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CAVM > SEC Filings for CAVM > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for CAVIUM, INC.

Form 10-Q for CAVIUM, INC.


2-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and the related notes that appear elsewhere in this document.

The information in this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended ("Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act"), which are subject to the "safe harbor" created by those sections. Forward-looking statements are based on our management's beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as "may," "will," "should," "could," "would," "estimate," "project," "predict," "potential," "continue," "strategy," "believe," "anticipate," "plan," "expect," "intend" and similar expression intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading "Risk Factors." Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

OCTEON ®, OCTEON® PlusTM, OCTEON Fusion®, FusionStackTM, NITROX®, NEURONTM, CelestialTM , ECONA®, PureVu® and WiVuTM are trademarks or registered trademarks of Cavium, Inc.


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. Our product allows our 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 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. We focus our resources on the design, sales and marketing of our products, and outsource the manufacturing of our products. Following summarizes our product timeline introduction throughout the period:

Timeline                 History
2000     - We were incorporated and commenced product development.
through
2003
         - We began shipping NITROX security processors commercially.
2004     - We introduced and commenced commercial shipments of NITROX Soho.
2006     - We commenced our first commercial shipments of OCTEON multi-core
           processors.
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.
2008     - We expanded our OCTEON and NITROX product families with new products
           including wireless services processors to address the needs for wireless
           infrastructure equipment.
2009     - We announced the OCTEON II Internet Application Processor, or IAP, family
           multi-core MIPS64 processors.
         - We acquired MontaVista Software, Inc. in December 2009. This acquisition
           complemented our broad portfolio of multi-core processors to deliver
           integrated and optimized embedded solutions to the market.
2010     - We announced the next generation NITROX III, a processor family with 16
           to 64-cores that delivers security and compression processors for
           application delivery, cloud computing and wide area network optimization.
2011     - We introduced NEURON, a new search processor product family that targets
           a wide range of high performance, L2-L4 network search applications in
           enterprise and service provider infrastructure equipment.
         - We also introduced another new product family, the OCTEON Fusion, a
           single chip SoCs with up to 6x MIPS64 cores and up to 8x LTE/3G baseband
           DSP cores which enable macro base station class features for small cell
           base stations.
2012     - We introduced OCTEON III, Cavium's 48-core 2.5GHz multi-core processor
           family that can deliver up to 100Gbps of application processing, up to
           120GHz of 64-bit compute processing per chip and can be connected in
           multi-chip configurations.
         - We announced Project Thunder, the development of a new family of 64-bit
           ARMv8 scalable multi-core processors for cloud and datacenter
           applications.
2013     - We introduced the LiquidIO family of 10 Gigabit Server Adapters which
           provide high-performance, programmable adapter platform to enable
           software defined networks for cloud service providers and datacenters.

The following summarizes our acquisitions in the last five years:

- We acquired MontaVista Software, Inc. in December 2009. This acquisition complemented our broad portfolio of multi-core processors to deliver integrated and optimized embedded solutions to the market.

- We acquired Celestial Systems, Inc. in October 2010. With the acquisition of Celestial Systems, we gained additional professional services such as Digital Media product development and Android commercialization and support.

- We completed the acquisition of substantially all of the assets and assumed certain liabilities of Wavesat Inc. in January 2011. This acquisition added multicore wireless digital system processing to our embedded processor product line.

- We completed the acquisition of substantially all of the assets and assumed certain liabilities of Celestial Semiconductor, Ltd. in March 2011. With the acquisition of Celestial Semiconductor, we added capabilities to enable a processor family targeted for the large and growing market of converged media, gateway and wireless display applications.


Since inception, we have invested heavily in new product development and our net revenue has grown from $7.4 million in 2004 to $304.0 million in 2013 driven primarily by demand in the enterprise network and data center markets and 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.

We also earn revenue from the sale of software subscriptions of embedded Linux operating system, related development tools, support and professional services. The net revenue for our software and services operations are primarily derived from the sale of time-based software licenses, software maintenance and support, and from professional services arrangements and training.

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 win 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.

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 a 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 network equipment providers and data centers as well as the semiconductor market as a whole.


Results of Operations

Our net revenue, cost of revenue, gross profit and gross margin for the periods
presented were:



                             Three Months Ended March 31,
                               2014                 2013           change        %
                                    (in thousands)
        Net revenue       $       83,241       $       69,530     $ 13,711       19.7 %
        Cost of revenue           30,350               26,159        4,191       16.0 %
        Gross Profit      $       52,891       $       43,371     $  9,520       22.0 %
        Gross Margin                63.5 %               62.4 %        1.1 %

Net Revenue. Our net revenue consists primarily of sales of our semiconductor products to network equipment providers and data centers and their contract manufacturers and distributors. Initial sales of our products for a new design are usually made directly to network equipment providers and data centers as they design and develop their product. Once their design enters production, they often outsource their manufacturing to contract manufacturers that purchase our products directly from us or from our distributors. We price our products based on market and competitive conditions and periodically reduce the price of our products, as market and competitive conditions change, and as manufacturing costs are reduced. We do not experience different margins on direct sales to network equipment providers and data centers and indirect sales through contract manufacturers because in all cases we negotiate product pricing directly with the network equipment providers and data centers. To date, substantially all of our revenue has been denominated in U.S. dollars.

Three customers together accounted for 41.8% of our net revenue for the three months ended March 31, 2014 and one customer accounted for 18.9% of our net revenue for the three months ended March 31, 2013. No other customer accounted for more than 10% of our revenues for the three months ended March 31, 2014 and 2013.

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. We have an existing agreement with a distributor to distribute our products primarily in the United States. Given the terms of the distribution agreement, for sales to this distributor, we defer revenue and costs until products are sold to its end customers. For the three months ended March 31, 2014 and 2013, 4.3% and 5.9%, respectively, of our net revenues were from products sold by this distributor. Revenue recognition depends on notification from this distributor that product has been sold to its end customers.

We use our distributors, other than the distributor discussed above, primarily to support international sale logistics in Asia, including importation and credit management. Total net revenue through these distributors accounted for 27.9% and 30.8% of net revenue for the three months ended March 31, 2014 and 2013, respectively. The inventory at these distributors at the end of the period may fluctuate from time to time mainly due to the OEM production ramps or new customer demands. 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.

Our net revenue increased by $13.7 million or 19.7% in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase in net revenue was attributable mainly to the increase in sales in our enterprise network; data center and access and service provider markets, combined of $17.4 million which was partially offset by the decrease in sales in our broadband and consumer market of $3.7 million. The overall increase in sales in our enterprise networks; data center; and access and service provider markets was mainly due to the fluctuation in demand for our products in those respective markets, as a result of the timing of our customers' volume production of our design wins. The decrease in sales of our broadband and consumer market was mainly due to the fluctuation in demand for our products in those respective markets and to a certain extent, due to lesser focus on certain consumer product markets.


The following table is based on the geographic location of our customers including the original equipment manufacturers, contract manufacturers or the distributors who purchased our products and services. For sales to our distributors, their geographic location may be different from the geographic locations of the ultimate end customers. Sales by geography for the periods presented were:

                                    Three Months Ended March 31,
                                      2014                 2013
                                           (in thousands)
                 United States   $       30,077       $       22,651
                 China                   22,004               16,820
                 Korea                    3,664                7,035
                 Mexico                   4,650                4,150
                 Finland                  7,712                2,455
                 Taiwan                   6,198                5,891
                 Malaysia                 2,834                3,465
                 Other countries          6,102                7,063
                 Total           $       83,241       $       69,530

Cost of Revenue and Gross Margin. We outsource wafer fabrication, assembly and test functions of our products. A significant portion of our cost of revenue consists of payments for the purchase of wafers and for assembly and test services, amortization of acquired intangibles and amortization related to capitalized mask costs. To a lesser extent, cost of revenue includes expenses relating to our internal operations that manage our contractors, stock-based compensation, the cost of shipping and logistics, royalties, inventory valuation expenses for excess and obsolete inventories, warranty costs and changes in product cost due to changes in sort, assembly and test yields. In general, our cost of revenue associated with a particular product declines over time as a result of yield improvements, primarily associated with design and test enhancements.

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 Samsung, TSMC, Global Foundries, and Fujitsu. We also outsource the sort, assembly, final testing and other processing of our product to third-party contractors, primarily ASE Electronics in Taiwan, Malaysia and Singapore, as well as ISE Labs, Inc., in the United States. We negotiate wafer fabrication on a purchase order basis. There are no long-term agreements with any of these third-party contractors. A significant disruption in the operations of one or more of these third-party contractors would impact the production of our products for a substantial period of time, 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 of our products, 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.

Cost of revenue increased by $4.2 million or 16.0% in the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to the increase in net revenue. Gross margin increased by 1.1 percentage point from 62.4% in the three months ended March 31, 2013 to 63.5% in the three months ended March 31, 2014. The increase in the overall gross margin was mainly due to overall increases in revenue, which was partially offset by the shifts of product sales mix of our higher and lower performance products. Higher performance products yields higher gross margins compared to our lower performance products.

Research and Development Expenses. Research and development expenses primarily include personnel costs, engineering design development software and hardware tools, allocated facilities expenses and depreciation of equipment used in research and development and stock-based compensation. We expect research and development expenses to continue to increase in total dollars to support the development of new products and improvement of existing products. Additionally, as a percentage of revenue, these costs fluctuate from one period to another. Total research and development expenses for the periods presented were:

                                       Three Months Ended March 31,
                                         2014                 2013            change           %
                                              (in thousands)
Research and development expenses   $       37,289       $       32,415     $    4,874           15.0 %
Percent of total net revenue                  44.8 %               46.6 %         -1.8 %


Research and development expenses increased by $4.9 million or 15.0% in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Research and development expense in the three months ended March 31, 2014 and 2013 included $4.2 million and $3.6 million, respectively, from a variable interest entity, or VIE. The remaining research and development expense increased by $4.3 million or 14.9%.

The increase was mainly due to increase in salaries and employee benefits of $2.5 million and stock-based compensation expense and related taxes of $2.0 million, mainly resulting from the increase in research and development headcount and increase in stock option and RSU grants. The other increase of $1.2 million was due to increase in facilities expense, design tools and other miscellaneous research and development, as a result of the increase in research and development activities to support the development of our new products. The increases as discussed above were partially offset by the decrease in outsourced product development cost mainly in our consumer related products of $0.7 million and decrease in depreciation and amortization expense of $0.7 million mainly due to the acceleration of estimated useful life of certain intangible assets in the first and fourth quarter of 2013. Research and development headcount was 631 at March 31, 2014 compared to 534 at March 31, 2013.

Sales, General and Administrative Expenses. Sales, general and administrative expenses primarily include personnel costs, accounting and legal fees, information systems, sales commissions, trade shows, marketing programs, depreciation, allocated facilities expenses and stock-based compensation. We expect sales, general and administrative expenses to increase in absolute dollars to support our growing sales and marketing activities resulting from our expanded product portfolio. Total sales, general and administrative costs for the periods presented were:

                                      Three Months Ended March 31,
                                        2014                 2013            change            %
                                             (in thousands)
Sales, general and
administrative expenses            $       15,932       $       15,240     $       692            4.5 %
Percent of total net revenue                 19.1 %               21.9 %          -2.8 %

Sales, general and administrative expenses increased by $0.7 million or 4.5% in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Sales, general and administrative expenses in the three months ended March 31, 2014 included $0.3 million from a VIE. The remaining sales, general and administrative expenses increased by $0.4 million or 2.8%. Salaries and employee benefits increased by $0.4 million and facilities expense and other miscellaneous sales, general and administrative expenses, combined increased by $0.1 million mainly due to the increase in headcount. In the three months ended March 31, 2013, we recorded credits of $0.7 million associated with the gain on sale of held for sale assets. The increases in sales, general and administrative expenses as discussed above were partially offset by the decrease in the cost incurred for severance and other benefits of $0.6 million related to restructuring activities during the three months ended March 31, 2014 and 2013, and the decrease in depreciation and amortization expense of $0.2 million mainly due to the acceleration of amortization of certain acquired intangible asset in the fourth quarter of 2013. Sales, general and administrative headcount was 171 at March 31, 2014 compared to 154 at March 31, 2013.

Other income (expense), net. Other income (expense), net primarily includes interest income on cash and cash equivalents, foreign currency gains and losses, financing expenses, change in the estimated fair value of notes payable and other, interest expense associated with capital lease and technology license obligations and interest expense associated with the notes payable of the VIE. Total other income (expense), net for the periods presented were:

                                     Three Months Ended March 31,
                                        2014                2013           change            %
                                            (in thousands)
Interest expense                   $          (459 )     $      (342 )   $      (117 )         34.2 %
Change in estimated fair value
of notes payable and other                    (858 )               -            (858 )       -100.0 %
Other, net                                     135              (261 )           396         -151.7 %
Total other expense, net           $        (1,182 )     $      (603 )   $      (579 )         96.0 %

Other expense, net, increased by $0.6 million in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was due to the increase in interest expense associated with notes payable of the VIE and long-term capital and technology license obligations and recognition of the change in estimated fair value of notes payable and other. These increases were partially offset by other, net which consists mainly of foreign exchange gains in the three months ended March 31, 2014 compared to foreign exchange losses in the three months ended March 31, 2013.


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