Inphi Corp
Q2 2018 Earnings Call Transcript

Published: 25 Jul 2018

[Operator:]

Good day, ladies and gentlemen. And welcome to Inphi's Second Quarter 2018 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 may be recorded. I would now like to introduce your host for today's conference, Mr. John Edmunds, Chief Financial Officer. Sir you may begin.

[John Edmunds:]

Thank you, Sabrina. Good afternoon everyone. Thank you for joining us today to discuss the financial results for the second quarter of 2018. I’m John Edmunds, Inphi’s Chief Financial Officer, and with me today is Ford Tamer, our President and Chief Executive Office. I will begin the call with the Safe Harbor, and then Ford will give you an overview of our business. After that I will provide a financial summary of Q2 and the outlook for Q3. Then we will be happy to take your questions. 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 2018 and beyond, the projected growth and size of our markets, our customers, market share, new products and design wins. 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 Web site 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. Now, to begin our review of the quarter, let me turn our call over to our CEO, Ford Tamer. Ford?

[Ford Tamer:]

Thank you for joining us for Inphi's second quarter 2018 earnings update. Let me start with a summary of our results for the quarter. Last quarter we told you that we believe that Q1 will be the bottom of the recent down cycle and that has proved to be accurate. We also said that we expected our long haul and Metro business would bounce back by 50% in Q1, and I’m pleased to tell you that it has approximately doubled. As expected, our COLORZ business was a bit down in Q2. This is in line with our view that although COLORZ would be lumpy between quarters it will be steady on a yearly basis. Overall, we slightly beat our revenue guidance and grew by 16% sequentially with $69.8 million in revenue in Q2. Our revenue guidance for Q3 is $77.5 million and represents 11% sequential increase. This is the second consecutive quarter of double-digit growth. In Q3, we expect our data center business to drive Inphi’s growth fueled by design win ramps for our PAM4 DSP, TIA and driver platform. Also in Q3 we expect our long haul and Metro business to be steady. This demonstrates the continuous strengths of Inphi across multiple business units. We remain positive on our outlook as we continue to introduce new products, grow our in site data center revenue and reengage with the [team] (Ph). On the profit line Q2 did see substantial growth from Q1's non-GAAP operating margin of negative 3.5% to a positive 10.1%. Our guidance would result in an estimated 17.6% non-GAAP operating margin in Q3 at the midpoint. This shows our success in managing operating expenses to be in line with the market environment and our revenue growth. On the bottom-line we also exceed our EPS by $0.02 at $0.15 per share for Q2. We expect the continued strength in revenue combined with continued OpEx management to position us to achieve EPS of $0.29 at the midpoint in Q3. Our forecast reflects the return to stability in the China long haul and metro markets, continued growth of our inside data center business and continued benefit of the restructuring we completed in Q1. We have weathered the previous China storm in the optical market and came out of it and even more robust Company and Inphi’s product innovation continues. Just last quarter, at the Optical Fiber Conference or OFC we announced many new products that are already in final qualification stage at module customers for U.S. cloud applications. So let’s go in the details of each product line. First, for our long haul and metro business Q1 was the bottom. The ZTE ban and trade matters negatively impacted the entire ecosystem resulting in an increase of about one month of excess inventory related to the end of Q1. Keep in mind that the ZTE contribution to our revenue was only supposed to grow to less than 5% of our total revenue. Our Q2 shipment rebounded strongly despite the impact of ZTE ban and customers pushing out some orders. Now, with the ZTE ban lifted, we expect the China market can return to normal. Our module customers have been asked to submit bids to supply components to ZTE and our team is now China discussing the situation with ZTE and many other customers. The market for coherent optics is experiencing rapid technology transition with the availability of a new generation more power, higher performance 16 nanometer-based DSPs. For long haul Inphi’s 32 Gigabaud coherent TIA and driver are in high volume production today and our 16 nanometer DSP would ramp into production later this year. The next growth phase for coherent optics would be in the metro market, due to the increasing demand for bandwidths for video, social networking, cloud services and 5G backhaul. This could potentially be a large opportunity for 100 gig and 200 gig coherent optics for the next few years. Inphi participates in this market with a complete chipset, including 32 Gigabaud and 45 Gigabaud TIA and driver and 15 nanometer DSP. I’m happy to report that our 32 Gigabaud coherent TIAs and drivers continue to be number one in market share, performance and product quality. Our 45 Gigabaud coherent TIAs and drivers are in mass production. And as we previously reported, our 1600 coherent DSP is taking share. We will grow our coherent DSP revenue in the second half of 2018 as existing customers design wins go into volume production. We are also encouraged with the large number of customer design wins for our next generation 64 Gigabaud coherent TIA and driver for 200 gig long-haul, 400 gig metro and 600 gig DCI markets. These products are in customer qualification now and we start ramping in second half 2019. These new design wins and new products should enable us to power through the friction introduced in the China market. We are confident in our Q3 forecast. We are watching the current news to assess any potential impact on our Q4 forecast and 2019 outlook. In addition, we continue to see traffic and demand for bandwidth growing exponentially. Infi continues to grow stronger in the data movement interconnect markets as our differentiated product offerings ramp to production with tier 1 customers. Moving to our data center markets, we are right where we plan to be with the production shipments of the Polaris 200 G and 400 G PAM DSP platforms along with Infi’s associated 28 Gigabaud linear TIA and driver for SR 8, LR8 and AOC applications. We expect sequential increases in revenue here for the next few quarters. In addition, to Porrima 400 GPAM DSP envied last quarter at OFC is on track to ramp by end of this year for DR4 for SR4 applications with Infi companion 56 Gigabaud linear TIA and driver. We have also announced at Porrima 100 gig and PAM DSP variant last week. That is really getting tremendous traction for cloud breakout DR 1 applications. We also continue to capture designers wins with our 200 gig and 400 gig PAM Retimer called Vega for line card applications. We previously announced a reference design win with a partner for the Vega gearbox, that supports up to 128 ports of a 100-gig connecting with existing NRZ-based copper and optics. We expect to make more progress with our PAM product line in late 2018 and also expect a more pronounced ramp in 2019 to continue to diversify our revenue stream. Also in our data center business our COLORZ DCI solution is performing steadily and we expect it to remain so through mid 2020. COLORZ is the first hundred gig DWDM pluggable that fits into a standard chase of port in a data center core switch or router. It is now in the second year of mass production with one of U.S cloud giants exhibiting outstanding quality and field operation. Our next-generation COLORZ solution at 400 gig is also deep and development and getting lots of interest from our customers. As you just heard, we are operating in the sweet spot of where we want to be, in the right markets with the right products at the right time and supporting our tier Q1 customers was our [indiscernible]. We are committed to continue to deliver as we promised. With that, let me turn the call over to John to walk through the financial details. John?

[John Edmunds:]

Thanks, Ford. Now let me recap the financial results, in the second quarter of 2018 Inphi reported revenues of 69.8 million which was down from the 84.4 million posted one year ago in Q2 2017 but up 16% sequentially over Q1 2018. Overall, Q2 was a step in the right direction and we are confident we can continue to grow and recover further as we move through the second half of 2018. Long haul and Metro products, including the coherent DSP represented 50% of the business, increased sequentially by 17.3 million, or nearly double in Q2 versus Q1. This was primarily due to our module customers in this market resuming a more regular pattern of ordering, having generally absorbed excess inventory built up over the four quarters ended in Q1 2018. At the same time, data center products, including COLORZ and Optical PHY business represented 41% of revenues, which was down 4.2 million or 13% sequentially. As we expected COLORZ business was a little bit lumpy or down in the quarter, while the Optical PHY business, including PAM products grew. The legacy transport business, representing 9% was down sequentially 3.4 million. This was expected due to the effect of Q1 being the last quarter to purchase certain older legacy products. The biggest of which was a 10, 100 Ethernet PHY, which were on end-of-life programs. Overall, the business came in slightly higher than expected at 69.8 million. In Q2 the Optical PHY business began to ramp, a few early PAM design wins. As we continue to ship in additional design wins the PAM revenue is expected to continue to grow throughout 2018 and into 2019. Also in Q3, we anticipate shipping approximately 500,000 of product to ZTE based largely on resuming programs that were previously suspended. As a result overall, we are now guiding Q3 revenue to increase by approximately 11% over Q2 to 77.5 million at the midpoint. Gross margins on a non-GAAP basis in Q2 came in at 68.4%, which was right at the midpoint of our guidance. The improvement from Q1 was due to a higher relative mix of amplifiers and other newer products beginning to ship. We expect the gross margins in Q3 to continue to improve by approximately 220 basis points to 70.6% at the midpoint based on a stronger mix of new products, expected to ship in the quarter. All in the non-GAAP gross margins for Q3 are expected to be in the range of 70.2% to 71%. In the back half of 2018, we will be shipping a number of new products with higher gross margins including Inphi's new coherent DSP product, the M200. This improved mix positions us to continue to improve overall gross margins. In Q2 2018 the GAAP gross margins were 56.7%, which was an improvement over Q1 GAAP 54.1%, due primarily to the same reasons as the non-GAAP gross margin improvement elucidated above. The GAAP figure includes purchase accounting adjustments and stock compensation expense. Please see the reconciliations in the press release for more detail. Q2 GAAP net loss was 28.5 million; we then add back adjustments of 33.4 million of certain standard GAAP expenditures. The standard adjustments are for stock compensation, purchase accounting related to acquisitions and convertible debt costs amortization. This quarter, we included a $2.1 million additional GAAP loss which was Inphi's contribution to a larger loss associated with terminated contracts absorbed by ClariPhy’s former shareholders via the merger escrow account. The claims pertaining to engineering fees advanced for a small customer customization products that will later discontinued. There were approximately 0.2 million net of other adjustments from GAAP to non-GAAP. Then we adjust for the associated tax benefit adjustment of 0.7 million to arrive at Q2 non-GAAP net income of 6.6 million. The 33.4 million of standard adjustment in Q2 was 2.7 million higher than the 30.7 million for the same adjustments in Q1. The difference was primarily driven by 1.7 million and higher stock compensation expense in Q2 due to the annual refresh, as well as 0.8 million for repurchase accounting and 0.2 million additional for debt cost amortization. The related income tax effects of these adjustments of a 0.7 million benefit in Q2 compares to an 8.1 million benefit in Q1. The difference was primarily due to a one-time release in evaluation reserves for GAAP that occurred in Q1 that did not recur in Q2. Please see the reconciliation of the press release for more detail. The non-GAAP net income of 6.6 million for Q2 2018 was up from the net loss of 1.97 million reported in Q1 2018. Now let’s look at the remaining components of non-GAAP reporting that led to this Q1 non-GAAP results. Non-GAAP operating expenses for Q2 totaled 40.7 million which was down 1.3 million from the 42 million reported in Q1. We have been reducing our gross operating spend consistently over the last four quarters, including a restructuring late in Q1. However, we believe this process may have bottomed in Q2 and the forecast in Q3, non-GAAP operating spending should be flat to slightly up. Overall non-GAAP operating margin has improved sequentially in Q2 from a loss of 2.1 million or negative 3.5% in Q1 to a positive 7.1 million or positive 10.1% in Q2. More than 85% of this $9.1 million differential is explained by higher revenue and higher gross margins and the other 15% came from operating expense savings. Interest income, net of management fees totaled 1.7 million in the quarter, which more than covered the cash cost of the convertible debt of 1.2 million. The convertible debt has a blended annual coupon rate of 0.972%. Fundamentally, we had other non-operating expense of approximately 0.3 million for the quarter, which is also included on that line. The GAAP income tax expense in Q2 was $58,000. In general we find the ongoing GAAP tax rate which changes throughout the year based on a number of factors to be difficult to forecast. We brought the non-GAAP effective tax rate for Q2 up to 9.8% based on a specific 0.7 million reserve for unrecognized international tax benefits based on an audit letter received in April of 2018 as an offer to settle a particular long-standing dispute. While we currently do not intend to accept that offer we do view it as a floor to an eventual range of settlement and so we book the reserve. This will bring the effective tax rate, including this issue for the balance of 2018 up to 3.6% and will move the 2019 rate to 5.5% unless or until we can settle the dispute in Inphi's favor. Cash income taxes paid in Q2 2018 was $200,000 primarily in Singapore, down from 1.6 million in Q1 of 2018. Now, turning to the balance sheet, overall cash was 384 million at June 30, down 10 million from the 394 million at the end of March, primarily due to income taxes associated with stock we’re holding and ROC investing. We had cash flow from operations of 8.9 million in Q2 as compared to 17.2 million in Q1 and compared to 11.1 million in Q2 one year ago. Cash flow from operations in Q2 was primarily generated by 13.7 million in GAAP net income including add backs offset by a $4.8 million expansion of working capital. Q1 appears to have generated better cash flow than Q2 because of the timing of cash collection in Q1 coming off of bigger Q4. In reality, we were generally more efficient with working capital Q2 than Q1 as evidenced by the lower DSO and inventory days in Q2. However, we will continue to focus on improving our working capital efficiency even as we expand our business going forward. Capital expenditures were 3.2 million in the quarter, down from 14.5 million included in Q1 which had included [max] (Ph) purchases. Free cash flow also improved from 2.7 million in Q1 to 5.7 million in Q2. DSO improved from 73 days at the end of March to 70 days at the end of June. Inventory increased by 0.9 million in the quarter due to changes in mix of inventory shipping. As a result, inventory days excluding the respective step up adjustments was 137 days or 2.6 turns at the end of June, down from 149 days or 2.4 turns at the end of March. Now, let me recap the business outlook for Q3 2018. 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 at the midpoint is forecasted to be up approximately $7.7 million or up 11% sequentially, in Q3, primarily due to strengthening in data center as well as approximately 0.5 million expected from resuming business with ZTE. This would bring revenue to $77.5 million at the midpoint plus or minus $2 million resulting in revenue in a range of between 75.5 million and 79.5 million. We expect non-GAAP gross margins to be in the range of 70.2% to 71%. We expect non-GAAP operating expense to be in the range of 39.9 million to 42.3 million. We are currently estimating the non-GAAP effective tax rate to be 3.6 for Q3 2018. We are confident these components should then align resulting in non-GAAP operating margin in the range of approximately 17.4% to 17.8%. This would also lead to non-GAAP net income of between approximately 12.8 million and 13.8 million. This would result in estimated non-GAAP income per share of between $0.28 and $0.30 based on approximately 45.35 million estimated diluted shares. For GAAP reporting for Q3, we expect a GAAP net loss in the range of 19.5 million to 20.3 million. GAAP earnings per share will then be a loss in the range of $0.44 to $0.46 per basic share on 43.95 million forecasted basic shares. A more complete reconciliation of the forecast for Q3 GAAP net income is included in the last page of the press release. We will not update this outlook during the quarter until the time of the next quarterly earnings release 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.

[Operator:]

[Operator Instructions] And our first question comes from line of Blayne Curtis with Barclays. Your line is now open.

[Unidentified Analyst:]

Hey guys this is [Tom Amoly] (Ph) on for Blayne Curtis, congratulations on the nice results. Can we start out with the Inphi drivers business. You guys had previously mentioned that into September and December, you are expecting some nice growth on the call you kind of described it is steady. Could you give us some color on how you see the business turning for the rest of the year?

[Ford Tamer:]

Hi Tom this is Ford. As we discussed, we see the Longhorn and Metro business to be study for the rest of the year.

[Unidentified Analyst:]

Great. And then the second question, you include a little of ZTE in the guidance of 500,000, you guys had previously talked about coming back to about 5% what do you think the time horizon is for that business coming back and what could we expect maybe for the rest of the year?

[Ford Tamer:]

We expect about 500K in Q3 about 1.5 million in Q4 and about 10 million back next year.

[Unidentified Analyst:]

Great. Thanks guys.

[Operator:]

Thank you and the next question comes from the line of Harlan Sur with JPMorgan. Your line is now open.

[Harlan Sur:]

Good afternoon and congrats on the solid quarterly execution. I think the team has said previously that you expect something close to where the street have you guys modeled, somewhere around 290, 292 four 2018 given the recovery in the core business, given the new program ramp, given the shot recovery Q2, Q3 on revenues and margins, you guys feel pretty comfortable about 290, 292-ish type revenue number from 2018.

[John Edmunds:]

Harlan we are really just guiding one quarter out at a time. Having said that, I don’t think we are uncomfortable with revenue expectations in that range, but arranged the Company is only officially guiding for the third quarter.

[Harlan Sur:]

Got it, okay. Could see the initial ramp of the data center business, you know we have heard that the large cloud guys, especially Google, Amazon and Facebook they have already qualified Tomahawk three and we have also heard that they are starting to place a pretty aggressive preproduction orders. So clearly they wanted to play sooner rather than later. We also saw Juniper launch their 200 and 400-gigs platforms today for second half ram sold. Our mind is it seems like the market is wanting to move more aggressive here, how is this impacting the uptake Inphi, Polaris, Vega and Porrima ramp, I mean just given that you guys have the most mature solution on PAM4, is this driving describing some on PAM4 this year versus your prior expectations?

[Ford Tamer:]

Thank you Harlan. This is Ford, good question. Yes you are right and we do believe there is a desire to grow more aggressively on the inside data center ramp for 200-gig and 400-gig. As you have seen from our remarks, we started to see Polaris with our 200-gig and 400-gig platforms ramp in Q2 and we expect this to grow sequentially in Q3 and Q4. In line with your comments about some of cloud folks wanting to be more aggressive. We do expect our Porrima platform to start ramping in Q4 as appose to Q1 of next year. So we do expect the Porrima ramp to be pulled in by few weeks from early next year into late this year.

[Harlan Sur:]

Just one last question on Porrima. I’m a little bit surprised. You guys recently announced single lambda 100-gig Porrima, it’s a interesting move right, because I think Inphi team was smart to kind of stay away from 100-gig cloud data center market. You have got a strong pipeline of wins with 200 and 400, so was 100-gig Porrima in response to a specific customer program, and how do you see the 100-gig single Lambda opportunity kind of unfolding for you guys?

[Ford Tamer:]

Yes, good question Harlan. The 100-gig we characterized as an opportunity for us to support our U.S. cloud customers, eventually our China cloud customers into what is called DR1 breakout application. So the main switch will come at 400-gig and then will support four different 100-gig legacy or - 100-gig links if you wish. So you would have to DR4 modules on the switch side supporting breakout of four times DR1 modules coming out of it on the other side.

[Harlan Sur:]

Great. Thank you.

[Operator:]

Thank you. And the next question comes from the line of Quinn Bolton with Needham and Company. Your line is now open.

[Quinn Bolton:]

Hey guys, congratulations on the nice results. Just wanted to come back first to the outlook for the coherent business, obviously much stronger than results in the TIAs and drivers in the June quarter. If I have got my numbers right, it looks like that business probably more than doubled just on the pure TIAs and drivers, just wondering if you could comment on that? And then sort of second question, if you look into the back half of the year, I think you mentioned stable for that business but the DSP ramping does that mean the drivers and TIAs actually come down a little bit in either Q3 or Q4?

[Ford Tamer:]

Quinn, this is Ford. Yes we have seen a TIA driver more than doubling and the overall long haul Metro business about doubling from Q1 to Q2 so that’s out of expectations, and so as a result, we do expect Q3 to be more flattish to Q2 and then we expect growth again into Q4 to answer your question. We are not breaking up the exact components of TIA driver versus DSP into that long-haul Metro segment.

[Quinn Bolton:]

Okay. It sounds like you expect some growth again into Q4?

[Ford Tamer:]

Yes, we do.

[Quinn Bolton:]

Okay great. And then just on the Polaris and Porrima, good to see the Porrima getting pulled in a little bit, I think previously you guys did talked about potential for as much as 20 million to 25 million in total PAM for plus driver TIA business inside the [indiscernible] business, is that still a good number for us to be thinking about?

[Ford Tamer:]

I think as John commented, at this point we are not changing our outlook, but as hard and asked we do see a desire to be more aggressive on some of these cloud vendors and pulling in. Some of these 400-gig ramp into Q4 and so as if this happens we obviously will see some upside to that PAM revenue.

[Quinn Bolton:]

Okay, great. And then just last question, obviously last night the acquisitions of Coriant Infinera, would that have any impact on your business, any material impact one way or the other on your business? Thanks.

[Ford Tamer:]

Well, we do a certain level of business today with Infinera Coriant and we do not expect the acquisition to change this materially one way or the other.

[Quinn Bolton:]

Perfect. Thank you.

[Operator:]

Thank you. The next question comes from the line of Ross Seymore with Deutsche Bank. Your line is now open.

[Ross Seymore:]

Hi guys. Just let me ask the question. First Ford a very high level one, it’s great news that ZTE settling down, you talked about the China has the chance to go back to business as usual. Is there any concern that you are seeing as you are over in China about the tariff side of things where telecom equipment is starting to be included in I think the next $200 billion round of issues with China? Is that something that is adding uncertainty in any way shape or form?

[Ford Tamer:]

Good question Ross. We have not seen a major impact from the first 34 or so billion dollars round of tariffs, and as we noted in our prepared remarks, we do not believe that the tariff would have an impact on our Q3 forecast. We are confident in our Q3 forecast. Also as beyond the prepared remarks though we do believe that if the next $200 billion of tariff goes into impact. It will have an effect on us and others in our ecosystem and we are watching this very closely both for Q4 and the 2019.

[Ross Seymore:]

Great and I guess as my next question you talked about steady I think was the word that you used for the COLORZ business. Is that inclusive in mainly just the existing customer that you think that will be kind of steady or steady equal a growth rate? Or is that include new customers that you had talked about in the past adopting the technology?

[Ford Tamer:]

The steady comment for the whole year but lumpy between quarters refers to the main customer. We do believe that there will be a steady demand for COLORZ until they deploy the 400-gig ZR application which should be in the mid 2020 timeframe. As a result, we are characterizing that business as steady through mid 2020. We are still hard at work on the second customer and expect to be able to discuss that further by end of the year.

[Ross Seymore:]

Okay one last follow-up for John. As we think about the gross margin trajectory, especially given the comments that Ford you had said about all of being equal it sounds like some of the [indiscernible] stuff is more likely than push out. It seems like that mix tailwind should be lasting beyond even the back half of this year. As you look forward into next year just puts and takes is there anything that would work against that assumption that you should have some gross margin tailwinds?

[John Edmunds:]

Well, you know you are always facing older products and there will be price declines on older products that we are shipping that we have to cope with every year. So our job is really to introduce new products with high gross margins that come and help balance that mix. And we look right now like we are working with a very broad range of new product introductions in the back half of this year that should, as you point out also carry through into 2019. So we are building a business up brick-by-brick here and we have to take it steady even though we would like to see momentum to come into it, but as we move forward into the back half of the year, we do expect to cross over 70% again in Q3 and maintain that in the fourth quarter and then we believe we can stay in that range through 2019.

[Ross Seymore:]

Great. Congrats. Thank you.

[Operator:]

And the next question comes from the line of Joe Moore with Morgan Stanley. Your line is now open.

[Joe Moore:]

Great, thank you. I wonder if you could talk about inventory on that core business you stated your customer inventory, do you think they will be [indiscernible] during Q2 and do you think where do you think that Q2 revenue number stands relative to end consumption?

[Ford Tamer:]

Thanks, Joe. I think the inventory China situation, we believe we are now back to normal which is about a quarter of inventory at the end of Q1. However, as we discussed with the ZTE ban and some of the tariff discussion that had a negative impact on China consumption and resulted in incremental one month of excess inventory. We expect this one month excess inventory be burned off in the next few months and inventory will be brought back to normal by Q4. So hopefully that addresses your question.

[Joe Moore:]

Okay, that’s helpful. Thank you. And then with regards to ClariPhy, you talked about wins that are driving revenues in the back half. Can you talk about sort of the types of wins that you are getting, the breadth, how many customers, that type of thing with the ClariPhy, what it looks like?

[Ford Tamer:]

Yes, so we discussed in the past that we are still on track to ramp about half a dozen customers in the second half of this year, Joe. We have a major European customer with a couple of smaller European customer, a major China customer with a couple of smaller China customer and ZTE coming back, we would add some revenue based on that new customer coming on board as well. So overall, we are still on track to ramp about half a dozen customer into production in the second half of this year.

[Joe Moore:]

Great, thank you.

[Operator:]

Thank you. And the next question will come from the line of Tore Svanberg with Stifel. Your line is now open.

[Tore Svanberg:]

Yes, thank you and congratulations on the results. Ford, it’s been a few months now since OFC. And I was just wondering if you could just give us a sense for how the design activity is going obviously especially on Porrima and any customer feedback you are getting about the performance of your solution so on and so forth?

[Ford Tamer:]

Tore, we are in a endeavor position today of being single source to Polaris and Porrima. We don’t expect this to last, but at this point, as far as we know, we are the only working solution for 200 and 400-gig, for 28 Gigabaud and 56 Gigabaud in the market today. We do expect [indiscernible] Broadcom to come back either with response solution or new solutions. But we are ready, our customers are fast and furious, getting to market with margin writing firmware and qualification. So we are the ones that has to catch up to us. So we are currently in a very good position.

[Tore Svanberg:]

Okay. And just about the COLORZ, how should we qualify your comment about COLORZ growing steadily between now and mid 2020, just trying to understand could it be significantly bigger business than what it is today and I assume when you talk about until mid 2020 400 GR will then take over?

[Ford Tamer:]

So just to clarify my comment Tore, I did not say growing steadily, I said steady. So may be another way to say it is flat. So we do not expect COLORZ as the main customer to grow or decline, we expect to be flat on a year-to-year basis but lumpy between quarters. And we expect that to last through mid 2020. Now the only growth we could have would be from additional second customer coming online. We don’t expect any news on that until Q4 and any substantial revenue for that until early next year. So the second customers in China - our main focus right now our Chinatown customers they are still very interested in this solutions and that's moving along in a very good way. We're planning in China, there is tremendous amount of interest in the 60 kilometer type of distance and several of the Chinese cloud giants and introducing COLORZ with 100-gig would pave the way to 400-gig where all of them now interested in the next generation as well. So the other thing I would say confirming my prepared remarks is on the 400-gig we do see a tremendous interest in the new COLORZ 400-gig delivering on IT over DWDM vision for the router, because what it does, it allows the same standard grey port to plug in the DWDM margin and enable ZR metro long haul distances in that same router port. So the vision of where COLORZ could go could be just tremendous and open up new market for us.

[Tore Svanberg:]

That is very helpful. Just one last question on the coherent DSP, you glad to see the design winds moving into production there is second half. I think you have a slide in your deck that talks about that being potentially a little more than the $200 million market next year. Should we assume that you could get about a quarter of that market next year.

[Ford Tamer:]

In the past we said our market share was about 20% and there is no reason for us not to be able to grow our market share to about 25 or so by next year. So that could be a good estimate Tore.

[Tore Svanberg:]

Very helpful. Congrats again. Thank you.

[Operator:]

Thank you. And the next question comes from the line of Mark Kelleher with D.A. Davidson. Your line is now open.

[Mark Kelleher:]

Great, thanks for taking the question, guys. Most of my questions have been answered. I just had one kind of hanging question, while the ZTE was shutdown was there any change in the ability or demands shifting from ZTE to other vendors, did you have any open opportunities that maybe you can exploit that kind of popped up while ZTE was in [indiscernible].

[Ford Tamer:]

Good question Mark. The China market stayed extremely disciplined when ZTE was on ban not only the OEMs were not going up to ZTE, but the China mobile carrier stopped issuing RFQ to maintain and preserve ZTE’s share and business. So those are tremendous amount of discipline in the China domestic market to preserve the ZTE position. In international markets it was slightly different, there wasn't obviously discipline and so you know, I think we have seen others gain share in the India market especially at potentially the expense to ZTE, not sure if this is going to be a long-term or not, but short-term, there has been some market shift in international markets.

[Mark Kelleher:]

Okay. Great, that is all I have. Thanks.

[Operator:]

Thank you. The next question comes from the line of [indiscernible]. Your line is now open.

[Unidentified Analyst:]

Thanks. Ford, I know this has been asked a few times, but going back to covers, is there even why we are seeing softness or steadiness for the next year, is this top customers deploying fewer instances or the causality of the slash you think.

[Ford Tamer:]

Could you clarify the question, are you saying are you surprised it's LAN or you think of why.

[Unidentified Analyst:]

Why is it flat, why wouldn’t it grow, and why isn’t the adoption being improved, just if you can qualify that and if this is expected then that’s fine?

[Ford Tamer:]

Understood. So, there was a early deployment in quite a few sites and so there was a pent-up demand early on that end of that potentially having a bigger early deployment if you wish, and then we had a bit of a low then we were back to a steady deployment across multiple sites and we are seeing the units actually increased due to new applications that this one customer has shown, but that’s being offset by the volume pricing as they cross different unit shipment milestones okay. So hopefully that helps answering the first question.

[Unidentified Analyst:]

Yes, it does Ford. Thanks and that is it from me.

[Ford Tamer:]

Thank you.

[Operator:]

Thank you. And the next question will come from the line of Paul Silverstein with Cowen and Company. Your line is now open.

[Unidentified Analyst:]

Hey guys this is [indiscernible] in for Paul. Just a couple of quick questions on one on the 45 and 64 Gigabaud business, did you guys had any material new wins which previously customers have may have vertically integrated and respective leaders and the opportunity for you there?

[Ford Tamer:]

Good question. Customers that were previously vertically integrated have not changed, so there is probably one customer as you are thinking about and that one customer has not changed, the rest is all open, there is only really one major customer that can move the needle that still and remains vertically integrated today in driver.

[Unidentified Analyst:]

Got it. And then in terms of looking at the second half of the year would you say that the bulk of your growth would be coming from inside the data center as appose through the Metro. I mean you said its steady, but the Metro and long-haul are steady, but would you say that most of the growth is actually going to come from upside and the inside data center for the business?

[Ford Tamer:]

Yes that’s correct, the second half growth would be mostly driven by the PAM and associated TIA driver for inside data center.

[Unidentified Analyst:]

Well then in terms of - I would suspect that given that this is fairly more cutting edge technology and that the cloud cause customers to have - there is really pent up demand for deploying 400-gigs, why shouldn’t we see margins in-site data center PAM4 business be that much more accretive for your overall margin profile exiting the year?

[John Edmunds:]

This is John. It’s accretive in and of itself, but its only part of the overall mix, so as it grows and it will grow steadily and as it grows over the course of the year and end of 2019 it will help us sustain gross margins at the levels that as I discussed previously. So we do see that as an accretive addition to the overall mix, but it is part of an overall mix and there is other movements that go on at the same time.

[Unidentified Analyst:]

So I guess maybe if I could ask one more question related. So what is gaiting the margin - what is offsetting this margin upside, is it aggressive pricing declines in China on your relatively 400 TIAs. Just help us to understand what are the puts and takes of the margins?

[John Edmunds:]

There is really nothing in terms of aggressive pricing declines, per say there is no one product that you would look at. We still get very good gross margins on all of our other products. But we have a fairly broad portfolio with pieces. And right now the PAM revenues as they grow are still a relatively small piece of the overall mix. So as they grow they will have a bigger impact overall and you will have other products like transport products where older products that will have some price erosion overtime just like any other technology.

[Unidentified Analyst:]

Can you help us quantify the puts and takes?

[John Edmunds:]

We don't go into that level of detail with people.

[Unidentified Analyst:]

Alright.

[John Edmunds:]

Thanks for the questions.

[Unidentified Analyst:]

Thank you.

[Operator:]

Thank you and the final question will come from the line of Richard Shannon with Craig-Hallum. Your line is now open.

[Richard Shannon:]

Ford and John thanks for taking my question. Probably just two from me. First of all regarding the 64 Gigabaud parts I know there is a previous question regarding the market. Merchant market size there, but curious how your share is looking there and the early stage in design wins. I think you talked about 70% share currently in TIAs and 15 drivers. How does your share look like in the early stage of design wins?

[Ford Tamer:]

Richard on 64 Gigabaud our design win share is excellent. So we could potentially gain share in 64 Gigabaud.

[Richard Shannon:]

Okay, perfect. That’s helpful and then second question for John. On OpEx, I think you talked about maybe a little bit of growth here in the third quarter. How should we think about that going forward maybe relative to growth rates or any way to think about modeling that?

[John Edmunds:]

Thanks for the question Richard. We are going to continue to try to be conservative in our investment, our spending over the next couple of quarters and try to bring leverage into the business as our revenues ramp here. So I would expect fairly modest increases in spending as I mentioned on the call it could be flat to slightly up in Q3 and again, flat to slightly up in Q4.

[Richard Shannon:]

Okay, that is helpful. All the questions from you guys. Thank you very much.

[Ford Tamer:]

Thanks Richard.

[Operator:]

Thank you and I’m showing no further questions. I would now like to turn the conference back over to Mr. John Edmunds for further remarks.

[John Edmunds:]

Thank you Sabrina. Inphi plans on attending the Oppenheimer conference in Boston on August 7th, the Jefferies conference in Chicago on August 28, the Citibank Technology Conference in New York on September 5th or 6th, the Stifel one on one conference in San Francisco on September 6th, and the Deutsche Bank conference in Las Vegas on September 12th. Ford and I would like to thank you for joining us today and we look forward to speaking with you again in the future.

[Operator:]

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