Inphi Corp
Q4 2016 Earnings Call Transcript

Published: 8 Feb 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to Inphi Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded. I would like to introduce your host for today's conference, Ms. Deborah Stapleton, Investor Relations. Ma'am, please go ahead.

[Deborah A. Stapleton:]

Good afternoon, everyone, and thank you for joining us today to discuss the financial results for the fourth quarter of 2016. I'm Deborah Stapleton, and with me today are John Edmunds, Chief Financial Officer; and Ford Tamer, our Chief Executive Officer. John will begin with the Safe Harbor. Then Ford will give you an overview of our business. After that, John will provide a financial summary of Q4 and the outlook for the first quarter of 2017. Then we'll be happy to take your questions. John?

[John S. Edmunds:]

Thanks, Deborah. Please note that during the course of this conference call, we may make projections or other forward-looking statements about Inphi, including references to our prospects and expectations for 2017 and beyond, the projected growth and size of our markets and our customers and market share, new products and design wins and the integration of ClariPhy. These forward-looking statements and all other statements made on this call which are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. These forward-looking statements speak only as of today's call. We do not undertake any obligation to provide updates after this conference call. For further information regarding risk factors for our business, please refer to our registration statements, as well as our most recent annual and quarterly reports on Forms 10-K and 10-Q, all filed with the Securities and Exchange Commission, accessible at www.sec.gov. Please refer, in particular, to the sections entitled Risk Factors. We encourage you to read these documents. Also during the course of this conference call, we may make reference to non-GAAP financial information. A reconciliation of this information is included in the press release and on our company website at www.inphi.com. This information is not a substitute for GAAP and should only be used to evaluate the company's results in conjunction with corresponding GAAP measures. For this year, in particular, you will notice that we are reporting based on continuing operations and that historical numbers in the press release have been adjusted to reflect our fiscal 2016 sale of the memory business to Rambus. This is being done in accordance with the GAAP rules for reporting discontinued operations. However, for convenience, we have included a reconciliation to the historical reports on our website for the six quarters ended June 30, 2016. In general the numbers we refer to in the conference call will be for continuing operations. When we refer to numbers that are not for continuing operations, we will so designate. Now, to begin our review of our quarter, let me turn the call over to our CEO, Ford Tamer. Ford?

[Ford G. Tamer:]

Thanks, John, and thank you for joining us for Inphi's fourth quarter and yearend 2016 earnings update. Once again I'm very pleased to report that we finished a strong year with accelerating momentum across all our product lines and markets. This is the 19th consecutive quarter in which we've met or exceeded our robust targets. We generated $80.9 million in Q4 revenue, an over 50% increase over last year's strong Q4. This is the third consecutive quarter of double-digit sequential revenue growth. For the full year 2016, we reported $266 million in revenue, a 38% increase over the $193 million in 2015. Our Q4 results indicate a top line acceleration across our product portfolio. To help with the annual comparison, the ClariPhy acquisition, which closed in mid-December, added about $1 million in revenue to our Q4. As our customers continue their successful deployment of our leading edge data movement interconnect products, we continue to deliver both top and bottom line results, with the latter at 28.9% non-GAAP operating margin. After taxes, we achieved $0.47 in fourth quarter earnings per share. This resulted in annual earnings of $1.51 per share versus $0.93 per share for 2015. Allow me to repeat what I said last year at this time. As proud as we are of these 2016 results, we're confident that the best is yet to come. We are guiding Q1 2017 revenue at the mid-point, our first full quarter with ClariPhy to $93.5 million and to $0.44 in non-GAAP earnings per share. This represents the fourth consecutive quarter of double-digit sequential revenue growth. Beyond that, we have new product introductions and key design wins which we believe will enable us to continue to gain share and keep us growing. Looking back on 2016 by divesting our memory business and acquiring ClariPhy, we continue to evolve Inphi towards complete data movement interconnect platform. As the market continues to transition to off-field communications and long haul, metro, between and inside data centers, we continue to focus on the best opportunities ahead. This is the result of hard work and strong performance from our entire team. I'm confident about the direction we're headed and Inphi's future prospects. In fact, let me use this first call of the new year to walk you through our strong position. We have a rock solid product line being introduced while we'll be catching the next wave in data movement interconnect. First our long haul and metro, TIA and driver fourth quarter revenue grew 90% year-over-year, which showed an acceleration from the 2016 calendar revenue growth of 83% year-over-year for that business. Our driver revenue grew over 110% year-over-year, and is now approaching our TIA revenue. We now have over 50% market share in the long haul and metro driver market. Our cumulative shipment of linear TIAs and drivers exceeded 2.7 million units, more than all our competitors combined. We continue to make progress in solution for discrete line cards and a longer ACO modules, digital or DCO modules and daughter cards. We continue to support partners with VCSEL, EML, DML and Silicon Photonics based optics. We sampled the first 64 Gigabaud devices for the 64 QAM Flex Coherent market. Next, with the ClariPhy acquisition, Inphi now has a companion coherent DSP for the long haul and metro markets. This allows us to provide our long haul, metro and DCI customers with a full and flexible complement of components, enabling their moves to ultrahigh-speed transmission, up to thousands of kilometers. Since announcing the acquisition, we sampled a new ASIC to our lead cloud DCI customer and have won new designs for our standard product in metro and long haul. We're gearing up to tape out a new low-power metro product, and the integration is proceeding well and according to plan. Moving to the DCI edge market, our ColorZ rollout is on plan for 80 kilometer links between datacenters. We shipped hundreds of units in Q4, and are gearing up to ship thousands in Q1. We expect our lead customer to begin production deployment in Q1. We also have many other customers and partners currently evaluating ColorZ for a variety of applications. While our production ramp and yields are meeting our targets, we will remain supply constrained for the first half of 2017. We plan to step up capacity in Q3, which will allow us to expand our customer base and application reach. We are early in the opportunity for this DCI edge market. And we expect this product to be a core offering for Inphi for the next 5 to 10 years in new applications and new markets. ColorZ is yet another example of Inphi's focused investing to provide early access to markets, just as they emerge and expand. Finally, on our optical PHY product line, our Q4 revenue grew 55% year over year, again, showing an acceleration compared to the 43% revenue growth rate for the full calendar 2016 as compared to 2015. The growth is mainly driven by the CFP and CFP2 platforms and mostly from China. We're starting to see the low power clock data recovery product, or CDR, as well as the 10/40 Gigabit server PHYs ramp as well. And as PAM design wins start going to production, we expect a continued ramp of revenue in the second half of the year and into 2018. Overall, Inphi is very much in the right place at the right time, with the right platform solutions. Our optical end-markets are evolving from cyclical growth to secular growth. This is driven by three markets today, China service providers, North America service providers and cloud operators. China growth was driven by the national backbone in 2016, and will be driven by the provincial backbone in new wireless infrastructure in 2017 and 2018. The North America service provider and cloud markets will be driven by continued growth of 100 gigabit per second and the ramp to 200 and 400 gigabit per second networks. We expect a fourth revenue stream with enterprise data centers going optical as they transition to 25 Gigabit I/O in 2018. While we've long been proud of our ability to supply award-winning, leading-edge components and solutions, our business has evolved from a leading supplier of amplifier and drivers to an annuity business built on five separate but individually thriving product lines

[John S. Edmunds:]

Thanks, Ford. Now, let me recap the key financial results. In the fourth quarter of 2016, Inphi reported revenues of $80.9 million, which includes $1.1 million of revenue from ClariPhy for the two weeks beginning on December 12. Revenues were up sequentially 14% and year over year by 53%. Revenue for the year in 2016 was $266 million, representing 38% revenue growth from the $193 million reported for continuing operations for 2015. Core communications revenue for 2016 has grown by 71% over 2015. We define our core communications as amplifiers, drivers, as well as 10, 40, 100 Gig physical interface products and ColorZ, all of which sell into the service provider and data center interconnect markets. For 2016, growth is coming from all four areas, with drivers more than doubling and the other product lines growing 58% on average. Our current estimates are that we expect core communications to continue to grow in the range of 42% to 46% year over year in 2017. The core communications products year-to-date continue to represent approximately 80% of communications while transport and legacy represents approximately 19% and ClariPhy making up the remaining 1%. Transport and legacy in Q4 was up from Q3, however, we forecast that it will decline over time at the rate of approximately 20% year over year. This remains consistent with our expectation for the transport and legacy business when we acquired it from Cortina back in 2014. Gross margins on a non-GAAP basis in Q4 came in at 73.3%, which was up 30 basis points from the 73% posted in Q3. In Q1 2017, we expect the gross margins to be down approximately 30 basis points to 70 basis points. All in, we estimate non-GAAP gross margins for Q1 to be in a range of 72.5% to 73.1%. We continue to believe that gross margins can remain comfortably above 70% for all of 2017. Q4 GAAP net income from continuing operations was $19.1 million, which compares to non-GAAP net income for the fourth quarter of $20.8 million. This $1.7 million improvement is derived by adding back the following recurring GAAP to non-GAAP adjustments

[Operator:]

Thank you. Our first question comes from the line of Brian Alger with ROTH Capital Partners. Your line is open. Please go ahead.

[Brian Alger:]

Good afternoon, guys. A fantastic quarter. A couple of questions, if I might, just on the guidance. Look, it sounds like first half is going to see some uptick in the business on the ColorZ front with acceleration in the second half. How big of a step function should we be thinking there from that ColorZ business? Obviously it's just starting to ramp.

[John S. Edmunds:]

So Brian, I think we've been clear all the way along that – since we talked about ColorZ at OFC last year that we thought we would be able to do around $30 million in 2017 in revenues for the ColorZ product set. So you can imagine, to be able to reach that kind of number, we'd have to be in the range of $4 million to $5 million in the first quarter. So incrementally that'll probably be about $3.5 million to $4 million or so in the quarter.

[Brian Alger:]

Okay. And then if we're adding customers in the second half, are they going to be on a similar trajectory to what Microsoft has seen where it's taken a slower time to qualify and to get that adoption? Or is there a learning curve that they're going to be able to ramp faster?

[John S. Edmunds:]

Well, definitely, they'll be able to leverage a learning curve. But it's one step at a time right now. So we just need to work through each quarter and we'll obviously have to ramp Q1's revenues throughout the year to reach the $30 million by the end of the year.

[Brian Alger:]

Okay, great. And just one quick follow-up. I was typing furiously but I think I saw that you're expecting 2017 growth for the core communications group to be 42% to 46%. Was that correct?

[John S. Edmunds:]

Yes. And that includes the ColorZ product set.

[Brian Alger:]

Great. Thanks. Nice job, guys.

[John S. Edmunds:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of Ross Seymore with Deutsche Bank. Your line is open. Please go ahead.

[Ross C. Seymore:]

Okay. Let me ask a question as well. I guess just a follow-up from Brian's question on that last part. Can you just walk through, Ford, a little bit about that core growth? What's driving the 42% to 46%? Obviously John just gave part of the answer with the ColorZ dynamic. But if you break down the other, I guess, four of your five product lines, any sort of incremental color on those would be helpful.

[Ford G. Tamer:]

Sure. So first on the TIA and driver, we continue to see a growth in the number of ports. So we continue to expect the 50% growth in the number of ports year on year from 2016 to 2017. The second driver is that linear continues to take share from limiting, so we're now expecting limiting to pretty much go away in the next couple of years. So linear share is growing. And we're growing with that. Number three, we are taking share in metro with some of the new products we have. Number four, we're taking share in the driver side of the business. Number five, we've got a bunch of new products on both 45 gigabaud as well as 64 gigabaud that are currently sampling with customers. Then we're starting to see new design wins that have helped some in Q4 but will help tremendously in 2017 in the DCO space, digital module space where the DSP is on, inside the module, especially in China. And then we continue to see growth in variety of different partner optics as we said, from EML to DML to silicon photonics. So quite a few vectors on the TIA and driver, which is really two of the five businesses, Ross. On the DSP side, we are sampling a new ASIC to our lead DCI customer. We'd expect that to grow this year. We're not expecting a lot of growth for the coherent DSP in 2017 but we do expect a nice growth in 2018. Then, as you go into the optical PHY product, we continue to see continued growth in a number of ports. We continue to see continued growth in the CFP, CFP2 with the Gearbox as well as the clock data recovery product. The Skylake introduction should help in the growth of that 10-40 Gigabit PHY. And finally in the second half of the year, we're finally going to start seeing a growth in the PAM products in the chip business, starting with 40 and 400 Gig and then going into 200 and 400 Gig later on, in later side of 2017 and to 2018. ColorZ is the last leg of growth and this is where we can have the highest data if you wish. And this is where we're very excited about, what could happen in the next few years as we see multiple applications and multiple user scenario develop, and our customers are pretty enthusiastic about the possibility. That's a brief overview, Ross.

[Ross C. Seymore:]

It was anything but brief but very, very helpful. I guess, John, on your side of things, if we think about the gross margin, what is the upside driver? What was the upside driver in the fourth quarter? And as you think about the revenue drivers that Ford just laid out for us, is there anything in that, that drives you necessarily down towards that 70% range? Or is that 70% number just more of a conservative round number when you're talking about the full-year number for gross margin?

[John S. Edmunds:]

Yeah. Obviously, the acquisition of ClariPhy with 80%-plus gross margins in their product set is going to add to the gross margin profile. There are things that moderate that from a mix point of view in our business. So for us, we've talked in the past, when we sell die-based product, particularly amplifiers in our case and some driver product that are die-based tend to have higher gross margins. We have a new service mount based driver, but that carries a package with it. So it tends not to have quite as rich a gross margin as the die-based products would have. So it's really a function mix at the end of the day that – and there'll be some pricing pressure over time, but we're also bringing out a lot of new products this year so our job's really to try to keep those two things balanced. So in general, those are the kind of factors that influence in one direction or another. We do have a lot of drivers of growth that we're anticipating in the first quarter here. And a lot of those are packaged so that has a little bit of a dampening effect although it's certainly manageable in the scheme of things.

[Ross C. Seymore:]

Great. Thank you very much, guys. And congrats on the results.

[John S. Edmunds:]

Thanks, Ross.

[Operator:]

Thank you. And our next question comes from the line of Quinn Bolton with Needham & Company. Your line is open. Please go ahead.

[Quinn Bolton:]

Hey, guys. Just a couple of quick clarifications and then a question just on the core comm growth of 42% to 46%, I assume that, that excludes the ClariPhy contribution of roughly $45 million?

[John S. Edmunds:]

That's correct.

[Quinn Bolton:]

Okay. And then OpEx, listen Q1 even with ClariPhy looks like it was coming in maybe $4 million or $5 million higher than what at least I had modeled. Can you walk us through sort of what the uptick in OpEx is? And any forecast or help you can give us sort of for OpEx trends through the rest of 2017?

[John S. Edmunds:]

So Quinn, the OpEx for Q1 is largely increasing because of the addition of ClariPhy. There are other factors, sort of puts and takes, but generally the core business would be flat to what it had been in Q4. So we did definitely have an uptick in Q4 as I mentioned on the call, in particular in the development foundry expense, and we continue to be introducing new products here. So we'll have that same level of qualification spending going on in foundry. So I think through the balance of the year, we expect a moderate amount of expense growth, and that will lead us to things in the Q2, Q3 timeframe and probably getting close to $50 million or maybe $51 million combined in the fourth quarter, to give you an idea.

[Quinn Bolton:]

Okay. And so if I look at the numbers John, you do have almost $36 million of OpEx in Q4 which probably included a couple of weeks of ClariPhy. If you're going to $45 million, $46 million, it sounds like ClariPhy's adding sort of $9 million, $10 million a quarter, is that kind of the right run rate then for the ClariPhy OpEx that really should be adding into the model?

[John S. Edmunds:]

Yes. It's roughly in that range per quarter.

[Quinn Bolton:]

Okay, great. And then just a sort of longer-term question. You gave, Ford, a lot of color on sort of what your growth drivers are. I was just kind of curious, Lumentum and Fabrinet both sort of talked here recently with their quarterly results about a slight slowdown in their telecom business. You guys clearly aren't seeing that, just wondering if you might have any thoughts, is it share gains, other factors, that they're allowing you to kind of see sort of a different trend in the telecom business?

[Ford G. Tamer:]

Yes. Very good question, Quinn. It's a combination of share gains, but also new customer products. So I mentioned a pretty large contribution from a CFP DCO from a China customer. And that's probably the largest DCO currently shipping in the market.

[Quinn Bolton:]

Got it. Thank you, Ford.

[Operator:]

Thank you. And our next question comes from the line of Tore Svanberg with Stifel. Your line is open. Please go ahead.

[Tore Svanberg:]

Yes. Thank you, and congratulations on the strong results. First question, either Ford or John, could you elaborate a little bit on what you said about being capacity constrained and what some of the plans are for especially the middle of this year?

[Ford G. Tamer:]

Yes. So we are increasing our yields and increasing our capacity per our targets. So we've got targets to increase both of these measures every quarter. We are on target and we see a step-up in Q3 that is a combination of both. So we see a step-up from the yields getting quite high and adding a lot more test capacity in Q3 to allow us to service a larger customer base, Tore.

[Tore Svanberg:]

Very good. And you talked about sampling a DSP to your lead DCI customer now. Could you also elaborate a little bit about that? It sounds like it's going to be more revenues in 2018 but for what specific application is that? And any comment on the size of that opportunity?

[Ford G. Tamer:]

Tore, this is an ASIC we're doing for a cloud DCI customer. We're not at liberty to discuss the magnitude or timing of their ramp, but we are very committed to make that customer successful and it's a major part of the revenue for that coherent DSP product line.

[Tore Svanberg:]

Very good. And last question from me, and Ford, you mentioned you expect to be at a $2 billion SAM by 2019. What sort of ambition do you have there on the share of that SAM by 2019?

[Ford G. Tamer:]

Fifty percent should work, Tore. Just kidding. It's maybe one-third. One-third would be a good target.

[Tore Svanberg:]

Great. Very good. Congratulations again, guys. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Richard Shannon with Craig-Hallum. Your line is open. Please go ahead.

[Richard Cutts Shannon:]

Thanks, guys, for taking my questions. And Ford, curious why you're not aiming for higher than 50% share. I say that in jest. But anyway, thanks for taking my questions. I guess my first question is it seems like you're doing an excellent job of gaining share with drivers. Obviously having the linear product available in the market earlier seemed to be a big part of that. Do you see any headwinds to those share gains? Are they sustainable for a while? Any discussion you could provide about that would be great to hear.

[Ford G. Tamer:]

Obviously growing 100% year-on-year is going to get much harder, Richard. So I think we are expecting to fall back in line along the growth of the whole core communication business. So we're probably more along the line of that 42% to 46% growth, excluding ColorZ. So if you exclude ColorZ you could see our TIA, driver and optical PHY would grow even less than that. We're not breaking it out, but it's a number under that number.

[Richard Cutts Shannon:]

Okay. Fair enough. I think you called out PAM4 – non-ColorZ PAM4 to maybe start to inflect in the second half of the year calling out I think you said 440 Gig products specifically, how do you see your timing of entrance into that market relative to competition? Any thoughts about what your share will be kind of starting out of the gate with those products?

[Ford G. Tamer:]

Yes. As some of you know who've been joining our conference calls for a few quarters now, these things take a long time. So we started sampling that PAM product a few years ago. We call this our gen 1, gen 2 PAM product. It's 100 Gigabit PAM product, but people are also using it for 40 Gig as well as putting it into multichip module for 400 Gig. And so that's what we're seeing going to revenue first in that second half of the year. We're also now about to sample a 200 Gig product. And we're currently developing a 400 Gig product. So we'll have a full portfolio of PAM products from 100 to 200 to 400. And we see the 200 starting to go to prototype, let's say, end of – prototype type of revenue end of this year. And then really reproduction revenue mid next year with the 400 Gig to follow. So that's the kind of time line, Richard.

[Richard Cutts Shannon:]

Okay. Fair enough. And, Ford, did I hear you mention enterprise type of products? I might've missed this, I was typing furiously. But if you did, if any details you can offer on that, that'd be great.

[Ford G. Tamer:]

Yeah. We did say that the enterprise would constitute a leg in that stool, if you wish, and we expect that to start going to contribute to revenue in the 2018 timeframe as enterprise starts going to 25 Gigabit I/O. So as they go to 25 Gigabit I/O, the uptake would have to go to 100 Gigabit, which will open up a opportunity for Inphi 100 Gigabit products.

[Richard Cutts Shannon:]

Okay, perfect. That's helpful. And one last quick question from me for John. John, I think you mentioned TIA and driver revenues in telecom were roughly the same. You've called out PHYs doing well in the optical side originally. Any way that you can help us scale the difference between those three product lines?

[John S. Edmunds:]

TIAs and drivers are probably about 75% of the core communication and the HSC tends to be about 25% of that.

[Richard Cutts Shannon:]

Got it. Perfect. Okay. That's all the questions from me, guys. Congratulations. Keep up the great work.

[John S. Edmunds:]

Thanks, Richard.

[Operator:]

Thank you. And our next question comes from the line of Joe Moore with Morgan Stanley. Your line is open. Please go ahead.

[Joe L. Moore:]

Great. Thank you. I wonder when you talk about having constraints on your growth that kind of get relieved over the course of the year, I guess sometimes we've seen that with companies grow at this rate that there is a digestion period as you catch up. What's your confidence that that doesn't happen, sort of your sense of customer inventories at this point?

[John S. Edmunds:]

Well, we have had a lot of growth but we try to monitor what customers are taking and whether inventory builds up with them. The good thing for us I think also, Joe, is that we're starting to diversify with more products. So as we shift ColorZ this year, as we begin to ship ClariPhy products, it provides more diversity overall so there can be different rates of growth in different parts of the business that we can then manage more effectively over time. So we're trying to run and manage a portfolio overall here. And while we're focused on growing as a company, we want to do that in the right way with our customers and with good quality. So that's our approach to it.

[Joe L. Moore:]

Okay, great. Thank you. And then on the PAM chip opportunity, as you've said, that's taken a little while to ramp. What's the competitive dynamic there? And as the timeframe shifts out in time, do you see the sort of different approaches whether it's single laser or other approaches becoming more viable as time goes by to handle that sort of inside the data center opportunity?

[Ford G. Tamer:]

Yes. So I think the dynamics are going to be very different in the second half of this year. The dynamic on the first generation of PAM product for us and other PAM product supplier has been that PAM was competing, if you wish, with NRZ product. So it's a zero-one limiting type of product, 4 by 25 Gig, versus the PAM being 2 by 50 Gig. And the switchers had NRZ interfaces coming out of them. What's going to be different this time is that in the third quarter of this year, you're going to start seeing switch products coming out with PAM interfaces, okay? And as you start seeing switch products coming out with PAM interfaces, then it makes sense for the modules to go back. So that's the big difference this time. I think there is no more discussion on PAM versus no PAM. It's all going to be PAM. There is a bit of a debate on a 200 versus 400, two lambda versus one lambda. But we're going to stay out of those discussions and support both. So we will have products for both two lambda 200 Gig and one lambda 400 Gig. And support both set of customers in that arena.

[Joe L. Moore:]

Great. Thank you very much.

[Operator:]

Thank you. And I'm showing no further questions at this time. And I would like to turn the conference back over to John Edmunds for any closing remarks.

[John S. Edmunds:]

Great. Ford and I would like to thank you all for joining us today, Deborah as well. And we'd like to let you know that we're planning on sending the Morgan Stanley Conference in San Francisco on March 2 to the Palace Hotel and the ROTH Conference in Los Angeles on March 13. We'll also be at OFC. And we'll be happy to visit with investors there if you happen to come by the booth. So we look forward to meeting with you guys again in the future. And we thank you for joining us today.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone have a great day.