Inphi Corp
Q3 2017 Earnings Call Transcript

Published: 1 Nov 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to Inphi's Third Quarter 2017 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 follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. John Edmunds.

[John Edmunds:]

Thank you, Aiala. Good afternoon, everyone. Thank you for joining us today to discuss the financial results for the third quarter of 2017. I'm John Edmunds, Chief Financial Officer; and with me today is Ford Tamer, our Chief Executive Officer. I will begin with the Safe Harbor and then, Ford will give you an overview of our business. After that, I will provide a financial summary of Q3 and then the outlook for the fourth quarter of 2017. Then, we'll be happy to take your questions. Begin with the Safe Harbor, 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, our customers, 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. You may notice that we are reporting, based on continuing operations to reflect our Q3 2016 sale of our memory interface business. This is being done in accordance with the GAAP rules for reporting discontinued operations. In general, the numbers we refer to in the conference call will be for continuing operations. Now, to begin our review of the quarter, let me turn the call over to our CEO, Ford Tamer. Ford?

[Ford Tamer:]

Thanks, John, and good afternoon. Thank you for joining us today. We appreciate your time and continued interest in Inphi. I am again pleased to announce that we delivered a solid quarter in line with our forecast and your expectations. In the third quarter of 2017, we generated revenue of $84.5 million, a small sequential increase over our June 2017 revenue of $84.4 million and 19.5% increase over to $70.8 million were reported in Q3 of 2016. This quarter non-GAAP net income of $17.3 million exceeded the consensus expectation of $17.1 million, even though we are continuing to invest heavily in our coherent DSP from the ClariPhy acquisition. On a non-GAAP basis, we earned $0.36 per diluted common share in Q3 2017, a 2.9% increase over our Q2 2017 EPS of $0.35 per share. We are especially pleased with this outcome in spite of the fact that China spend on long haul and metro optical continues to be weak. We see no change positive or negative as compared to last quarter. We expect the driver and optical PHY inventories to be depleted in Q4 and the TiA inventory to be depleted in Q1. We are encouraged by the Belt and the Road program being adopted as part of China's constitution at the 19 National People's Congress. The belt and the road is an ambitious program to build broadband infrastructure linking China which its neighbors and many geographies beyond its borders. Various industry watchers have reported that this could result an increased orders from Chinese telecom service provider and original equipment manufacturers to component and subsystem suppliers like Inphi. We also see the recent China Unicom 100 gigabit tender as a positive. However, the timing of the turnaround remains uncertain and visibility remains limited. To provide more balance, we continue to diversify our business by growing our revenue with cloud providers. Q3 was another record quarter for COLORZ, exceeding 10,000 unit shipments end of the quarter. As you recall, COLORZ is Inphi's DWDM solution for 80 kilometer DCI edge. Microsoft highlighted the COLORZ solution as part of the regional gateway architecture at the latest as your Ignite conference in Orlando, in late September. COLORZ is now supporting live customer traffic and cloud data centers across four continents. The latency, scale, performance, power, CapEx and OpEx benefits of COLORZ are now proven across the words largest big data sets. We continue to be on track with our second COLORZ customer go into production in Q4 of this year and ramp into volume in Q1 of next year. In Q3, we completed our annual strategic plan and feel confident that Inphi’s vision to be the leader and after electronic components for cloud and service provider is on track. Our design win funnel points to strong revenue and EPS growth at the various products that we have been working on go to volume production at the end of 2018. To give you a flavor of the new products, I will highlight the announcement we made at the European Conference on Optical Communication or ECOC in September in Gothenburg, Sweden. We were busy in the three markets we serve, long haul metro between data centers and inside data centers. Starting with the long haul metro market, we introduce our M200 coherent DSP for low power, high performance, 100 gigabit and 200 gigabit per second applications. This is the first 16 nanometer DSP from our ClariPhy acquisition, M200 deliveries best-in-class performance while enabling the high density for CFP and CFP2 DCO coherent modules, as well as line card for CFP2 ACO architectures. M200 raises the performance bar, such as allowing traffic to pass through 20 consecutive Reconfigurable Optical Add-Drop Multiplexers or ROADMs in a telecom network, a key metric for success for the China service provider market. We have sampled M200 to many OEMs and module partners and expect their solutions to become available by end of 2017. In addition, the coherent DSP team had a system OEM customer got to production, it was a custom coherent ASIC which the customer has targeted to ramp to volume in Q4 and throughout 2018. Also in the long haul metro market, we have secured over 12 design wins and are continuing our progress towards production of course 45 and 64 gigabit TiA and driver product families. We have over 15 TiA and driver products currently at various stages of development, which positions us to maintain our market leadership in 2018 and beyond. And we are continuing to receive each score on quality from our Tier 1 customers, who perceive and try as the gold standard. Now on to our solutions for moving data between data centers, at ECOC show, we announced and generated significant momentum for our new COLORZ-Lite DWDM solution for campus networks up to 20 kilometer distances. As we told you earlier, the first member of the COLORZ family was designed as a DCI edge solution to accelerate data movement for regional networks up to 80 kilometers. Now COLORZ-Lite allows increased capacity on existing fiber between buildings on the same campus to carry up to 3.2 terabit of bandwidth for fiber up to 20 kilometers. This is achieved by multiplexing 32 wavelengths on the same fiber using Inphi’s DWDM solution and a partner line system. This is over 32 more times bandwidth then is possible and was current 100 gigabit solutions today and it keeps our customers from having to big trenches to layout new fibers. Along with the cost optimize, COLORZ-Lite solution, we announced a new partnership with II-VI for Campus Optimized Line Systems. COLORZ-Lite has been sampling and going through test and qualifications for several months and we expect to begin ramping into production with customers in late Q4. Finally, also at ECOC, we made two important announcements in our third market interconnects within the datacenter. First, in the lead up to the show, we announced Vega our 16-nanometer PAM4 DSP Retimer for Cloud and Enterprise datacenters. Vega is our newest family of 50, 100, 200 and 400 gigabit per second Gearbox and Retimer DSPs for system line cards. Vega announced system OEMs, who are building switches and routers to bridge the system line cards to multi-rate optical modules from 50 to 400 gigabit further evidenced of our Inphi’s helping the industry move to terabit cloud optical interconnects. Second, we announced the expansion of our Polaris 50 gigabit per second PAM DSP for next-gen 50, 100, 200 and 400 gigabit per second deployments. This lounge featured and integrated EML and VCSEL Driver along with the companion linear TiA to continue to drive our performance, while driving down those power and cost. We have Cloud and HPC customers building Polaris-based 200 and 400 gigabit PAM modules for deployments starting in the first half of 2018. Also in Q3, we secured over 30 design wins for our PAM DSP inside optical modules and over 10 design wins for our PAM Retimer online cards. Also in Q3, we received new customer awards for technology innovation and quality. As you can see, it was a very strong quarter from a product announcement standpoint. We look forward to the impact these new products would have on our future quarterly earnings and our growing footprint in the market. Now let me turn the call over to John for a deeper discussion of our financial results in Q3 and our current outlook for Q4. John?

[John Edmunds:]

Thanks Ford. Now, let me recap the financial results. In the third quarter of 2017, Inphi reported revenues of $84.5 million. Revenues were up 19% year-over-year and up sequentially 0.1% from Q2. Of the 19% year-over-year growth approximately 10% was organic. If you are comparing our numbers to consensus, please note one broker on first call has not updated his numbers in over six months, since the previous analyst left the firm, who originally expected $92 million in revenue for Q3. Core communications products such as amplifiers, drivers, 10-gig, 40-gig and 100-gig optical timer products, coherent DSP and COLORZ continue at 83.2% of total revenue, which was down about $0.5 million compared to the 83.9% of revenue, the core represented in Q2. The revenue from datacenter products including COLORZ and optical PHYs were up sequentially by mid single-digit millions of dollars. However, long haul and metro components including the coherent DSP declined sequentially by a similar amount and so essentially offset the growth in datacenter. The transport and legacy products were 17% of revenues or up about $0.5 million from the 16% revenues reported in Q2, but are expected to decline again in Q4. Due to promotional end-of-life programs, we now expect transport and legacy revenues to grow by about 5% this year as opposed to previous years when the business had declined. We also expect transport and legacy to revert to a declining trend line again in 2018. Gross margins on a non-GAAP basis in Q3 came in at 71.4%, which as expected – was up approximately 110 basis points from the 70.3% posted in Q2. This improvement was primarily due to mix of product, including more dye-based amplifiers shipping as part of the overall mix. In Q4 2017, we expect the gross margins to be down approximately 10 to 50 basis points based on a slightly less favorable mix of products. All in all, we estimate non-GAAP gross margins for Q4 to be in the range of 70.6% to 71.6%. GAAP gross margins were 49.8% in Q3, but include purchase accounting adjustments and stock compensation, which when excluded bring the non-GAAP gross margin up to 71.4% for Q3. Please see the reconciliation in the press release for more detail. Q3 GAAP net loss from continuing operations was $48.8 million, including a write-down on previously capitalized ClariPhy intangibles of $36.7 million. This adjustment came about due to a Q3 post-acquisition change in the ClariPhy product roadmap. When we deducted $36.7 million that leaves a GAAP net loss of $12.1 million, we then add back standard adjustments of $27.9 million of certain GAAP expenditures to arrive at non-GAAP net income of $15.8 million for the third quarter of 2017. The $27.9 million of adjustments compares to $30.6 million for the same adjustments in Q2. These are primarily for stock compensation, purchase accounting, related to acquisitions, and debt cost amortization as well as the related income tax effects of these adjustments. Please see the reconciliation in the press release for more detail. The non-GAAP net income of $15.8 million for Q3 2017 compares to non-GAAP net income of $15.6 million in Q2 2017. Now let's look at the remaining components of non-GAAP reporting that led to the Q3 non-GAAP result. Non-GAAP operating expense for Q3 totaled $43.1 million which was up $1.3 million from Q2s $41.8 million. Q2 benefited from a $3 million NRE fee which was reflected as an expense to offset. So when we adjust for this, it tells you that our operating spending other than the NRE offset was down approximately $1.7 million in Q3 as compared to the Q2 levels. Overall in Q3, we were able to deliver non-GAAP operating margin of $17.3 million or 20.5%. This was down 0.3% from the 20.8% we recorded in Q2 due to slightly higher operating expense. Year-over-year, the non-GAAP operating margins of 20.5% in Q3 of 2017 were down from the 29.6% posted in Q3 of 2016. Organically, the Company would have reported about 27% operating margin or $20.8 million on 10% higher revenue in Q3 of 2017 This $20.8 million in operating margin in Q3 of 2017 was virtually the same as the $20.9 million posted in Q3 of 2016. Then the remaining $3.5 million difference to get to $17.3 million in Q3 2017, non-GAAP operating income represents the net ongoing P&L investment for the cost to complete the new metro-based coherent DSP products as part of the ClariPhy acquisition. Interest income totaled $1.1 million in the quarter, which offset the cash costs of the convertible debt of $1.2 million. Making the net carry cost of the convertible debt about 100,000 for the quarter, the convertible debt was blended – has a blended annual coupon rate of 0.972%. We brought the non-GAAP effective tax rate down slightly for the year to 8%, which means we benefited from using the cash up rate of 7.6% in the quarter, leading us to book $1.3 million for Q3 non-GAAP tax provision. We are confident that an 8% rate is sustainable for the balance of 2017 and as far as we can see for 2018 as well. The GAAP income tax expense was $10.2 million tax benefit against the pretax loss of $58.9 million. If we remove the IPR&D write-down and we had a tax charge of 135,000 against a loss of $11.9 million. The charge is because we are a taxpayer in Singapore, but have losses in the U.S. and a full valuation allowance for book in the U.S., meaning we cannot as yet recognize the potential U.S. tax benefits for book. We are currently forecasting the GAAP rate for the year to be roughly a negative 3.4%. However, this rate generally changes as we move through the year. Cash income taxes paid in Q3 2017 was $1.8 million or $2.1 million paid year-to-date primarily in Singapore, up from the 43,000 paid in Q3 of 2016 or 226,000 paid year-to-date at the end of Q3 2016. Non-GAAP net income for the third quarter of 2017 was $15.8 million or $0.36 per diluted share, which was up sequentially from the $15.6 million or $0.35 per diluted share we reported in Q2. Year-over-year, a $15.8 million and $0.36 compared to $20.6 million or $0.46 for Q3 2016. The difference is due almost entirely to a higher net investment in coherent DSP development due to the acquisition of ClariPhy. Now turning to the balance sheet. Overall, cash was $405 million, up $24 million from the June 30 balance of $381 million. We had cash flow from operations of $18.6 million in Q3, compared to $11.1 million in Q2 and compared to $25.6 million in Q3 one year-ago. The $7.5 million sequential increase in cash flow from operations from Q2 to Q3 comes from more income including income related adjustments, representing 49% in total, while the other 51% is from being relatively more efficient with working capital in Q3. DSO expanded from 67 days at the end of June to 77 days at the end of September, due primarily to a miscommunication from a large customer and their integrator. Those problems have now been resolved and so since the end of the quarter, we have collected over $11 million or nearly 80% of the particular receivables that cause the DSO to be over 60 days, inventory, after removing a step-up in inventory purchase accounting adjustment increased by $0.5 million in the quarter. As a result, inventory days excluding the respective step up adjustments was 119 days at the end of June and 125 days at the end of September. Although this is higher than the 80 days I typically like to carry about half of the delta is due to the strategic buys where we have bought ahead for specific supply chain reasons, we have analyzed the other half in anticipate that these will be consumed over time. Capital expenditures were $12.6 million in the quarter, approximately 63% of which was for 216 nanometer tape-outs in Q3 totaling about $8 million. We also had separate additional payments of $3.3 million for software royalties and IP licenses used for development. We also received $10.7 million in cash from the escrow related to the sale of the memory interface business to ramp us. Now let me recap the business outlook for Q4 2017. I remind everyone again that the following statements are based on current expectations as of today and include forward looking statements. Actual results may differ materially. We do not plan to update nor do we take on any obligation to update this outlook in the future. Revenue is forecasted to be up approximately $2 million, in Q4 plus or minus $2 million or $86.3 million plus or minus, 2.3%. We anticipate this will result in total Q4 revenue in a range of between $84.3 and $88.3 million. We expect non-GAAP gross margins to be in a range of 70.6% to 71.6%. We expect non-GAAP operating expense to be in a range of $43.3 to $44.3 million. We are currently estimating the non-GAAP effective tax rate to be 8% for Q4 of 2017. We are confident these components should then align resulting in a non-GAAP operating margin in the range of 19.2% to 21.4%. This should also lead to non-GAAP net income between $14.7 million and $17.2 million, which on approximately $44.3 million estimated diluted shares would result an estimated non-GAAP earnings per share of between $0.33 and $0.39. For GAAP reporting for Q4, we expected GAAP gross margins of 59.9% to 61.4%, stock-based compensation expense to be approximately $12.3 million. Purchase accounting related adjustments of approximately $11.7 million. Acquisition related expenses of $0.7 million and non-cash amortization of debt expense of $6.25 million. Finally, these GAAP adjustments should also generate additional tax benefits for GAAP of approximately $1.2 million. This would imply a GAAP net loss in the range of $11.9 million to $14.4 million. GAAP earnings per share would then be a loss in the range of $0.28 to $0.34 per basic share and $42.7 million forecasted basic shares. A more complete reconciliation of the Q4 GAAP net income forecast is attached to the last page of the press release. We will now update this outlook during the quarter and so a time of the next quarterly earnings release, and unless Inphi publishes a notice stating otherwise. So please ask any questions you may have today during the general Q&A period. And now we would be happy to take your questions. Aiala?

[Operator:]

[Operator Instructions] Our first question is from Quinn Bolton with Needham & Company. Your line is now open.

[Quinn Bolton:]

Hey, guys congratulations. I wanted to start with COLORZ that seems to continue to drive some of the near-term growth in the business. Ford, I think last quarter you said that you had shift cumulatively 10,000 units since the beginning of the ramp back in Q4 2016. This quarter you shipped 10,000 in a single quarter. So are we looking at COLORZ now probably up in the upper teens in terms of revenue contribution in the quarter?

[Ford Tamer:]

So we went from 10,000 shipped in six months to 10,000 shipped in the quarters. So COLORZ contribution is significant now as part of our overall revenue growth.

[Quinn Bolton:]

Okay. And second question of COLORZ, you’ve talked about the second customer for COLORZ on track for Q4 and then in your commentary around COLORZ-Lite, you said that that product was also on track for a late Q4 shipment. Wondering if those are the same things or is the second customer are you distinguishing between COLORZ and COLORZ-Lite. So you can have a second customer on COLORZ and additional customer on COLORZ both ramping in the fourth quarter. Just trying to clarify that whether COLORZ and COLORZ-Lite are sort of viewed as the same or different products?

[Ford Tamer:]

We do view COLORZ and COLORZ-Lite as the same product timely. So we haven't disclosed whether that second customer as a COLORZ or COLORZ-Lite customer Quinn. But we would view it as the same. So it's very possible to second customer to be a COLORZ-Lite customer.

[Quinn Bolton:]

Understand. And then lastly just it looks like you guys have some pretty nice design wins in the third quarter for Vega and Polaris. Can you give us some sense when you start to see meaningful revenue contribution from those products? Is that kind of a first half of 2018 timing?

[Ford Tamer:]

Good question, Quinn. So we have received quite a few design wins within the quarter for Vega and Polaris as well as announced a new plan products there we're working on. And we expect Polaris and Vega to ship in the first half of 2018 driven by – in the case of Polaris driven by both Cloud and HPC customers. They are building 200 gigabit and 400 gigabit modules using our 50 gigabit PAM solution. So that should be well ahead of any other PAM solution in the market. So we do believe Polaris will ship first and the leader in getting Cloud and HPC customers to market. Vega will also ship in the first half of 2018 along with an enterprise system OEM customer, who is designing Vega on its line cards in their systems along with their switch. And so we're also quite excited about Vega because Vega is getting tremendous market share and that sort of system OEM customer base and that again should ship in the first half 2018. And then we do expect our unannounced PAM product to sort of be a larger contributor to revenue starting in the late 2018. So that's sort of the rollout of the different products through 2018.

[Quinn Bolton:]

Thank you, Ford.

[Operator:]

Our next question is from Vivek Arya with Bank of America Merrill Lynch. Your line is now open.

[Vivek Arya:]

Thank you for taking my question. I think Ford, China was roughly 27%, 28% of sales in Q2. I'm curious how large was the contribution in Q3 and if you have a sense for how much it's tracking in Q4? And I think the part B of that question is that you alluded to still some incremental inventory adjustment I think on the TiA side that could take until Q1, so how should we think about Q1 seasonality? So just China contribution and then Q1 seasonality.

[John Edmunds:]

Vivek, this is John. I don't have the exact China shipments in front of me for Q3, but they would have been down a little bit relative to Q2. And with the China Congress going on, I guess tend to understand that there will be yet a little softer in Q4. We do expect them to bottom out and hopefully improve in Q1, but we don't have a lot of visibility yet to know that that's going to be the case. So that's kind of where we are and what we're working with there. There is good news as Ford pointed out on tender offers and so we do expect plus or minus people trying to manage their inventory at the year end that people will be investing in a growth cycle again next year.

[Vivek Arya:]

And then secondly, when I think longer term right, you're getting very good growth from the COLORZ product. What is the long-term strategy because obviously selling modules drives good sales, but then explicit view somewhat to customer concentration and then some other volatility. What is the strategy longer-term for this business?

[John Edmunds:]

So at the last quarterly earnings call, we did discuss the fact that Inphi was chosen as the forward error correction standard of choice by the Optical Interconnect Forum or OIF for 400 Gigabaud. So the COLORZ roadmap which today is 100-gigbit per second and then move to a standard-based OIF standard for 400-gigabit and we expect those products to start making a meaningful contribution to revenue in the late 2019 timeframe. They will sample in early 2019 and then make contribution to revenue in the late 2019 timeframe. So there's a whole roadmap to COLORZ going from 100-gigabit to 400-gigabit and there is other parts of the product family as you could see we went from COLORZ to COLORZ-Lite. We've got other variants of COLORZ that we're working on that haven't yet been announced and we're finding unification of COLORZ everyday. So we do expect this to be a significant part of our revenue between datacenters moving forward into the future.

[Vivek Arya:]

Got it. And just lastly, as you rollout COLORZ how do you think about just the interplay on the gross margin side. Because I would imagine that selling more modules there's probably a little bit of pressure, but the growth that I think you're expecting from ClariPhy that should hopefully offset this gross margin impression. So is this still reasonable to assume that gross margins can sort out this best-in-class 70%, 71% plus over the next few years?

[John Edmunds:]

As you could see, Vivek COLORZ is a significant part of our revenue now in Q3 and our gross margins are doing well. So as you could see COLORZ actually cannot be too far from corporate averages given the gross margin doing quite well. So we do not expect COLORZ to be a drag on the gross margin in a meaningful way.

[Vivek Arya:]

Thank you.

[Operator:]

Our next question is from Joseph Moore with Morgan Stanley. Your line is now open.

[Vinayak Rao:]

Hi. This is Vinayak calling in for Joe. Given that like understanding this lot, not a lot of visibility in your China business. Can you touch upon what demand trends you are seeing for the long haul metro business outside China and how was that business in Q3 and what's the expectation in Q4?

[Ford Tamer:]

Hi, Vinayak. This is Ford. So we do have a new corporate presentation that has been uploaded and we have revised our numbers for the long haul and metro port. So I would refer you to the corporate presentation and we've got a section on long haul and metro and this is Slide number 18 in our corporate presentation. What we've done is we've taken down the number based on the latest Cignal AI and company estimate forecast. So you could see that we now have a number for 2017 of 301 key ports growing to 376 key ports by 2018. So we’ve tempered those numbers down, but as you could see, we still are positive on over 20% growth from 2017 to 2018. Okay. And so the answer to your question on China. First in China, we do believe that again the belt and road being added to the constitution in China is a positive that should result and hopefully better news starting Q1. And as far as non-China, we still see the deployments of our customers along with Verizon, AT&T deployments are continuing, but overall with tempered expectation for 2017, you could see here about a 10% growth only from 2016 to 2017 number of coherent port getting back to a 20% growth from 2017 to 2018.

[Vinayak Rao:]

Got it. From a follow-up, I just want to touch upon the ClariPhy business. Can you provide an update like how is the business trending related to your expectation and also touch upon the competitive environment there because you expect to see growth in 2018, so how do you see yourself position next year in coherent DSPs?

[John Edmunds:]

Good question Vinayak. So we are positive on the latest M200 product. Continuing with ClariPhy heritage of high performance as you could see from my prepared comment, we do believe that the performance of that M200 DSP is second to none, especially as it gets to long haul type of performance, I did discuss crossing 20 ROADMs being a pretty big milestone that that you need to go capture share in the China market. We currently have a significant number of customers about half a dozen system OEM and module makers that are finalizing their solution to come to market end of this year and that should drive the growth from 2017 to 2018 for us. Those wins are pretty solid. They in some cases have customer IP into some of these basics, and so it's very difficult for these wins to be displaced. So we believe these wins a pretty solid was marquee names in Europe, China and the U.S. So we've got some strong Tier 1 design wins that should help drive the growth from 2017 to 2018. And then as you can see from John's discussion of impairment, what we did is we actually changed the roadmap in ways to be more competitive. So we had – the ClariPhy acquisition had a certain product on the roadmap. That in our view was probably behind and we did because continued development of that product to leapfrog and put the roadmap ahead, and so we are excited about where the new roadmap can take us and we'll be able to discuss it in due time.

[Vinayak Rao:]

Got it, very helpful.

[Operator:]

Our next question is from Tore Svanberg with Stifel. Your line is now open.

[Tore Svanberg:]

Yes, thank you. Few questions, first of all back to COLORZ. So with COLORZ-Lite now, can you just give us a sense for the total market and I know you kind of look at the product, but we look at COLORZ versus COLORZ-Lite. How much Vega does the market get with the Lite version.

[Ford Tamer:]

Tory, this is Ford. Very good question. So the market is quite larger it’s simple reason is on the COLORZ transition, as discussed in my prior comments, the OEMs and the cloud providers are getting ready now to go to a 12.8 terabits switch generation and that 12.8 terabit switch generation, which the switch it should be available in 2018 is going to require 400-gig modules to go along with it, 200-gig and 400-gig modules. So the COLORZ-Lite would then as far as finding new customers, the new customers for COLORZ would be a bit more challenging given for 400-gig is going to come around the corner. So we still are making good progress with some customers on COLORZ. But the life of that generation will be shorter. On the other hand for campus that problem doesn't go away and we are finding a lot more customers now for COLORZ-Lite and believe the COLORZ-Lite is significant market expansion in both U.S. and China and fiber starved environment. So the COLORZ benefits are tremendous, but if you look at the COLORZ-Lite benefit is even better because the fundamental issue is fiber exhaust situation, where you're getting to capacity a fiber being exhausted in campus reputation, where people are migrating 200-gigabit and beyond. And so the alternative here is to dig trenches to lay out new fiber or to put COLORZ-Lite to put 32 times more bandwidth in that same fiber. So that COLORZ-Lite application I think is going to be a very strong market expansion.

[Tore Svanberg:]

That's right, helpful. And just that atrocity as we look at 2018 and as you start to get revenue from Vega and Polaris. How will you report that so far you've been reporting your core business, I'm just wondering will you include those products on the core or will you start sort of offering a separate reporting unit for us.

[John Edmunds:]

Those who will continue I think as part of the core really as data center types of products.

[Tore Svanberg:]

Okay, so with that then John. I know in the past you kind of given us what you expect core growth to be I guess at this point given Vega and Polaris, you are expecting nice growth in your core business in 2018?

[John Edmunds:]

Yes. I think again the [indiscernible] the legacy and transfer business will decline and we think 15% to 20% decline, assumption is reasonable there and we do expect to grow as a company next year in the 15% to 20% sort of range. So that's roughly where the Streets put us right now. So the difference in those two numbers are going to drive core growth.

[Tore Svanberg:]

Very good, that’s helpful. Just one last question on ClariPhy, so when should we start to see the first revenue from the M200 product and when do you expect to sample the 7-nanometer offering?

[John Edmunds:]

So the 16-nanometer revenue will start in Q4 based on sampling quantity, so I think the sampling quantities are the supply of the customer to start the validation and quantification of their systems. And we expect those systems to go in production in the second half of 2018 and we expect the 7-nanometer to be a 2019 product and ramp Tore.

[Tore Svanberg:]

Very helpful and congratulations on the execution. Thank you.

[Operator:]

Our next question is from Ross Seymore with Deutsche Bank. Your line is now open.

[Ross Seymore:]

Hi, guys. Thanks for allowing me ask the question. Congrats on the solid execution as well. The first question, Ford I know you don't have a ton of visibility in China, but just conceptually, I think you talked in prior quarters about your core business in TiAs drivers optical PHYs et cetera being over 60% of your revenues in early parts of this year and that fell precipitously because the demand and inventory that everybody knows about. If we think going forward, is there any reason to think that the new demand trend will eventually get back to the same level as it was? Would it be higher? Would it be lower? Any sort of kind of conceptual discussion on where you think that can get to would be helpful?

[John Edmunds:]

Ross, this is John. I think you heard Ford talk in his speech about the potential for growth and [indiscernible] drivers at this 20% sort of level for next year in 2018. And so I think that's kind of a mid range recovery. Don't know that we will get back to the levels in the back half of 2016 because quite frankly those numbers may have been inflated for system companies in China stockpiling at the time. But I do think in the driver business, is recovering about to the early part of 2016 stage and then the amplifiers taken a little longer because the inventories are spread a little bit more through the module supply chain. But we do think there will be a recovery next year and should be something in the range of 20% or so.

[Ross Seymore:]

My next question, switching gears over to the COLORZ side of things, Ford, you talked about some of the dynamics between COLORZ and COLORZ-Lite just to one of the prior questions. Can you just talk about it from a customer point of view, is that the primary growth that you expect to come in 2018 more from new customers and is your core customer likely to grow that here as well or some of those COLORZ versus COLORZ-Lite dynamics going to come in and potentially weigh on the first core customer?

[Ford Tamer:]

So in 2018, we expect the first COLORZ customer to continue to grow. And then we expect to introduce new customers for both COLORZ and COLORZ-Lite to come in and help us grow the business beyond that, Ross. We're not going into further details at this point.

[Ross Seymore:]

And my last question is on the ClariPhy side of things, you went into details why you did the write-off an impairment et cetera. Does that change anything about the timing of the revenue ramp? I know you have a lot of new DSP products that you also rattled off, but if we start to think about the dollar contribution that ClariPhy could represent in 2018, has that really changed whether because the new products get you more encouraged about the growth or because the impairment creating a little bit of a haul from that product line that you discontinued?

[Ford Tamer:]

The forecast for ClariPhy has been the same, so as we discussed previously, so we haven't changed our view on ClariPhy. Our view on this impaired product was already baked into the forecast we were given when we were discussing this last quarter. So our view of ClariPhy is still the same.

[Ross Seymore:]

Great. Thanks guys.

[Operator:]

Our next question is from Harlan Sur with JPMorgan. Your line is now open.

[Harlan Sur:]

Good afternoon, guys. And nice job on the quarterly execution. I think in the prepared remarks, you said several inventories expect to work that done this quarter, TiAs inventories work through the next quarter, but let's assume that even without a pick up in the provincials, there already is a current consumption rate by your customers, right, that your business should snap back to ones the inventory burn is complete. So I guess the question is how far below consumption rate are you guys shipping, is it $5 million below consumption, is it $8 million below consumption? Again, just trying to get a sense of where your business should trend to sort of once you finish the inventory burn?

[Ford Tamer:]

Yes. Harlan, we at this point are not predicting a snap back, we're predicting sort of a gradual recovery. Okay, so we have to work our way through the inventory situation on TiA first in Q1. And then we predicting now that business to gradually recover in Q2, Q3 and Q4 of next year. Really the next few weeks are going to be very key to understand the implications of what the best and they are being adopted as part of the constitution means for this new infrastructure spend in China. And so we are cautiously optimistic, but we wait and see to really understand what happens next weeks are going to be very critical.

[Harlan Sur:]

Okay. Appreciate the insights there. So if we assume that we do get a pick up in China metro deployment next year and kind of shifting gears to your coherent DSP. So given that you've got 16-nanometer in the market now assuming China picks up next year, would you be ramping the M200 with multiple customers into China and estimate that coherent DSP combine with your amplifiers and drivers roughly doubles the dollar content for port, am I in the right ballpark?

[Ford Tamer:]

Harlan, you're in the right ballpark, coherent DSP could give us the opportunity to double the dollar purport. Obviously, that would be for merchant silicon. So this would be for ports that are actually open to merchant silicon. There's still a significant part of that coherent market that depends on ASIC, and so that’s more of an internal DSP that’s not available. So even though the dollar purport could double the available number of port is smaller just because you still have a certain number of port that are captive to in ASIC. Does that answer the question or?

[Harlan Sur:]

Yes. That answers the question. And my question before that was if China provisional picks up, are you going to be – is the coherent DSP going to be participating with multiple different customers there?

[Ford Tamer:]

Yes, I'm sorry. So on the China question for coherent DSP, yes we have multiple customers in China they would be participating in the coherent DSP.

[Harlan Sur:]

Okay. Great. And then just my final question on COLORZ. Great sequential growth for this entire year that second customer ramping now. I think you guys have previously said that we've got good confidence ongoing COLORZ at least 50% next year. So I guess the question there is you still feel confident on the 50% growth number for 2018 and more importantly do you guys have the capacity in place to support that kind of growth? Thanks.

[Ford Tamer:]

Harlan, yes we're still confident in a 50% gross year-over-year and yes we will have capacity in place to support that kind of growth. The capacity is being expanded as we speak.

[Harlan Sur:]

Okay. Great. Thanks Ford.

[Operator:]

Our next question is from Brian Alger with ROTH Capital Partners. Your line is now open.

[Brian Alger:]

Great. Thanks for taking my questions. A lot of these have come through, but just on the COLORZ versus COLORZ-Lite question. I'm curious if there's any difference with regards to the revenue outlook and when we looked at the revenue between each datacenter, we kind of looked at the number of ports and how much bandwidth they'd want to connect between the datacenters? How should we think about the revenue comparison between COLORZ-Lite versus the original COLORZ given that there is the campus aspect the 20 kilometer versus 80 kilometer et cetera?

[Ford Tamer:]

Thanks Brian. This is Ford. COLORZ-Lite will be a more cost effective solution because is going after campus applications shorter distances. So that offering does not support the 80 kilometer needed for COLORZ between datacenter, it is more of a 2 to 20 kilometer distance for buildings that are located on the same campus. And so overall, the revenue purport would be lower although the number of ports could be larger, aggregated amongst more – all the customers.

[Brian Alger:]

Okay. And how should we think about it from a margin standpoint? You described earlier that the COLORZ product line is not too far off. The corporate average is COLORZ-Lite going to be in the same ballpark?

[John Edmunds:]

COLORZ-Lite would be a lower margin, given to be a lower price.

[Brian Alger:]

Okay, great. And as we look at kind of the macro picture here, it sounds though the headwinds are pretty well known at this point and maybe abating a little bit here in the fourth quarter. But a number of new products introduced, a number of them starting in Q4, going into Q1, are there any other than just normal seasonality effects? Are there any headwinds that we should be concerned about starting out 2018 or are should we really be looking at this at 2018 has been a year of new of products introductions?

[John Edmunds:]

I mean Brian you're right. The headwinds are understood and we've been pretty open of what they are and you're right 2018 is will be mostly a year of new product introductions. I think we are going to remain careful and on how quickly we ramp those numbers just because it always takes longer to ramp a new technology and then we all would like. So it's just going to take a certain amount of time to see these new products go to production and then ramp to high volume revenue. So it would be a gradual increase throughout 2018.

[Brian Alger:]

Okay. Thanks and congratulations again guys.

[Operator:]

Our next question is from Hans Mosesmann with Rosenblatt Securities. Your line is now open.

[Hans Mosesmann:]

Thanks. Ford most of my questions have been answered, but I do have a question. Have you guys had enough opportunity to discuss pricing or entering any kind of price negotiations with your customers, particularly on the China front? And if not when would you expect those to occur? Thanks.

[Ford Tamer:]

Thanks, Hans. So we get that question a lot, which is lucky given you have inventory do you think you’re going to be in a position, where the customer is going to come back and renegotiate prices with you in their favor and so we do get just question a lot and so far we have seen a pretty supportive environment, where – yes they will come back and try to negotiate, but they’re also understand a modern investment we're making, the mass costs are going higher, [captool] costs are going higher. So as we go to 7-nanometer, the expense of producing a new die gets that much more expensive and the customers we have understand they need to keep a supplier like us in unhealthy financial shape to be able to keep investing. So even though when we have these negotiations on a regular basis and even though – even for a situation could put us in a weaker position. We've seen so far the customer being reasonable as they understand that we have to make the investment to support their needs.

[Hans Mosesmann:]

Okay. And just to clarify to net it all out, yes, you would expect that the price dynamic through next year would be kind of normal in terms of the erosion of existing products and so on.

[Ford Tamer:]

Yes, Hans, you're right. We expect the price erosion to be normal.

[Hans Mosesmann:]

Okay, great. Thank you.

[Operator:]

Our next question is from Delos Elder with Jefferies. Your line is now open.

[Delos Elder:]

Good afternoon and thank you for letting us a question. This is Delos on behalf of Mark. I was curious just few questions on China. I was wondering in the next few weeks, you mentioned would be very crucial. Are there any milestones here like meetings or I guess it's kind of wanted to dig into the timeline for the resumption of growth in China?

[Ford Tamer:]

Delos, this is Ford. Again the next few weeks, how many a few weeks is the question. I think we’re going to be very closed situation. I'm back in China in 10 days from now. I just got back from Taiwan in Japan. So we're in the region on a regular basis and we're very close to the customers. So we're on constant communication with our customers and they're telling us that we should expect more clarity when we visit and then so it's going to be ongoing dialogue. I don't think there is any magic one that says as in, two weeks or four weeks or six weeks, we just turn it being told by customers that they expect clarity in the next few weeks.

[Delos Elder:]

Gotcha, that’s fair. And then just maybe one more philosophically, can you discuss your overall China strategy, your approach to the market and maybe how it's changed over time given how involved they've become in the electronics industry and the semiconductor industry?

[Ford Tamer:]

I think our approach has been and continues to be to produce differentiated high quality products that are going to add value to their customer’s right and to the extent that they can easily do the products themselves then we may not be in the right market. So there has been a differentiated high value-add quality reliable partner to our OEM and module, and cloud customers, and so that we need to do this. So we need to continue to do this. We need to continue to leapfrog. We need to continue to stay ahead to warrant, continue to be a good supplier once when we do becomes a commodity then we're probably in the wrong business. So at this point there's no indication that the products we're doing are commodity, in fact it's becoming harder and harder, it’s becoming more and more expensive. As we go through higher and higher speeds with longer and longer distances and enabling terabit pipes between datacenter, inside datacenter and metro long haul is extremely hard and the problem is only going to get harder. So we don't believe there were enough in a place right now where we're going to be easily displaced, but we will keep watching it and we’ll keep having to run fast and keep doing good offerings and good products.

[Delos Elder:]

Great. And then finally one more. Can you discuss the progress of silicon photonics, your platform there? I assume most of it is related to COLORZ still, I was just curious if you seeing any traction beyond that platform? And also what do you think gives it a competitive advantage compared to other silicon photonics platforms?

[Ford Tamer:]

So we have been very focused on doing silicon photonics in the place where we think it make sense. And at this point, we're doing it between datacenters. Obviously, in both the long haul and metro and inside datacenter, we go partner with a variety of module partners that have their own optics. And so in addition to silicon photonics, we obviously support partners that bring in their VCSEL or DML or EML solutions through the market. So we are – a new transit from that point of view, we are a component supplier that – first and foremost, our mission is to make our customer successful. And so we don't have any big religion on silicon photonics versus DML versus EML versus VCSEL, will support all of the above. And our goal in life is to provide solutions that are going to make our customer successful. So you’ll see our support all of different optics out there and do what's right for customers. And so far we've been only focused on silicon photonics between datacenters.

[Delos Elder:]

Great. Thank you.

[Operator:]

Our next question is from Richard Shannon with Craig-Hallum. Your line is now open.

[Richard Shannon:]

Hi, Ford and John. I just had a couple questions here. I guess the first one is on the M200. Ford, can you help us delineate or understand where you're seeing earlier interest in pick up here, I think you talked about overall pick up there kind of early next year, but the applications between ACO and DCO?

[Ford Tamer:]

Sorry, pick up on which one?

[Richard Shannon:]

I'm wondering which application DCO or ACO are you seeing more pick up relatively sooner and larger for the M200?

[Ford Tamer:]

Okay. So we have a number of customers building DCO with the M200 and we also have customer doing ACO. The DCO probably be predominant to the current ratio on the market is 3

[Richard Shannon:]

Okay, perfect. Thank you. And my last question is related to Polaris. You talked about a number of design wins and I forgot exactly delineated them, but I wonder if you can help us understand what you think your share has been and so far in this early stage of design cycles?

[Ford Tamer:]

Yes. Very good question. So on Polaris again, the application is 50 gigabit PAM and 50 gigabit PAM there really only two vendors ourselves and Broadcom. All the other vendors that are trying to get into this market are working on 100 gigabit PAM. And so we’ve got – as I said announced product we obviously work on 100 gigabit PAM as well and have a fair share of market wins as well in the technology. When it comes to Polaris versus 50 gigabit PAM, we believe we’ve got the predominant share and leading share majority share outside in the market?

[Richard Shannon:]

Okay. Perfect that’s what I was looking for. That’s all my questions guys. Thank you very much.

[Operator:]

And our next question is from Paul Silverstein with Cowen & Company. Your line is now open.

[Fahad Najam:]

Thank you. This is Fahad in for Paul and I do apologize, I have a number of questions. This is the only opportunity I get to ask questions. Can you remind us what’s your revenue from ClariPhy was in the quarter?

[Ford Tamer:]

Fahad, we don’t disclose that number separately.

[Fahad Najam:]

Any reason to say that the trends in ClariPhy revenue this quarter or has been in line essentially with previous performance. And then a clarification did I hear you correctly think saying that you expect ClariPhy revenue in 2018 to essentially double. So this help us understand if I heard that correctly into if that is the case help us the reference double to what?

[Ford Tamer:]

So Fahad, I don’t think we said the revenue would double for ClariPhy in 2018. So further I think we did say in the call that both we had a decline in the long haul business including the amplifiers and drivers, and the coherent DSP.

[Fahad Najam:]

Okay, all right. And then just switching over to Polaris, given that you mentioned is a 50-gig PAM4 solution, is it right to think that you are targeting primarily the 200-gig market with this opportunity and depending on then 400-gig comes in your essentially using this as a hedge against, any perspective delay in 400 you taking up?

[Ford Tamer:]

Good question. This is Ford. So one more topic on the prior question, on the last quarterly earnings we have discussed that the ClariPhy DSP place on the same TiA driver, the same market as a TiA driver meaning coherent and so it was down the same way TiAs driver was down because the number of coherent port were down. Moving on to the Polaris, 50-gigabit PAM question, yes, we are playing in the 200-gigabit, but some customers also building 400-gigabit modules using Polaris and we don't see it as a hedge. We again do not decide. We would support both 50-gigabit and 100-gigabit PAM. And we let our customers decide what makes sense for them. So we're going to be totally neutral on 50-gigabit versus 100-gigabit PAM supporting both solutions. And we have a very good market share for both solution and both flavors. And we support multiple optics partner building modules in that space for both flavors.

[Fahad Najam:]

Got it, appreciate it. And one last question if I may. On the pricing environment both in China and outside, can you provide some commentary; I believe the Chinese have a biannual reset of pricing. So if any recent conversations you have had on pricing there and also current prevailing prices outside of China?

[John Edmunds:]

This is John again. I think we already answered that question for an earlier questioner. We don't expect anything unusual in the Chinese pricing per se, and anything that we wouldn't face any other year. And as far as pricing outside of the environment, we aren’t seen a lot of heavy negotiating on pricing either inside or outside of China. So it's pretty much normal operating conditions for the most part.

[Fahad Najam:]

Appreciate it. Thank you very much.

[John Edmunds:]

Thank you. End of Q&A

[Operator:]

And I’m showing no further questions. I would now like to turn the call back to Mr. Edmunds for any further remarks.

[John Edmunds:]

Thanks, Aiala. We would like to thank you for joining us today and we want to let you know we're attending the Stifel conference in Chicago on Thursday, November 9, the Needham event in New York on November 14, Bank of America Conference in Boston on December 7. Again, Ford and I would like to thank you for joining us and we look forward to speaking with you again in the future.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone have a great.