sampling stage to high volume but that will happen throughout 2008.

Turning to NETL7, Q4 was a real exciting time for NETL7, we are seeing a couple of things happening. One is our lead costumer is getting ready to ramp into volume production with five different products based on our 10-Gigabit products, but also maybe more importantly, our costumer are starting to come to us for the broader based application and not just in a high end 10-Gig area, but also out to access points and things like that, for what they want to do is deep content inspection in a much broader set of application in boxes.

So the design activity has really picked up there and we expect to close quite a few design wins in 2008. Exactly when that will translate to revenue is harder to predict but if anything our expectations on NETL7 had gone up significantly on a kind of mid to long term basis, based on these new opportunities.

Adam Benjamin - Jefferies & Co.

Could you talk a little bit about what sort of what end-markets you are talking about for NETL7?

Mike Tate

I am a little bit hesitant to do that this early because our costumers consider this highly proprietary and differentiating that they are going to be using our product in their end products and I do not think they want us to telegraph exactly where they are going to put this, but it is much more broadly based throughout the network as opposed to just at the edge point.

Operator

And the next question comes from Allan Mishan from Oppenheimer. Please proceed.

Allan Mishan—Oppenheimer

Hey guys, a couple of questions for you. First of all how was the linearity in the quarter-- I noticed the DSO picked up

Mike Tate

The DSO’s are more of a function of the Aeluros acquisition we picked up in all the receivables on the acquisition date and we will probably see the DSO’s trend back towards our typical to 35 to 40 days. Linearity was typical for NetLogic, pretty smooth throughout the quarter.

Allan Mishan—Oppenheimer

And then Cisco announced the major new switch router this week, the “Nexus 7000”, could you tell us if that uses your products either KBP or maybe some Aeluros products that you can light us on and if that is the Generation 4 or not?

Mike Tate

It does utilize NetLogic. KBP products are Gen3 based, not Gen4.

Allan Mishan—Oppenheimer

Are your competitors at launch as far as you know?

Mike Tate

We believe that we are the primary supplier at this time

Allan Mishan—Oppenheimer

And then any commentary on the Japanese market, the Alaxala, whether that may comeback sometime during this quarter or next quarter or sometime this year?

Mike Tate

Yes! At this time we definitely do not expect it to take place in Q1. It has been pretty hard for us to predict when it will take place, so as a view point now, we are taking a very conservative stance and when we are modeling and talking about our business. We are not really counting much at all for the launch. We do believe it ultimately does take place, but until we get more specifics as of the timing and that is the stance we will take.

Allan Mishan—Oppenheimer

Okay great! And then last question for me is the SFP plus that you are shipping today for actual production, is that on line cards? And if so, is that at any tier one vendors?

Ron Jankov

It is a line card and yes, it is at tier one vendors.

Operator

The following question comes from Sandy Harrison from Signal hill. Please proceed.

Sandy Harrison—Signal Hill

Ron, if you could just spend a quick second kind of talking about some of the opportunities that you highlighted in your prepared remarks and maybe if you could kind a frame for modeling purposes some of the ASPs and other associated things that we could kind of use. So for example; when you talk about the Merchant switch market and Layer 3 switch market, with the NETLite and a knowledge-based processor in there. What sorts of dollar amount are you looking at and realizing that there is obviously different pricing structures but, is it 10 bucks, was it 20 buck or a 100 bucks, kind of frame it up to that maybe in the other color for some other applications you might be able to provide for us.

Ron Jankov

Historically we have said that for the NETLite, these desktop switches that we expect anywhere from $30.00 to $100.00. I would say that we are now expecting something more like between $50.00 and a $100.00 If anything we are seeing those applications are using a richer mix of our NETLite product versus a least expensive NETLite product, so I will say that $50.00 to a hundred would be the typical per line card or switch in that desktop switching area. But on the acknowledge-based processors, we have talked that it is anywhere from below $100.00 up to over $300.00 for the highest TAM knowledge processors

Sandy Harrison—Signal Hill

And then if you might spend a quick second on kind of a highlighting some of the market opportunities as well as some of the dynamics going on, not only in the SFP plus opportunity but also in its impact on transition and some of that can get confusing, any color you could offer on those sort of opportunities of what the market looks like there would be helpful.

Ron Jancov

Yes, well there is impact is the older module which is built physically larger but maybe more importantly it burns a lot more, have a much higher power profile. With the X2 module, it is smaller and has a much lower power requirement, so you can increase the port density for 10-Gig. Because the Aeluros team has the lowest form factor, they got a much higher penetration in X2 and are the leading supplier in the X2.

So, as more and more companies start to switch from XENPAK to X2 so that they can get a better port density, we are going to be a beneficiary of that change. It is kind of a change that happens over time. It will take two to three years for that to play out but it should be kind of a steady migration in our favor. Turning to SFP plus that take it to the next level were it is even lower power and even smaller form factor. Again, the low latency of smallest footprint lowest power solution that we are offering put us in a great competitive position there as well and we feel we are very aggressive and confident about our ability to win, a lot of SFP-plus design.

Sandy Harrison—Signal Hill

If you look out taking a broader perspective if you would Mike, from some of your expenses, in the expenses for Q1, are you accounting for some true ops and some early cost that you do not expect to see run through for the rest of the year after you have caught up or is this something that we could model from relatively flattish perspective.

Mike Tate

Yes, so we all look at Q1, we do see a step up because it is a full quarter of the Aeluros acquisition but it actually happened to be a quarter where our takeout in kind of a non recurring engineering expenses were kind of at a lower level. Q4, we actually had great successions coming up with two 55–nm parts and create a little increase in the R&D expenses beyond what we had guided, but the fact that they were so successful in first pass, we have a little bit of a pause now and that level was spent for a non recurring engineering.

So if anything, we will see kind of trend back up to more normal levels of Q2 and beyond.

Sandy Harrison—Signal Hill

Obviously now, getting the specifics, but is there some plans anytime in the next couple of quarters where you will see another big step up in spending or new projects that we should be modeling for that opposed to that as you see it?

Ron Jankov

At this point it should be a normal trend to an R&D which would incorporate additional investment in 55-nm during the course of the year but nothing that is creating any kind of an unusual spike.

Sandy Harrison—Signal Hill

Got you there Ron, lastly for those of us that are relatively new to the story, you got a lot of moving pieces here heading in the right direction. A lot of new opportunities with both existing costumers such as Cisco and it would be helpful if you could maybe characterize or try to prioritize what you see as the growth engines for this year and things we should be watching for.

Ron Jankov

Well, I mentioned certainly the 10-Gig, that the transition to X2. Our key success with our NL7000 or GEN4 NL8000 and now we are in NL9000. These new products are going to be quite a few both access go and outside of Cisco will be wrapping a production throughout the year and that should give us a steady growth basis with all these new projects and it is not just the new products from us but also the diverse applications where they go. I think Mike mentioned this, there is a lot of places where we have not been before like mainstream switching, the data center switching, some new Edge and even in core routing, where we are getting a higher penetration later in the year.

I would say that the launch of these new programs, virtually any kind of new bulk coming out of either Cisco or any non Cisco account probably has a NetLogic product in it.

Operator

And the following question comes from Nick Aberle - Caris & Company. Please proceed.

Nick Aberle - Caris & Company

First question is maybe just talk about visibility, typical we have pretty good visibility but we are just curious given over the macroeconomic concern, if that has changed at all here heading into Q1?

Mike Tate

Sure, yes! Said given the current backdrop right now. We have taken a little bit more conservative stance in what we have guided to and have a better than normal visibility that we typically have.

We also spend a lot more time looking at costumer forecast in the backlog and bookings patterns, in overall we are encouraged by what we are seeing, the bookings have been pretty healthy over the last month or two, and the backlogs are pretty good positioned for the company.

Nick Aberle - Caris & Company

Some of the sediment change affected design activity at all or is that still coming along?

Mike Tate

I would say design activity is without a doubt across all of our products at a record level. I think that people trying to move to the next generation boxes that become even more urgent and it is really focused between a Layer 4to Layer 7, so much activity there to do so many more HTL in quality service as well as to add deep packet inspection to these new boxes so our application engineers and sales force et cetera is busier than they have ever been.

Nick Aberle - Caris & Company

And is it possible to kind of break down what design wins you guys bagged in Q4?

Mike Tate

We had design wins across the Board and I think the ones that we want to highlight is the fact that we got five design wins for the NL9000, which is the first time we have ever actually gotten orders. Revenue production orders for a part that was not even out yet. That is how badly our customers wanted this fifth generation technology, so it was the first time that we have ever done that and we did over 15 design wins overall, which is continuing our kind of record pace.

Nick Aberle - Caris & Company

And those NL9000 wins, are those Cisco-related or non-Cisco related? Is that a Cisco part or a non-Cisco?

Mike Tate

It is kind of like with the Layer 7 stuff. The customers who are using the 9000 consider it very proprietary that they are using this new technology because it can allow them to reach a different power performance level so they do not want us to talk about what they are doing and we will not be able to announce the customers until their boxes come out, but one thing I can tell you is that the tier ones is across the board are excited about this technology.

Nick Aberle - Caris & Company

And then on the gross margin, was just curious, has the T CAM2 business that you have added in the Aeluros business, you have added affected gross margin here for the total company anyway.

Mike Tate

As we guided for Q4, we said the margins would come down to kind this range where we are at. A good part of that was the fact that we are doing more volumes in desktop switching including the Cypress transaction, but looking forward, we still feel very good about the 65% target model and we will be achieving that in Q1.

Nick Aberle - Caris & Company

Last question, with respect to NETLite, you guys are getting closer here it seems to getting this thing rolling, based upon the activity starting to heat up here, any additional feel for what the total share in the adjustable market for those markets is?

Mike Tate

It is really hard to predict right now, but right now, what we are seeing is that these initial designs, this is going for Layer 3 desktop switching, we are seeing the initial volumes will come from because of the higher end boxes, but we are also getting more and more traction with the real mainstream guys, who are moving upstream to the Layer 3 desktop switching, so initially you will see it kind of from the high-end and move to the mainstream, but more and more you are seeing people who want to put Layer 3 in this type of functionality into desktop switching in the past. They kind of lightly managed boxes, so the trend is actually moving stronger to our direction.

Ron Jankov

I would say that the number of design wins we were looking at in Q1 in the first half is greater than we had anticipated. I think these new solutions are going to hit a broader swathe of customers than we originally envisioned.

Operator

We have a question from Kevin Cassidy from Thomas Weisel Partners, please proceed.

Kevin Cassidy – Thomas Weisel Partners

With your success with the 55-nm products, any plans for taking older products and shrinking them to that process?

Ron Jankov

You know the market is moving forward so fast. Our customers need next generation features and new functionality and all kinds of new stuff that we just do not have time to go back and redo something from before, but typically sometimes what we will do is we will come out with a new product with new functionality that can fit in to a previous socket, but yet adds a lot of new functionality to that socket. So, that would be what we would do, I suppose than just doing a cost reduction.

Kevin Cassidy – Thomas Weisel Partners

I understand so, 55-nm is now the platform forward?

Ron Jankov

Yes, it is.

Operator

The following question comes from Romit Shah from Lehman Brothers.

Romit Shah-Lehman Brothers

Mike, based on your earlier comment, it sounds like there is about a million dollar contribution from Aeluros in Q1 so, organically growth sounds like it is around 1% to 2%, perhaps you guys are being ultraconservative, but it does not feel like it really matches up with the comments on orders, backlog and inventories.

Mike Tate

I think we see the same news reports that you guys do that the economic backdrop seems uncertain and we want to be very particularly cautious this quarter with our guidance. So, I think we are being a little more conservative than we normally would be.

Romit Shah-Lehman Brothers

It sounds like the design win activity is quite strong. How are you confident that these design wins are going into production as scheduled?

Mike Tate

Well, I am very confident that they are going to into production. As scheduled as always, a tough one to call. Certainly these first couple of Gen-401’s went into production right on time and that is a good sign and there is a couple more Gen 401’s close on our heels that look like they are going to come out on time, as well, so far so good on that. Across the board, we have so many that any given quarter, a number of them will be going even if some other ones are late.

Romit Shah-Lehman Brothers

I got you, if I could just lastly, not necessarily direct competitor, but TMC made some comments the other week that they are still thinking inventory reduction out of Cisco and was kind of spilling into Q1. Can you guys in the last just elaborate a bit more on what you are saying in that particular region?

Mike Tate

For Cisco in particular, we have implemented the vendor manage inventory over the last two quarters starting in Q3 and completing in Q4. So, we have just gone through that process, which result in a breakdown of our revenues, but also, we have now moved to kind of a just-in-time basis with Cisco. We think the inventory levels are very lean and lot of the growth that we see coming out in Cisco as you move through 2008 is really being driven by new product launches, you know we have 18 pending designs that are going to launch over the next say six quarters.

Ron Jankov

Also in Q4, our European Teleco costumers as well as China adjusted their inventories as well. So, we are going into the quarter pretty lean across the board.

Operator

We have a question from Rueben Roy from Pacific Crest Securities, please proceed.

Reuben Roy – Pacific Crest Securities

Mike, I was wondering if you could talk about the how your backlog at this point compares with that at the same point in Q3.

Mike Tate

So, in reflection to our guidance, it is at our very high point. We are being conservative relative to our guidance, in relation to our backlog right now, just given the kind of the back up that we are in right now. We feel very confident in our visibility right now. It goes out into Q2 though.

Reuben Roy – Pacific Crest Securities

And then, Ron you talked a little bit about the cable market and the transition potentially of Docsis 3.0 coming. Does that mean that your cable business slows until that starts to roll out or how should we think about the cable end market for NetLogic at this point.

Ron Jankov

No, not necessarily, cable is actually coming back a little bit, already here in Q1 and with the addition of Motorola and Cisco as costumers even prior to Docsis 3, we can have a pretty good year in cable even prior to the Docsis 3, but the reason we have pointed out Docsis 3 is that we have a long term growth task here in cable, both as the continuing build of Docsis 2, as well as when Docsis 3 starts to kick in. So, we have pretty long visibility on growth here in cable.

Reuben Roy – Pacific Crest Securities

One last one on the NETLite and desktop switching discussion, you mentioned high-end customers potentially shipping earlier than mainstream. Is it just the mainstream guys that you are waiting on the merchant NPU’s or is it in both cases?

Mike Tate

Both cases, there are designs in the high-end and the mainstream that are leveraged to both.

Reuben Roy – Pacific Crest Securities

So, second half for both of those.

Operator

The following questions come from Cody Acree from Stifel Nicolaus, please proceed.

Cody Acree - Stifel Nicolaus & Company, Inc.

On your caution for Q1, would you contrast it more as a little bit of hesitancy leaning more towards in inventory left to work through or just a matter of order in?

Mike Tate

It just really the economic backdrop that you see right now, so we decided it is prudent and given this backdrop to just be conservative to our guidance and rely less in turns during the quarter to hit that number. But, it is not really a reflection of anything that we are seeing from forecast or bookings right now.

Cody Acree - Stifel Nicolaus & Company, Inc.

But not an issue of inventory more, just an issue of a question of ramp?

Mike Tate

Yes, from our vantage point, we believe the inventory levels are at a very good level across our customer base right now.

Cody Acree - Stifel Nicolaus & Company, Inc.

If you looked at Cisco versus non-Cisco through the year, obviously, a lot of Cisco design wins, but a lot of other moving parts as well. How would you characterize Cisco versus non-Cisco ramps for the year? Is this going to get larger or we are we kind of seeing this within range?

Mike Tate

I think that is going to depend on exactly when certain boxes ramp both inside the Cisco and outside of Cisco. That said, the public expects to see a little bit higher growth outside of Cisco, just because we are adding some new customers that we have not have had before. But, at the same time we are adding new divisions within Cisco, which is almost like adding a new customer. So, it also depends on when boxes ramp.

Cody Acree - Stifel Nicolaus & Company, Inc.

Ron could you just talk of competition of a lot of interest Cisco and non-Cisco, is that bringing new competition?

Ron Jankov

The competitive a situation is relatively stable, I think with the exception of the fact that we have disrupted it with these two 55-nm parts, the one we have announced and the one we will announce in the next couple of months or so. I think that does change the competitive dynamics significantly in our favor, because these parts can do things that are not possible competitive parts, but as far as additional different players coming in the market or something like that, we do not see that happening.

Operator

And, we have another question from Sandy Harrison from Signal Hill, please proceed sir.

Sandy Harrison – Signal Hill

Just a quick another shot at the question on backlog in turn, so basically, given the fact that you guys are looking out. You are more focused on turns business challenges potentially than you are, anything you are seeing in backlog or otherwise. Is that a correct statement?

Mike Tate

We usually guide to a quarter with very little turns requirement to make our guidance and in this quarter it is very, very low turns.

Sandy Harrison – Signal Hill

Lower than usual?

Ron Jankov

Right and effectively, we are not relying on turns in any measurable way for this quarter.

Operator

We have follow-up question from Allan Mishan from Oppenheimer, please proceed.

Allan Mishan-Oppenheimer

Just one last quick one, with some more time past, can you update us on your latest understanding of what SpansLogic means for the competitive landscape for you guys attacking Cisco, thanks.

Mike Tate

I do not think anything has changed there. There is limited applicability within or what kind of end-box that can go into and in terms of the opportunities at Cisco, there are so many new divisions that are expanding their use of knowledge-based processors, using them for the first time or moving from Gen2 to Gen3 or Gen2 all the way to Gen4, even Gen5 designs. There is no question if there is going to be an increase at Cisco for knowledge-based processors even in a scenario where Span is using a maximum amount, which is still not clear.

Operator

There are no other questions at this time.

Mike Tate

Thank you and thanks to everyone for joining us today. During the first quarter, we will be presenting at the Thomas Weisel Partners Technology Conference and the Deutchse Banks Small and Mid Cap Growth Conference. We thank you for your continued interest in NetLogic and look forward to speaking with you in the near future.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Good day.

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