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Article by DailyStocks_admin    (08-31-11 12:26 AM)

Description

Cavium Inc. Corporate VP, IC Engineering Anil Kumar Jain bought 10000 shares on 08-24-2011 at $ 26.37

BUSINESS OVERVIEW

Overview

We are a provider of highly integrated semiconductor processors that enable intelligent processing for networking, communications, storage, wireless, security, video and connected home and office applications. We refer to our products as enabling intelligent processing because they allow customers to develop networking, wireless, storage and electronic equipment that is application-aware and content-aware and securely processes voice, video and data traffic at high speeds. Our products also include a rich suite of embedded security protocols that enable unified threat management, or UTM, secure connectivity, network perimeter protection, Deep Packet Inspection or DPI, network virtualization, broadband gateways, third generation/fourth generation or 3G/4G wireless infrastructure, storage systems, wireless High-Definition Multimedia Interface or HDMI cable replacement and embedded video applications. Our products are systems on a chip, or SoCs, which incorporate single or multiple processor cores, a highly integrated architecture and customizable software that is based on a broad range of standard operating systems. As a result, our products offer high levels of performance and processing intelligence while reducing product development cycles for our customers and lowering power consumption for end market equipment. We focus our resources on the design, sales and marketing of our products, and outsource the manufacturing of our products.

We generate the majority of our net revenue from sales of our products to providers of networking equipment that sell into the enterprise network, data center, broadband and consumer, access and service provider markets. Our products are used in a broad array of networking equipment, including routers, switches, content-aware switches, UTM and other security appliances, application-aware gateways, voice/video/data, or triple-play, gateways, wireless local area network, or WLAN, and 3G/4G WiMax/Long Term Evolution, or LTE access, aggregation and gateway devices, storage networking equipment, servers and intelligent network interface cards, Internet protocol, or IP surveillance systems, digital video recorders, wireless HDMI cable replacement systems, video conferencing systems and connected home and office equipment such as print servers, wireless routers and broadband gateways. The acquisition of MontaVista Software, Inc. (“MontaVista”) in December 2009 complements our broad portfolio of multi-core processors to deliver integrated and optimized hardware and software embedded solutions to the market. Our MontaVista software products generate a majority of revenue from sales of software subscriptions of embedded Linux operating system, related development tools, support and professional services.

Industry Background

Traffic on the Internet, wireless networks and enterprise networks is rapidly increasing due to trends that include greater adoption of multimedia, video, smart-phones, IPTV and rich, interactive Internet applications, voice over IP, or VoIP, video over broadband, file sharing, greater use of web-based cloud services and the proliferation of stored content accessed through networks. Enterprises, service providers and consumers are demanding networking and electronic equipment that can take advantage of these trends, and address the significant market opportunities and life-style changes that these new applications provide. As a result, there is growing pressure on providers of networking equipment, wireless, storage and electronic equipment to rapidly introduce new products with enhanced functionality while reducing their design and manufacturing costs. Providers of networking, wireless, storage and electronic equipment are increasingly seeking advanced processing solutions from third-party vendors to access the best available technology and reduce development costs.

Video on demand, IPTV, peer-to-peer (P2P) video, and Internet video are forecast to account for approximately 90 percent of all consumer IP traffic by 2013 according to Cisco Systems Inc.’s Visual Networking Index forecast. New media rich applications for both consumers and enterprises, like Facebook, YouTube, Hulu, MySpace, high definition (“HD”) movie downloads, video conferencing, online gaming, distance learning and telemedicine are the major drivers of this growth. Currently, internet video on the PC is the primary driver of this growth. In the future, Internet delivery of video to the TV and mobile devices followed by cost effective, HD interactive video communications is expected to fuel the future growth of video traffic over the Internet. This growth of video over the network is driving many of our customers in the networking and communications space to acquire video technology, applications and expertise. To address the future needs of our customers we acquired differentiated, low-latency video encoding technology via our purchase of W&W Communications, Inc. (“W&W”) in 2008.

The acquisition of MontaVista complements our broad portfolio of multi-core processors to deliver integrated and optimized embedded solutions to the market. Our MontaVista software products generate a majority of revenue from sales of software subscriptions of embedded Linux operating system, related development tools, support and professional services. In October 2010, we acquired Celestial Systems, an India-based technology and services partner with long term connections and synergies with MontaVista. With the acquisition, we gain critical mass in delivering key technologies and services such as Automotive Infotainment Systems, Digital Media product development and Android commercialization support.

The processing needs of advanced networking systems can be described in the context of the Open System Interconnection, or OSI, Model, which divides network activities, equipment, and protocols into seven layers. According to this model, Layers 1 through 3 are the physical, data link and network layers, respectively, which provide the protocols to ensure the transmission of data between the source and destination regardless of the content and type of data processed. Traditionally, network infrastructure products have focused on Layer 1 through 3 products that route and switch data traffic based solely on the source and destination address contained in the packet header. Processors that provide Layer 1 through 3 solutions are widely available from many vendors. Layers 4 through 7 are the transport, session, presentation and application layers, which provide the protocols to enable the reliable end-to-end communication of application information. Intelligent processing generally takes place in Layers 4 through 7. In order to provide this intelligence, advanced networking systems must include processors that enable extensive inspection of the application and data content, or deep packet inspection, and make intelligent switching and routing decisions based upon that inspection. To address customer demands, providers of networking equipment must offer products that include functionality such as intelligent routing or switching of network traffic prioritized by application and data content, and security services. Processors required for Layer 4 through 7 processing are significantly more complex than processors that provide only Layer 1 through 3 solutions.

The processing needs of the digital video market can be categorized into five distinct market segments namely capture, process, transport, receive and display. Our networking products serve in the video traffic transport market with single and multicore processors. The video transport market includes equipment used in cable networks, satellite networks and the Internet such as routers, switches and content load-balancers that support the bandwidth, low-latency and quality of service required for video. Video processing technology is required to play in the capture, process and display segments of the market. The video capture market includes all types of video recording equipment ranging from high-end broadcast quality cameras to IP cameras for video surveillance, video conferencing and personal use camcorders, IP cameras and webcams. The video process market needs high-channel density and translating and transcoding for video infrastructure equipment such as cable head-end video systems, IP Multimedia Subsystem, or IMS, gateways, broadcast systems, multi-channel digital video recorders (DVRs), video conference multi-point control unit and gateways. The video display market includes LCD screens and flat panels, plasma displays and projectors where high quality 1080p HD encode and decode and low latency are required for display and wireless connectivity. This market is served by our video processing products. Networking, wireless, storage and electronic equipment providers address the need for next generation video systems using a variety of approaches. These approaches include internally designed custom semiconductor products, such as application-specific integrated circuits, or ASICs, digital signal processors, or DSPs, field-programmable gate arrays, or FPGAs, or other proprietary chips, multiple chip offerings, general purpose central processing units, or CPUs, from merchant suppliers, software-based solutions or a combination of these approaches. While these approaches have been adequate for the basic Layer 1 through 3 processing, they are less effective as the need for Layer 4 through 7 intelligent processing increases and line rates continue to increase. As a result, providers of networking equipments are increasingly turning to third-party vendors for high performance, power-efficient and cost-effective intelligent processing products.

Products

OCTEON ® , OCTEON Plus ® , OCTEON II ® , NITROX ® , ECONA ® and Pure Vu TM are trademarks or registered trademarks of Cavium Networks, Inc.

We offer highly integrated semiconductors that provide single or multiple cores of processors, along with intelligent Layer 4 through 7 processing for enterprise network, data center, broadband and consumer, and access and service provider markets. Our products provide scalable, low-power, high performance processors that integrate single or multiple cores, hardware accelerators, memory controllers and input/output interfaces into a single chip and are available across a wide range of price and performance points. All of our products are compatible with standards-based operating systems and general purpose software to enable ease of programming, and are supported by our ecosystem partners. Our MontaVista Software products offer commercial grade embedded Linux operating systems, development tools, support and services. Our software embedded Linux products provide a high quality operating system and productivity tools across a wide range of embedded processors that are sold by us.

Our OCTEON, OCTEON Plus and OCTEON II Multi-core MIPS64 processor families provide integrated Layer 4 through 7 data and security processing (with additional capabilities at Layers 2 and 3) at line speeds from 100Mbps to 40Gbps. OCTEON processors integrate control plane processing, packet processing, security processing and content acceleration, as well as a broad set of input/output interfaces in a single chip. This integration shortens the data paths, eliminates redundant packet processing, simplifies board design and reduces the cost and power consumption compared to alternative products that use multiple chips. Our OCTEON processors have been adopted in a wide variety of original equipment manufacturer, or OEM, networking equipment, including routers, switches, content-aware switches, UTM, and other security appliances, application-aware gateways, voice/video/data, or triple-play, gateways, WLAN and 3G/4G access and aggregation devices, storage networking equipment, servers and intelligent network interface cards.

The OCTEON Plus and OCTEON II processor families incorporate new interfaces and acceleration features for packet processing, quality of service and content processing for multimedia aware networking and 3G, 4G-LTE, and WiMax wireless applications over the previous generations. The OCTEON Plus and OCTEON II processor families also expanded OCTEON’s core target markets in storage, wireless and control plane applications. The OCTEON Plus and OCTEON II processor families also provide hardware acceleration for storage applications such as iSCSI, RAID 6 and data de-duplication and are aimed at iSCSI targets, Fiber Channel to iSCSI bridges and disk arrays.

Our NITROX processor family offers stand-alone security processors and Layer 7 content processors that provide the functionality required for Layer 3 to Layer 7 secure communication in a single chip. These single chip, custom-designed processors provide complete security protocol processing, encryption, authentication algorithms and intelligent deep packet inspection to reduce the load on the system processor and increase total system throughput. The NITROX family consists of products with up to 64 security processors on a chip, providing up to 40Gbps of cryptographic processing up to 200k RSA operations/sec, and are used in a wide variety of OEM networking and data-center equipment, including security appliances, UTM appliances, Layer 4 through 7 load balancers, and other cloud services applications. The NITROX DPI Layer 7 content processor family includes our patented deep packet inspection technology and is used in routers/switches, wireless infrastructure equipment, UTM appliances and Layer 4 -7 load balancers.

Our OCTEON Plus broadband communication processor family consists of single and dual core processors that target wired and wireless broadband gateway applications, with performance requirements ranging from 100Mbps to 1Gbps. The MIPS64-based SoC OCTEON processors integrate single or dual 64-bit CPUs, and provide high performance security processing for applications requiring up to a 1Gbps line rate. These processors are primarily used for broadband routers, WLAN access points and UTM appliances.

The ECONA family of multi-core ARM-based System-on-Chip (SoC) products is targeted at applications that demand highly integrated, cost-effective, energy efficient processing platforms in the broadband-connected, digital home and office markets. The ECONA SoC family integrates multi-core ARM CPUs, comprehensive input/output, or I/O, options and hardware offload blocks for high performance connected gateways and networked storage, security gateways, wireless access, portable media devices and other networked appliances. With integrated power management hardware, the ECONA SoC family is also designed ground-up to meet very stringent power consumption requirements for the Consumer Electronics (CE) devices to enable fan-less operation and compact industrial design. The ECONA SoC family provides best-in-class performance / dollar and performance / watt for the targeted applications.

The PureVu CNW3XXX video processors offer the industry’s lowest end-to-end encode-decode latency, high channel density and low power solution for interactive and recording video applications. These processors integrate an H.264 encoder and decoder on a single chip with support for 1080p60 encode/decode, as well as encoding and decoding multiple HD, SD and CIF streams. Through our Super Low Latency (SLL) Technology™ many demanding interactive video applications are possible on CNW3XXX processors. The PureVu CNW3XXX processors are targeted for use in either highly interactive video applications, such as gaming, or in high channel-density video recording applications or in applications that require both low latency and high channel-density; including video conferencing, wireless HDMI adapters, video surveillance DVRs and video servers, gaming, and single or multi-sensor HD and SD IP cameras. The PureVu™ CNW5XXX family combines Cavium’s Super-Low-Latency (SLL) H.264 video processor, high performance NITROX security technology, and intelligent networking and packet processing capabilities in a fully integrated SoC that brings our revolutionary netHD™ technology to a variety of video applications, including wireless display, HDMI cable replacement, home media distribution, and video conferencing. The high degree of integration deployed in the CNW5XXX family is intended to provide customers with aggressive system bill-of-materials cost in order to enable mass market adoption in such devices as flat panel TVs, Blu-ray players, notebook PCs and netbooks, gaming consoles, as well as SMB and SOHO video communication systems.

The MontaVista software products include embedded Linux operating systems, support, development tools and professional services. The MontaVista software product line helps our customers build products around our SoCs in a more time and cost efficient manner. The MontaVista embedded Linux operating system is available in multiple editions based upon the target market. Our MontaVista Linux MVL6 product includes commercial grade Linux operating systems with pre-packaged open source packages and development tools that reduce development time and cost of building products. In addition to our MontaVista software products we also market and sell discrete software stacks designed to help our customers build products with fewer development resources. Furthermore, we offer customized professional services that help our customers build feature rich products using our processor and Linux expertise. In 2010 MontaVista released MontaVista Linux Carrier Grade Edition 6.0 (CGE 6.0) a sixth-generation embedded Linux for the highly demanding network equipment and carrier environments. Key to CGE 6.0 is a multicore resource management architecture that will allow multiple embedded technologies to run side-by-side in a virtualized environment. The MontaVista virtualization platform is based entirely on Linux and includes Linux Containers and KVM virtualization as well as an ultra-fast, RTOS-like Bare Metal Engine (BME) implementation. MontaVista Software continues to implement and support CGE 6.0 across multiple architectures and semiconductor platforms.

Customers

We primarily sell our products to providers of networking, wireless, storage and consumer electronic equipment, either directly or through contract manufacturing organizations and distributors. By providing comprehensive systems-level products along with our ecosystem partners, we provide our customers with products that empower their next-generation networking systems more quickly and at lower cost than other alternatives.

We currently rely, and expect to continue to rely, on a limited number of customers for a significant portion of our revenue. Cisco Systems, Inc. accounted for 22% of net revenue in 2010.

Sales and Marketing

We currently sell our products through our direct sales and applications support organization to providers of networking equipment, original design manufacturers and contract electronics manufacturers, as well as through arrangements with distributors that fulfill third-party orders for our products.

We work directly with our customers’ system designers to create demand for our products by providing them with application-specific product information for their system design, engineering and procurement groups. Our technical marketing, sales and field application engineers actively engage potential customers during their design processes to introduce them to our product capabilities and target applications. We design products in an effort to meet the increasingly complex and specific design requirements of our customers. We typically undertake a multi-month sales and development process with our customer system designers and management. If successful, this process culminates in a customer decision to use our product in their system, which we refer to as a design win. Volume production can begin from nine months to three years after the design win depending on the complexity of our customer’s product and other factors. Once one of our products is incorporated into a customer’s design, it is likely to be used for the life cycle of the customer’s product. We believe this to be the case because a redesign would generally be time consuming and expensive.

Manufacturing

We use third-party foundries and assembly and test contractors to manufacture, assemble and test our semiconductor products. This outsourced manufacturing approach allows us to focus our resources on the design, sales and marketing of our products. Our foundries are responsible for procurement of the raw materials used in the production of our products. Our engineers work closely with our foundries and other contractors to increase yields, lower manufacturing costs and improve quality.

CEO BACKGROUND

Anthony J. Pantuso

Anthony J. Pantuso, age 48, has served as a director since 2004. He has been a Managing Director at NeoCarta Ventures, a venture capital firm, since November 1999. From November 1996 to July 1999 he served as Senior Vice President for GE Equity, a division of GE Capital, a private equity investment company. Prior to working at GE Equity, Mr. Pantuso served in various positions at US WEST, Inc., MediaOne and Ernst & Young. He currently serves on several private company boards. Mr. Pantuso received a BS in Business Administration from Colorado State University. The Nominating and Corporate Governance Committee believes that Mr. Pantuso’s experience in numerous senior financial positions within large public companies as well as his experience in the venture capital business, position him to contribute financial, financing, and general business expertise to the Board of Directors. The Committee believes that Mr. Pantuso’s financial experience and experience as a director for other private companies is especially valuable in his position as a member of Cavium’s Audit Committee.

C.N. Reddy

C.N. Reddy, age 55, has served as a director since 2001. He is a co-founder of Alliance Semiconductor Corporation, which until 2006, was a provider of semiconductor products and solutions, and has held various positions. Since October 2000, he has served as the Executive Vice President for Investments at Alliance, during which time he has been responsible for Alliance’s investments in private technology companies and identifying future possible technology company acquisitions for Alliance. From December 1997 to October 2000, he served as Executive Vice President and Chief Operating Officer at Alliance. From May 1993 to December 1997, he served as Senior Vice-President Engineering and Operations at Alliance. From 1985 to May 1993, he served as Vice President Engineering at Alliance. From February 1985 to October 2000 he also served as Secretary of Alliance. Mr. Reddy has served as a member of the board of directors since Alliance’s inception in 1985. He was a member of the founding management team at Cypress Semiconductor Corporation. Prior to that, he held positions at Texas Instruments Incorporated and National Semiconductor Corporation. Mr. Reddy is currently the Executive Vice President of Investments and serves on the board of directors at Alliance Semiconductor. He currently serves on several private company boards. Mr. Reddy received an MSEE from Utah State University. The Nominating and Corporate Governance Committee believes that Mr. Reddy’s long experience in the semiconductor industry as well as long tenure on our Board of Directors brings necessary industry and historic knowledge and continuity to the board. The Committee also believes that Mr. Reddy’s extensive experience in finance and executive positions and as a past director of other companies, as well as his semiconductor industry background, position him to contribute financial, operational and industry expertise to the Board of Directors.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a provider of highly integrated semiconductor processors that enable intelligent processing for networking, communications, storage, wireless, security, video and connected home and office applications. We refer to our products as enabling intelligent processing because they allow customers to develop networking, wireless, storage and electronic equipment that is application-aware and content-aware and securely processes voice, video and data traffic at high speeds. Our products also include a rich suite of embedded security protocols that enable unified threat management, or UTM, secure connectivity, network perimeter protection, Deep Packet Inspection or DPI, network virtualization, broadband gateways, 3G/4G wireless infrastructure, storage systems, wireless HDMI cable replacement and embedded video applications. Our products are systems on a chip, or SoCs, which incorporate single or multiple processor cores, a highly integrated architecture and customizable software that is based on a broad range of standard operating systems. As a result, our products offer high levels of performance and processing intelligence while reducing product development cycles for our customers and lowering power consumption for end market equipment. We focus our resources on the design, sales and marketing of our products, and outsource the manufacturing of our products.

From our incorporation in 2000 through 2003, we were primarily engaged in the design and development of our first processor family, NITROX, which we began shipping commercially in 2003. In 2004, we introduced and commenced commercial shipments of NITROX Soho. In 2006, we commenced our first commercial shipments of our OCTEON family of multi-core MIPS64 ® processors. We introduced a number of new products within all three of these product families in 2006. In 2007 we introduced our new line of OCTEON based storage services processors designed to address the specific needs in the storage market, as well as other new products in the OCTEON and NITROX families. In 2008, we expanded our OCTEON and NITROX product families with new products including wireless services processors to address the needs for wireless infrastructure equipment. In 2009, we announced the next generation OCTEON II Internet Application Processor (“IAP”) family multi-core MIPS64 ® processors, with one to 32 cores to address next generation networking applications support converged voice, video, data mobile traffic and services. In addition, in 2009, we expanded our NITROX product family offering to include the NITROX DPI processor, which facilitates several significant enhancements and increased performance.

In the third quarter of 2008, we acquired substantially all of the assets of Star for a purchase price of approximately $9.6 million. With the acquisition of Star, we also added the Star ARM-based processors to our portfolio to address connected home and office applications and have since introduced our ECONA line of dual-core ARM processors for that address a large variety of connected home and office applications.

In the fourth quarter of 2008, we acquired W&W for a total purchase price of $8.3 million. This acquisition launched us into the video processor market with a broad product line called PureVu. The PureVu family of video processors and modules incorporate proprietary and patent pending video technology that produces perceptual lossless video quality and delivers sub-frame latency with extremely low power and cost. These products address the need for video processing in wireless displays, teleconferencing, gaming and other applications.

In the fourth quarter of 2009, we acquired MontaVista for a total purchase price of $45.2 million. In addition, per the merger agreement, we paid $6.0 million, consisting of a mix of shares of our common stock and cash to certain individuals in connection with the termination of MontaVista’s 2006 Retention Compensation Plan. This acquisition complements our broad portfolio of multi-core processors to deliver integrated and optimized embedded solutions to the market.

In the fourth quarter of 2010, we acquired Celestial Systems, Inc. for aggregate cash consideration of $4.4 million and a possible earn-out of $1.5 million in cash upon the achievement of certain milestone as set forth in the asset purchase agreement. With the acquisition of Celestial Systems, we gain critical mass in delivering key technologies and services such as Automotive Infotainment Systems, Digital Media product development and Android commercialization and support.

On January 25, 2011, we completed the acquisition of substantially all of the assets of Wavesat Inc., including, but not limited to, certain intellectual property, all of Wavesat’s rights to, in and under customer contracts and other material agreements, inventory, equipment, work in progress, fixed assets, certain accounts receivable and goodwill. We paid approximately $10.0 million in cash, plus the aggregate amount of certain liabilities, which were specified in the related purchase agreement. Following the closing, we also paid approximately 1.5 million to Wavesat in connection with a transition services agreement, pursuant to which Wavesat continued to employ certain employees prior to their becoming our employees. This acquisition will add multicore wireless digital system processing to our embedded processor product line.

On January 31, 2011, we entered into an asset purchase agreement with Celestial Semiconductor, Ltd., a Cayman Islands company. On the terms and subject to the conditions set forth in the asset purchase agreement, we will purchase certain assets of Celestial Semiconductor. Under the terms of the asset purchase agreement, we will pay approximately $55.0 million in total consideration, consisting of a mix of cash and shares of our common stock. In addition, the Company may pay additional cash consideration of up to $10.0 million after the closing per an earn-out provision based upon the sales of Celestial Semiconductor’s products following consummation of the transaction. With the acquisition of Celestial Semiconductor, Inc., we will have a proven processor family targeted for the large and growing market of digital media players.

For a complete discussion on our 2008 to 2010 and subsequent acquisitions, see “Note 5 Business Combinations” in Item 8, of this Annual Report, which is incorporated herein by reference.

Since inception, we have invested heavily in new product development and our net revenue has grown from $19.4 million in 2005 to $34.2 million in 2006, $54.2 million in 2007, $86.6 million in 2008, $101.2 million in 2009 and $206.5 million in 2010 driven primarily by demand in the enterprise network and data center markets, and more recently in 2009 the revenue growth was mainly due to increased demand in the broadband and consumer markets. We expect sales of our products for use in the enterprise network and data center markets to continue to represent a significant portion of our revenue in the foreseeable future, however, we do expect growth in the broadband and consumer as well as the access and servicer provider markets.

We primarily sell our products to OEMs, either directly or through their contract manufacturers. Contract manufacturers purchase our products only when an OEM incorporates our product into the OEM’s product, not as commercial off-the-shelf products. Our customers’ products are complex and require significant time to define, design and ramp to volume production. Accordingly, our sales cycle is long. This cycle begins with our technical marketing, sales and field application engineers engaging with our customers’ system designers and management, which is typically a multi-month process. If we are successful, a customer will decide to incorporate our product in its product, which we refer to as a design win. Because the sales cycles for our products are long, we incur expenses to develop and sell our products, regardless of whether we achieve the design win and well in advance of generating revenue, if any, from those expenditures. We do not have long-term purchase commitments from any of our customers, as sales of our products are generally made under individual purchase orders. However, once one of our products is incorporated into a customer’s design, it is likely to remain designed in for the life cycle of the product. We believe this to be the case because a redesign would generally be time consuming and expensive. We have experienced revenue growth due to an increase in the number of our products, an expansion of our customer base, an increase in the number of average design wins within any one customer and an increase in the average revenue per design win.

Key Business Metrics

Design Wins. We closely monitor design wins by customer and end market on a periodic basis. We consider design wins to be a key ingredient in our future success, although the revenue generated by each design can vary significantly. Our long-term sales expectations are based on internal forecasts from specific customer design wins based upon the expected time to market for end customer products deploying our products and associated revenue potential.

Pricing and Margins. Pricing and margins depend on the features of the products we provide to our customers. In general, products with more complex configurations and higher performance tend to be priced higher and have higher gross margins. These configurations tend to be used in high performance applications that are focused on the enterprise network, data center, and access and service provider markets. We tend to experience price decreases over the life cycle of our products, which can vary by market and application. In general, we experience less pricing volatility with customers that sell to the enterprise and data center markets.

Sales Volume. A typical design win can generate a wide range of sales volumes for our products, depending on the end market demand for our customers’ products. This can depend on several factors, including the reputation, market penetration, the size of the end market that the product addresses, and the marketing and sales effectiveness of our customer. In general, our customers with greater market penetration and better branding tend to develop products that generate larger volumes over the product life cycle. In addition, some markets generate large volumes if the end market product is adopted by the mass market.

Customer Product Life Cycle. We typically commence commercial shipments from nine months to three years following the design win. Once our product is in production, revenue from a particular customer may continue for several years. We estimate our customers’ product life cycles based on the customer, type of product and end market. In general, products that go into the enterprise network and data center take longer to reach volume production but tend to have longer lives. Products for other markets, such as broadband and consumer, tend to ramp relatively quickly, but generally have shorter life cycles. We estimate these life cycles based on our management’s experience with providers of networking equipment and the semiconductor market as a whole.

Critical Accounting Policies and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the dates of the consolidated financial statements, the disclosure of contingencies as of the dates of the consolidated financial statements, and the reported amounts of revenue and expenses during the periods presented. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected. See “Risk Factors” for certain matters that may affect our future financial condition or results of operations.

Revenue Recognition

We derive our revenue primarily from sales of semiconductor products and sales of software licenses and services. We recognize revenue when all of the following criteria have been met: (1) persuasive evidence of a binding arrangement exists, (ii) delivery has occurred, (iii) the price is deemed fixed and free of contingencies and significant uncertainties, and (iv) collection is probable. Our price is considered fixed or determinable at the execution of an agreement, based on specific products and quantities to be delivered at specified prices, which is often memorialized with a customer purchase order. Our agreements with non-distributor customers do not include rights of return or acceptance provisions. We assess the ability to collect from our customers based on a number of factors, including credit worthiness and any past transaction history of the customers.

Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of revenue. We generally recognize revenue at the time of shipment to our customers. Revenue from the sales of semiconductor products consists of sales of our products for a new design are usually made directly to networking OEMs as they design and develop their products. Once their design enters production, they often outsource their manufacturing contract manufacturers to purchase our products directly from us or from our distributors.

Revenue is recognized upon shipment for sales to distributors with limited rights of returns and price protection if we conclude we can reasonably estimate the credits for returns and price adjustments issuable. We record an estimated allowance, at the time of shipment, based on the historical patterns of returns and pricing credits of sales recognized upon shipment.

Revenue and costs relating to sales to distributors are deferred if we grant more than limited rights of returns and price credits or if it cannot reasonably estimate the level of returns and credits issuable. We have a distribution agreement with Avnet, Inc. to distribute our products primarily in the United States. Given the terms of the distribution agreement, for sales to Avnet, revenue and costs are deferred until products are sold by Avnet to its end customers.

We also derive revenue from licensing software and providing software maintenance and support. Software arrangements typically include: (i) an end-user license fee paid in exchange for the use of our products for a specified period of time, generally 12 months (time-based license); and (ii) a support arrangement that provides for technical support and unspecified product updates and upgrades on a when and if available basis over the period of the related license.

Revenue from software and service arrangements is recorded when all of the following criteria are met.

Persuasive evidence of an arrangement exists — We require either a written contract signed by both the customer and us, or a shrink-wrap or click-through contract whereby the customer agrees to our standard license terms, together with a non-cancellable purchase order, or a purchase order from these customers that have previously negotiated an end-user license arrangement or volume purchase arrangement.

Delivery has occurred — We deliver software to our customers electronically and considers delivery to have occurred once the access codes are provided that allow the customer to take immediate possession of the software.

The fee is fixed or determinable — Our determination that an arrangement fee is fixed or determinable depends principally on the arrangement’s payment terms.

Collectibility is probable — We assess the collectibility of an arrangement on a case-by-case basis, based on the financial condition of the customer as well as any established payment history.

We allocate revenue between elements in a multiple-element revenue arrangement based on vendor specific objective evidence of fair value (“VSOE”) for each undelivered element. VSOE is based on the price charged when an element is sold separately. We enter into multiple-element arrangements that generally include time-based licenses and support that are typically not sold separately. Revenue from such arrangements is deferred and recognized ratably over the term that support is offered, which is typically 12 months.

The software arrangement may also include professional services, and such services may be purchased separately. Professional services engagements are billed on either a fixed-fee or time-and-materials basis. For fixed-fee arrangements, professional services revenue is recognized under the proportional performance method, with the associated costs included in cost of revenue. We estimate the proportional performance of the arrangements based on an analysis of progress toward completion. We periodically evaluate the actual status of each project to ensure that the estimates to complete each contract remain accurate, and a loss is recognized when the total estimated project cost exceeds project revenue. If the amount billed exceeds the amount of revenue recognized, the excess amount is recorded as deferred revenue. Revenue recognized in any period is dependent on progress toward completion of projects in progress. To the extent we are unable to estimate the proportional performance then the revenue is recognized on a completed performance basis. Revenue for time-and-materials engagements is recognized as the effort is incurred.

In addition, we also enter into multiple element arrangements, which consist of the combination of licensed software, support and professional services. Professional services in such arrangements do not involve significant customization, modification or development of software licensed under the time based licenses and are not essential to the functionality of such software. Provided that the total arrangement consideration is fixed and determinable at the inception of the arrangement, we allocate the total arrangement consideration to professional services and time based licenses bundled with support based on VSOE for professional services and VSOE for time based licenses bundled with support. Each unit of accounting is then accounted for under the applicable revenue recognition guidance. For arrangements with services that are essential to the functionality of the software, the license and related service revenues are recognized using proportional performance method.

If we are unable to establish VSOE for each undelivered element of the arrangement, revenue for the entire arrangement is deferred until the time that we are able to establish VSOE for the undelivered elements or there is only one remaining undelivered element. When the revenue is deferred, the direct costs incurred in relation to the professional services arrangement are deferred and is recorded as deferred costs in prepaid expenses and other current assets.

Stock-Based Compensation

We apply the fair value recognition provisions of stock-based compensation, and accordingly, use the prospective transition method, which requires us to determine fair value only for awards granted, modified, repurchased or cancelled after the adoption date. The share-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as compensation expense net of an estimated forfeiture rate over the vesting period. We use the Black-Scholes option-pricing model to determine the fair value of stock options, which require various subjective assumptions, including expected volatility, expected term and the risk-free interest rates. We estimate the expected volatility based on the historical stock price volatility of comparable companies over the estimated expected term of our share-based awards. We use the simplified method as permitted under the provisions of stock-based compensation to determine the expected term of our share-based awards. We calculate the expected forfeiture rate based on average historical trends. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates and judgment. If factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview

We are a provider of highly integrated semiconductor processors that enable intelligent processing for networking, communications, storage, wireless, security, video and connected home and office applications. We refer to our products as enabling intelligent processing because they allow customers to develop networking, wireless, storage and electronic equipment that is application-aware and content-aware and securely processes voice, video and data traffic at high speeds. Our products also include a rich suite of embedded security protocols that enable unified threat management, or UTM, secure connectivity, network perimeter protection, Deep Packet Inspection or DPI, network virtualization, broadband gateways, third generation/fourth generation or 3G/4G wireless infrastructure, storage systems, wireless High-Definition Multimedia Interface or HDMI cable replacement and embedded video applications. Our products are systems on a chip, or SoCs, which incorporate single or multiple processor cores, a highly integrated architecture and customizable software that is based on a broad range of standard operating systems. As a result, our products offer high levels of performance and processing intelligence while reducing product development cycles for our customers and lowering power consumption for end market equipment. We focus our resources on the design, sales and marketing of our products, and outsource the manufacturing of our products.

From our incorporation in 2000 through 2003, we were primarily engaged in the design and development of our first processor family, NITROX, which we began shipping commercially in 2003. In 2004, we introduced and commenced commercial shipments of NITROX Soho. In 2006, we commenced our first commercial shipments of our OCTEON family of multi-core MIPS64 ® processors. We introduced a number of new products within all three of these product families in 2006. In 2007 we introduced our new line of OCTEON based storage services processors designed to address the specific needs in the storage market, as well as other new products in the OCTEON and NITROX families. In 2008, we expanded our OCTEON and NITROX product families with new products including wireless services processors to address the needs for wireless infrastructure equipment. In 2009, we announced the next generation OCTEON II Internet Application Processor (“IAP”) family multi-core MIPS64 ® processors, with one to 32 cores to address next generation networking applications support converged voice, video, data mobile traffic and services. In addition, in 2009, we expanded our NITROX product family offering to include the NITROX DPI processor, which facilitates several significant enhancements and increased performance.

In the third quarter of 2008, we acquired substantially all of the assets of Star Semiconductor Corporation (“Star”) for a purchase price of approximately $9.6 million. With the acquisition of Star, we also added the Star ARM-based processors to our portfolio to address connected home and office applications and have since introduced our ECONA line of dual-core ARM processors for that address a large variety of connected home and office applications.

In the fourth quarter of 2008, we acquired W&W Communications, Inc. for a total purchase price of $8.3 million. This acquisition launched us into the video processor market with a broad product line called PureVu. The PureVu family of video processors and modules incorporates proprietary and patent pending video technology that produces perceptual lossless video quality and delivers sub-frame latency with extremely low power and cost. These products address the need for video processing in wireless displays, teleconferencing, gaming and other applications.

In the fourth quarter of 2009, we acquired MontaVista Software, Inc. for a total purchase price of $45.2 million. In addition, per the merger agreement, we paid $6.0 million, consisting of a mix of shares of our common stock and cash to certain individuals in connection with the termination of MontaVista’s 2006 Retention Compensation Plan. This acquisition complements our broad portfolio of multi-core processors to deliver integrated and optimized embedded solutions to the market.

In the fourth quarter of 2010, we acquired Celestial Systems, Inc. for aggregate cash consideration of $4.4 million and a possible earn-out of $1.5 million in cash upon the achievement of certain milestones as set forth in the asset purchase agreement. With the acquisition of Celestial Systems, we gain critical mass in delivering key technologies and services such as automotive infotainment systems, digital media product development and android commercialization and support.

On January 25, 2011, we completed the acquisition of substantially all of the assets and assumed certain liabilities of Wavesat Inc. We paid $10.0 million in cash, plus the aggregate amount of certain liabilities, which were specified in the related purchase agreement. We also made advances to Wavesat in the form of a loan prior to the closing of the acquisition amounting to $500,000 to fund Wavesat’s operations. Following the closing, we also paid a total of $2.0 million to Wavesat in connection with a transition services arrangement, pursuant to which Wavesat continued to employ certain employees prior to their becoming our employees. This acquisition added multicore wireless digital system processing to our embedded processor product line.

On March 4, 2011, we completed the acquisition of substantially all of the assets and assumed certain liabilities of Celestial Semiconductor, Ltd. Under the terms of the asset purchase agreement and related supplemental agreement, we paid approximately $20.3 million in total cash consideration and issued 806,265 shares of our common stock. In addition, we may pay additional cash consideration of up to $10.0 million per an earn-out provision as specified in the asset purchase agreement. With the acquisition of Celestial Semiconductor, we have a proven processor family targeted for the large and growing market of digital media players.

Since inception, we have invested heavily in new product development and our net revenue has grown from $19.4 million in 2005 to $206.5 million in 2010 driven primarily by demand in the enterprise network and data center markets and increased demand in the broadband and consumer markets. For the three and six months June 30, 2011, our net revenue was $71.6 million and $135.2 million, respectively. We expect sales of our products for use in the enterprise network and data center markets to continue to represent a significant portion of our revenue in the foreseeable future, however, we do expect growth in the broadband and consumer as well as the access and servicer provider markets.

We primarily sell our semiconductor products to OEMs, either directly or through their contract manufacturers. Contract manufacturers purchase our products only when an OEM incorporates our product into the OEM’s product, not as commercial off-the-shelf products. Our customers’ products are complex and require significant time to define, design and ramp to volume production. Accordingly, our sales cycle is long. This cycle begins with our technical marketing, sales and field application engineers engaging with our customers’ system designers and management, which is typically a multi-month process. If we are successful, a customer will decide to incorporate our product in its product, which we refer to as a design win. Because the sales cycles for our products are long, we incur expenses to develop and sell our products, regardless of whether we achieve the design win and well in advance of generating revenue, if any, from those expenditures. We do not have long-term purchase commitments from any of our customers, as sales of our products are generally made under individual purchase orders. However, once one of our products is incorporated into a customer’s design, it is likely to remain designed in for the life cycle of the product.

We believe this to be the case because a redesign would generally be time consuming and expensive. We have experienced revenue growth due to an increase in the number of our products, an expansion of our customer base, an increase in the number of average design wins within any one customer and an increase in the average revenue per design win.

The acquisition of MontaVista in December 2009 complements our broad portfolio of multi-core processors to deliver integrated and optimized hardware and software embedded solutions to the market. Our MontaVista software products generate a majority of revenue from sales of software subscriptions of embedded Linux operating system, related development tools, support and professional services. The net revenue for our software and services are primarily derived from the sales of time-based software licenses, software maintenance and support, and from professional services arrangements and training.

Key Business Metrics for Semiconductor Products

Design Wins. We closely monitor design wins by customer and end market on a periodic basis. We consider design wins to be a key ingredient in our future success, although the revenue generated by each design can vary significantly. Our long-term sales expectations are based on internal forecasts from specific customer design wins based upon the expected time to market for end customer products deploying our products and associated revenue potential.

Pricing and Margins. Pricing and margins depend on the features of the products we provide to our customers. In general, products with more complex configurations and higher performance tend to be priced higher and have higher gross margins. These configurations tend to be used in high performance applications that are focused on the enterprise network, data center, and access and service provider markets. We tend to experience price decreases over the life cycle of our products, which can vary by market and application. In general, we experience less pricing volatility with customers that sell to the enterprise and data center markets.

Sales Volume. A typical design win can generate a wide range of sales volumes for our products, depending on the end market demand for our customers’ products. This can depend on several factors, including the reputation, market penetration, the size of the end market that the product addresses, and the marketing and sales effectiveness of our customer. In general, our customers with greater market penetration and better branding tend to develop products that generate larger volumes over the product life cycle. In addition, some markets generate large volumes if the end market product is adopted by the mass market.

Customer Product Life Cycle. We typically commence commercial shipments from nine months to three years following the design win. Once our product is in production, revenue from a particular customer may continue for several years. We estimate our customers’ product life cycles based on the customer, type of product and end market. In general, products that go into the enterprise network and data center take longer to reach volume production but tend to have longer lives. Products for other markets, such as broadband and consumer, tend to ramp relatively quickly, but generally have shorter life cycles. We estimate these life cycles based on our management’s experience with providers of networking equipment and the semiconductor market as a whole.

Revenue and costs relating to sales to distributors are deferred if we grant more than limited rights of returns and price credits or if we cannot reasonably estimate the level of returns and credits issuable. During the quarter ended June 30, 2007, we signed a distribution agreement with Avnet, Inc. to distribute our products primarily in the United States. Given the terms of the distribution agreement, for sales to Avnet, revenue and costs are deferred until products are sold by Avnet to their end customers. For the three months ended June 30, 2011 and 2010, 5.9% and 6.9%, respectively, and for the six months ended June 30, 2011 and 2010, 5.3% and 6.5%, respectively, of our net revenues were from products sold by Avnet. Revenue recognition depends on notification from Avnet that product has been sold to Avnet’s end customers.

Our distributors, other than Avnet, are used primarily to support international sale logistics in Asia, including importation and credit management. Total net revenue through distributors was $21.7 million and $17.2 million for the three months ended June 30, 2011 and 2010, respectively, which accounted for 30.3% and 34.5% of net revenue, respectively, and $39.1 million and $31.3 million for the six months ended June 30, 2011 and 2010, respectively, which accounted for 28.9% and 34.2% of net revenue, respectively. While we have purchase agreements with our distributors, the distributors do not have long-term contracts with any of the equipment providers. Our distributor agreements limit the distributor’s ability to return product up to a portion of purchases in the preceding quarter. Given our experience, along with our distributors’ limited contractual return rights, we believe we can reasonably estimate expected returns from our distributors. Accordingly, we recognize sales through distributors at the time of shipment, reduced by our estimate of expected returns.

Revenue derived from licensing software and providing software maintenance, support and training amounted to $4.7 million and $4.9 million for the three months ended June 30, 2011 and 2010, respectively, and $11.0 million and $9.9 million for the six months ended June 30, 2011 and 2010, respectively. Revenue from professional service arrangements amounted to $5.7 million and $934,000, for the three months ended June 30, 2011 and 2010, respectively, and $13.2 million and $2.3 million for the six months ended June 30, 2011 and 2010, respectively.

Our net revenue increased by $21.8 million or 43.7% in the three months ended June 30, 2011 compared to the same period in 2010 and $43.7 million or 47.8% in the six months ended June 30, 2011 compared to the same period in 2010. The increase in net revenue in the three and six months ended June 30, 2011 was mainly attributable to the increase in sales of $12.9 million and $24.6 million, respectively, from our enterprise network, data center and access and service provider markets, combined, as a result of the increase in demand for our new and existing products generally from our top five customers. Net revenue in our software and services segment also increased by $4.4 million and $8.5 million for the three and six months ended June 30, 2011, respectively, which was mainly driven by increased professional service contracts with our existing and new customers. In addition, net revenue increase of $4.5 million and $10.6 million for the three and six months ended June 30, 2011, respectively, in broadband and consumer markets mainly from increased customers demand contributed to our overall growth.

We use third-party foundries and assembly and test contractors, which are primarily located in Asia, to manufacture, assemble and test our semiconductor products. We purchase processed wafers on a per wafer basis from our fabrication suppliers, which are currently TSMC, Samsung, Fujitsu, Renesas and UMC. We also outsource the sort, assembly, final testing and other processing of our product to third-party contractors, primarily ASE and ISE. We negotiate wafer fabrication on a purchase order basis and do not have long-term agreements with any of our third-party contractors. A significant disruption in the operations of one or more of these contractors would impact the production of our products which could have a material adverse effect on our business, financial condition and results of operations.

Our gross margin has been and will continue to be affected by a variety of factors, including the product mix, average sales prices, the amortization expense associated with the acquired intangible assets, the timing of cost reductions for fabricated wafers and assembly and test service costs, inventory valuation charges, the cost of fabrication masks that are capitalized and amortized, and the timing and changes in sort, assembly and test yields. Overall gross margin is impacted by the mix between higher performance, higher margin products and services and lower performance, lower margin products and services. In addition, we typically experience lower yields and higher associated costs on new products, which improve as production volumes increase.

Gross margin decreased from 60.8% in the three months ended June 30, 2010 to 59.9% in the three months ended June 30, 2011, a decrease of 0.9 percentage points and an increase from 60.3% in the six months ended June 30, 2010 to 60.4% in the six months ended June 30, 2011, an increase of 0.1 percentage points. The decrease in gross margin for the three months ended June 30, 2011 compared to the same period in 2010 was primarily due to the increase in inventory reserve related to the inventories acquired from acquisition, which was partially offset by the overall decrease of product cost associated with fabricated wafers, assembly and test costs and improved overhead absorption as a result of the increased volume production, which was partially offset by the reduced average selling price for selected customers. The decrease in overall product cost and improved overhead absorption contributed to the increase in the overall gross margin for the six months ended June 30, 2011 compared to the same period in 2010.

The tax benefit for the three and six months ended June 30, 2011 was primarily related to increased federal, state and foreign income taxes reduced by the recording of a discrete tax benefit of approximately $340,000 and $886,000, respectively. The discrete tax benefit is solely related to increased federal research and development credits that result from the exercise of compensatory stock options. The tax provision for the three months ended June 30, 2010 was primarily related to international and state income taxes. The tax benefit for the six months ended June 30, 2010 was primarily related to the utilization of net operating losses for federal and state income tax purposes offset by foreign income taxes on the earnings of the Company’s foreign operations.

The difference between the provision for (benefit from) income taxes that would be derived by applying the statutory rate to the our income before tax and the benefit from income taxes actually recorded for the three and six months ended June 30, 2011 was primarily due to the impact of differential in foreign tax rates, non-deductible stock-based compensation charges, and other non-deductible items, offset by the federal research and development credit benefits. The difference between the provision for (benefit from) income taxes that would be derived by applying the statutory rate to our income (loss) before tax and the benefit from income taxes actually recorded for the three and six months ended June 30, 2010 was primarily due to the impact of the differential in foreign tax rates, non-deductible stock compensation charges and other non-deductible items, offset by the use of net operating loss carryforwards available for use under applicable statutes.

Our net deferred tax assets relate predominantly to the United States tax jurisdiction. The valuation allowance is determined in accordance with the provisions of income taxes which require an assessment of both positive and negative evidence when determining whether it is more–likely-than-not that deferred tax assets are recoverable; such assessment is required on a jurisdiction by jurisdiction basis. At the end of 2010, we released our valuation allowance against our federal deferred tax assets because we believed that sufficient positive evidence existed from historical operations and future projections to conclude that it was more-likely-than-not to fully recognize our deferred tax assets. However, we continue to maintain a full valuation allowance against our California and Massachusetts deferred tax assets of $11.8 million because the likelihood of the realization of those assets had not become more-likely-than-not.

As of June 30, 2011 and December 31, 2010, we had gross unrecognized tax benefits for income taxes associated with uncertain tax positions of $13.4 million and $12.9 million, respectively. If all of these unrecognized tax benefits were recognized, the entire amount would reduce our annual effective tax rate. We are not anticipating any significant changes in unrecognized tax benefits in the next twelve months.

Our major jurisdictions in which we are subject to income tax reporting requirements are the U.S. federal, the states of California and Massachusetts, Japan, India, China and Singapore. We are compliant with all income tax return filing and payment requirements in the major jurisdictions. As of June 30, 2011, there were no on-going tax audits in the major jurisdictions.

CONF CALL


Angel Atondo

Good afternoon, everyone. Welcome to Cavium Networks' third quarter 2009 financial results conference call. Leading the call today are Mr. Syed Ali, President and CEO of the company, and Art Chadwick, Vice President and Chief Financial Officer.

Before we begin, I would like to remind you that various remarks that we make on this call, including those about our future financial results, including revenues, gross margins, operating expenses, design wins, product plans, our competitive situation, market trends and our anticipated growth and profitability all constitute forward-looking statements for the purpose of the Safe Harbor Provisions under the Private Securities Litigation Reform Act.

These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our most recent Form 10-K and Form 10-Q filed with the SEC, in particular to the section entitled Risk Factors, and to other reports that we may file from time to time with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. These forward-looking statements speak only as of the date hereof and we disclaim any obligations to update these forward-looking statements.

In addition, Cavium reports gross margin and net income and basic and diluted net income per share in accordance with GAAP and additionally on a non-GAAP basis. Management believes the non-GAAP information is useful because it can enhance the understanding of the company's ongoing economic performance and Cavium, therefore, uses non-GAAP reporting internally to evaluate and manage the company's operations.

Cavium has chosen to provide this information to investors to enable them to perform comparisons of operating results in a manner similar to how the company analyzes its operating results. The full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today and we ask that you review it in conjunction with this call.

I will now turn over the call to Cavium's Syed Ali.

Syed Ali

Thanks, Angel. And thanks to everyone for joining us today. In brief, Cavium's third quarter revenue was $25.9 million, which represents a 14% sequential increase, and a 6% year-over-year growth. Non-GAAP gross margins grew 370 basis points quarter-over-quarter, and came in at 55.7%, which resulted in a non-GAAP net income of approximately $0.8 million or $0.02 per share.

Our GAAP loss for the quarter was $4.2 million or $0.10 per share. During the quarter, we also generated a healthy cash flow. Art will provide more details on the Q3 financial results and Q4 guidance shortly.

I will now move on to give you a breakdown of our Q3 revenues, along with the general update on the demand environment. I will discuss design wins and new customer and partner relationships.

Q3 was our second quarter in a row this year of strong double-digit sequential topline growth. In our last conference call, we had mentioned that unlike our growth in the first half of calendar year 2009, which was primarily driven by sales into the broadband and consumer segment that we expected our growth in the second half of calendar year 2009 to be driven strongly by sales into the enterprise and datacenter segments.

This is now happening in a way which is even more robust than our expectations. This quarter, the enterprise and datacenter segment was up from 43% of sales in Q2 of 2009, to 51% of total revenues and grew 34% quarter-over-quarter. Growth in this segment was driven by several new product ramps and to a smaller extent a continuing recovery in the run rate business.

The securities segment, which was very soft in the first half, also had a strong rebound in the third quarter. The remaining segments, including consumer broadband, access service provider, and software and services segment combined for 49% of sales, and declined 2% quarter-over-quarter.

The broadband and consumer segment was the second largest segment and came in at 36% of revenues, and declined 6% quarter-over-quarter. Our top customer in Q3 was once again Cisco Systems, which came in at 26% of sales and grew 61% quarter-over-quarter. The other two 10% customers were Actiontec for Verizon, and Sumitomo Electric for NTT, which were 11% and 10% respectively, both of which were down due to softness in fiber to the home deployments in Q3.

Other customers who had excellent sequential growth include, Citrix, Juniper, F5, Huawei and SonicWall, all of which are starting new product cycles that use our processors.

Now, I would like to move on and talk about the business and booking trends that we have seen in Q3. Q3 was a record bookings quarter again. Book-to-bill was once again well in excess of one. Additionally, the booking trends were very linear right through the quarter.

In Q4 we expect revenues will continue to be driven by new product ramps, as well as a continued in the run rate business. We expect continued strength in the enterprise and datacenter segment, driven by increasing sales to our top enterprise customers including Cisco, Juniper, Citrix, F5 and Brocade.

The access and service-provider segment should also now start seeing healthy growth, driven by Tier 1 customers rolling out new Edge and Access routers and switches, and wireless infrastructure, such as Huawei, Alcatel-Lucent, and Nokia-Siemens, along with a range of ATCA, AMC system manufacturers, such as RadiSys, Kontron, GE and Emerson.

I would also like to point out that in this ATCA AMC space, which has finally started to ramp, we have built an extremely strong position amongst pretty much all the major suppliers as the processor of choice for Layer 3 to Layer 7 data and security applications.

In the broadband and consumer segment, we expect our revenues in the fiber to the home segment to be soft again in this quarter, and we have factored that into our Q4 guidance. On the flip side, we expect nice growth from our PureVu line of video processors, which for the first time should contribute over $1 million in revenue for the quarter.

Additionally, our ARM based ECONA processor line is also showing excellent growth, albeit off a small revenue base as the first design wins of the existing products post the Star Semiconductor acquisition go to production.

Now, I would like to add a quick comment about our PureVu line of video processors. Our solutions have started to ship into video conferencing, embedded applications, and wireless high definition delivery boxes for Asian Tier 2, Tier 3 customers. We expect to see a nice revenue ramp in these applications starting this quarter.

In addition, we are in various stages of evaluation at major Tier 1 CE device manufacturers for TV, set-top box, notebook, and standalone dongle applications. The feedback that we have received so far on video quality and reliability has been very positive.

We will also be announcing a highly integrated and cost reduced solution for this specific application this quarter, which will meet all the feature, footprint, cost and power needs of these very high volume applications. We believe that this solution will significantly accelerate the wireless display market. Many of the major Tier 1 CE vendors that are evaluating our current solution have worked closely with us, and have played a significant role in defining and fine tuning this product so that it fits in very efficiently with their architecture.

Now, I would like to move and give an update on design wins in Q3. During the quarter, we further increased the total number of quarterly design wins at an extensive set of Tier 1 OEMs. Our relatively new ECONA and PureVu lines also contributed a meaningful portion to new wins this quarter.

Design wins are spread across all four target segments, and across low to high price and performance points. New design wins were approximately evenly distributed across enterprise, datacenter, service provider, and broadband consumer segments. We closed multiple new design wins at a number of our Tier 1 customers, including Cisco, Alcatel-Lucent, Huawei, Ericsson, ZTE, BigBand, Aruba, Ciena, Ixia, RadiSys, Kontron, GE, Sumitomo, Avision and (inaudible).

In the enterprise and datacenter segment we won new designs in SME routers, security and XML appliances, WAN optimization gateways, test and measurement equipment, enterprise access points, DNS gateways and military systems.

In the access and service provider segments we won significant new designs in utility routers, services cards, Edge QAM, service provider line card control plane, ATCA, AMC, and NIC cards, and cellular aggregation systems.

In the broadband and consumer segment we won new designs in fiber to the home broadband, and SMB routers and switches, and for (inaudible) wireless HD delivery at smaller Tier 2, Tier 3 customers.

Our recently announced products are gaining significant traction in the market. Our flagship OCTEON II line is seeing tremendous amounts of interest in all our target markets and has started getting significant design wins. Our overall pipeline of potential new design wins spans all of our product lines and remains extremely strong.

Now moving on and talking about the new products that we announced in the past quarter. In September, we introduced the ECONA CNS3XXX family of highly integrated system-on-a-chip processors. These processors feature up to two ARM11 CPU cores, at up to 700 megahertz, a rich set of over 10 hardware accelerators, several of which are leveraged from our OCTEON and NITROX lines, and a range of I/Os for seamless voice, video and data connectivity.

Sophisticated power management techniques enables super lows power operation, starting at less than 1 watt. The ECONA CNS3XXX family is targeted for applications in the digital home, including fiber to the home broadband gateways, CE devices, NAS appliances, media and print servers, IP cameras, and wireless access points.

Then current with our ECONA product introduction we announced that one of our major customers, Sumitomo has selected ECONA processors for use in their next generation fiber to the home gateway to achieve lower bill of materials cost, significantly lower power consumption and increased CPU headroom. The new ECONA processors increased our addressable stamp significantly, while at the same time delivering an optimized cost structure for us, which will help improve our gross margins in the broadband segment.

During the quarter, we also sampled the NITROX Deep Packet Inspection Layer 7 content processors, and completed evaluations at some major Tier 1 OEMs worldwide. The NITROX DPI processors offer 4 gigabits to 20 gigabits of deterministic performance, with low latency and support for an unlimited number of pattern rule-sets and flows.

Initial results from the OEM evaluations have validated that the NITROX DPI processors are significantly superior to existing solutions in several critical metrics, such as deterministic and high performance regardless of number of flows and patterns being examined, as well as the compactness of the pattern memory required.

We also continue to make excellent progress towards delivering our next generation OCTEON II and PureVu products to market. We also had several relationship announcements during the quarter.

At the time of our CNS3XXX processor system-on-a-chip announcement several key ecosystem partners highlighted support for ECONA, this include Tuxera with its next generation drivers for storage applications, TeamF1's comprehensive turnkey SMB VPN/Firewall gateway and Wi-Fi Access Point Software on ECONA processors for digital home applications, D2 Technologies with their voice over IP solutions. Entropic's third-generation MoCA 1.1 compliant solution, which when fed with our ECONA processors delivers feature-rich, high- performance, next generation fiber to the home gateways, with greatly reduced cost and power.

Wind River software platform optimized for the ECONA processor line, this will target connected broadband home and small office customer premises equipment that deliver dynamic IP centric services and support high definition video and audio, Internet telephony, remote configuration, monitoring and home automation.

We also announced a number of customer and ecosystem partner relationships using our OCTEON, NITROX, PureVU products.

SoftAtHome's turnkey solution for high-performance gateways was announced in the quarter, as well as, Aricent's LTE evolved Packet Core Solutions for OCTEON II products. GE Fanuc's OCTEON based AMC and NIC form-factor solutions for military and aerospace customers. Enea's unique mulit-core, real time operating system for OCTEON, for designers of 3G and 4G wireless infrastructure.

Xyratex's OCTEON plus Intelligent I/O controller for an industry standard storage bay reference platform. Hitachi's deployment of NITROX PX Security Adapters in their server product line. MontaVista's carrier grade OS solutions for next generation LTE and WiMAX 4G wireless networks.

And finally Broadcast Sports, Inc. deployment of Cavium's PureVu processors to enable corporate view at premier NASCAR, Indy 500, and other racing events nationwide.

To summarize, Q3 was indeed an extremely strong quarter on all metrics. Topline growth, gross margin expansion, design wins, and we also generated a positive non-GAAP net income. The leverage in our model will drive our superior topline growth to result in a nice expansion in our operating margins in the coming quarters.

We have a strong pipeline of new products coming to market over Q4 and Q1 2010, including the low power ARM based ECONA processors, the OCTEON II line and our next generation PureVu products. We believe that we are extremely well positioned as a company to deliver excellent topline and bottom line growth over the coming quarters.

On that note, I would now like to turn the call over to Art Chadwick, who will provide a detailed discussion on the Q3 financial results and guidance for Q4, and after that, we'll be happy to take your questions.

Art Chadwick

I'll first go through Q3 financial highlights and then provide some guidance for the fourth quarter. So as Syed mentioned, all key business metrics this quarter were very positive. We had record orders, a very strong book to bill ratio, 14% sequential sales growth, record quarterly revenue, positive cash flow, gross margin expansion, as well as a strong improvement to the bottom line, and in addition, we have record design wins across multiple Tier 1 customers and market segments.

Revenue in the third quarter was $25.9 million, which as Syed mentioned, was a 14% sequential increase over the second quarter, and 6% higher than the same quarter last year. Sales into the enterprise and datacenter markets accounted for 51% of total sales, and that was up from 43% in Q2, driven by strong sales into the Enterprise market including strong sales to Cisco.

Sales into the broadband and consumer market were 36% of total sales, down from 43% in Q2, due primarily to lower sales to Actiontec for Verizon and Sumitomo for NTT. Remaining 13% of sales went in to the access and service provider market and into software and services.

Cisco was again our largest customer this quarter, with sales increasing 61% sequentially. Sales to Cisco were $6.7 million or 26% of sales, up from 18% last quarter. Sales to Actiontec were $2.8 million or 11% of sales, down from 19% last quarter, and sales to Sumitomo were $2.5 million or 10% of sales, down from 13% last quarter. Sales to our top five customers accounted for 55% of total sales, compared to 56% last quarter.

As you know, in our press release, we announced both GAAP and non-GAAP results, and we ask that you please refer to our press release for the detailed reconciliation between GAAP and non-GAAP results.

We had good gross margin expansion this quarter. Non-GAAP gross margins were 55.7%, which was a 370 basis point improvement over Two quarter, due to a more favorable product mix, improved overhead absorption, as well as continued reductions in wafer assembly and test costs.

Non-GAAP operating expenses were $13.5 million. This was 5% higher than last quarter due primarily to increased R&D spending. Non-GAAP R&D expenses in Q3 were $8.3 million, up from $7.9 million last quarter. Non-GAAP SG&A expenses were $5.1 million, up from $4.9 million last quarter. We ended the quarter with 334 employees, an increase of 16 during the quarter. Non-GAAP operating income was $1 million, which was a substantial improvement over the $0.9 million loss last quarter.

The improved operating income was due to the higher sales, higher gross margins, and operating expenses that increased at less than half the rate of our sales growth. Net interest and other income was a net expense of $50,000 due to almost non-existent money market interest rates, and income tax expense was $167,000 for the quarter.

The GAAP loss for the quarter was $4.2 million, which is compared to $6.2 million in Q2. The non-GAAP net income was $0.8 million or $0.02 per share, and this was a $0.04 per share improvement over last quarter. The non-GAAP net income excludes $4.9 million in stock-based compensation, and acquisition-related expenses.

We had positive cash flow this quarter, and increased our cash balance by $4 million. We ended the quarter with more than $70 million in cash and equivalents, and no bank debt. The positive cash flow this quarter came from positive cash earnings, as well as a decrease in accounts receivable.

Accounts receivable were $11.7 million, down from $15.3 million last quarter, and DSOs in Q3 were 41 days, which was dramatically lower than DSOs of 60 days in Q2. This was due to good customer collections, as well as linear shipments during the quarter. However, DSOs of 41 days is unusually low, and we do expect them to increase somewhat in Q4.

Inventory at the end of the quarter was $18.3 million, an 11% increase over Q2, which is relatively consistent with the 14% sequential increase in sales.

I would now like to provide some guidance and how we see the fourth quarter. First of all, we are starting Q4 with record high backlog and excellent visibility and our turns requirement is lower than ever.

In Q4, we are expecting strong sequential sales growth, continued gross margin expansion, and improving operating margins as we take advantage of the leverage in our financial model. We currently expect that sales in Q4 will be between $29 million and $30 million, which would be a sequential growth rate of between 12% and 16% over Q3.

At the midpoint of this range, sales would be 33% higher than they were in the same quarter last year. The increased sales are expected to come primarily from higher sales into the enterprise and data-center market, including increased sales to Cisco, Juniper, Citrix, F5, Brocade and others.

This guidance also assumes that sales into the broadband and consumer market, specifically sales to Actiontec for Verizon, and Sumitomo for NTT will be down sequentially. We expect continued gross margin expansion due to continued improved product mix, continued material cost reductions and continued improvement in manufacturing overhead absorption.

Non-GAAP gross margins in Q4 are expected to be between 57% and 58%, which would be a 130 to 230 basis point sequential improvement over gross margins in Q3.

Non-GAAP operating expenses in Q4 are expected to increase somewhere between 5% and 7% sequentially, which would put non-GAAP OpEx at somewhere between $14.2 million, and $14.4 million. The increased spending is all focused on new product development.

Net interest and other income will essentially be zero in Q4 due to the extremely low interest income we're currently earning on money market funds. Income tax expense is expected to be approximately $250,000 in the fourth quarter.

In 2010 and longer term, we believe that our worldwide blended tax rate will be somewhere between 15% and 20% of non-GAAP income. So based on those assumptions, we expect that Q4, non-GAAP net income will be somewhere between $0.05 a share and $0.06 per share.

Our Q4 GAAP loss will also include approximately $4 million in stock, and acquisition based composition expense, and approximately $1 million in amortized, acquired, intangible assets. We expect that our non-GAAP share count will be approximately 46 million shares.

So in summary, our leading indicators are all very positive, and we are starting Q4 with record backlog and strong sales momentum. We expect to see good gross margin, and operating margin expansion in Q4 and beyond. We have recently introduced a number of significant new products across all four of our major product families, all of which are being very well received by our customers.

The increasing design win traction across multiple customers and markets continues to support our long-term growth plans. In addition, we have a solid balance sheet and no debt, which continues to give us a competitive advantage in the current market environment.

So on that note, I'd like to hand the call back to the operator for Q&A.

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