Inphi Corp
Q4 2017 Earnings Call Transcript

Published: 8 Feb 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to Inphi's Fourth Quarter 2017 Earnings Conference Call. As a reminder, this conference may be recorded. I would now like to introduce your host for today's conference, Ms. Deborah Stapleton, Investor Relation. Ma'am, go ahead.

[Deborah A. Stapleton:]

Thank you. Good afternoon, everyone, and thank you for joining Inphi today to discuss the financial results for the fourth quarter of 2017. I'm Deb Stapleton, Investor Relations; and with me today are John Edmunds, Chief Financial Officer; and Ford Tamer, Inphi's Chief Executive Officer. John will begin with a Safe Harbor then Ford will give you an overview of our business. After that, John will provide a financial summary of Q4 and then the outlook for the first quarter of 2018. After that we'll be happy to take your questions. John?

[John S. Edmunds:]

Thanks, Deb. 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, as well as the projected growth and size of our markets, our customers, market share, new products and design wins both worldwide and by geographic segment 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 the Q3 2016 sale of our Memory Interface business. In general, the numbers we referred 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 G. Tamer:]

Thanks, John. And thank you for joining us for Inphi's fourth quarter and year end 2017 earnings update. I will begin with a brief summary of Q4 and 2017 and a review of the current market situation. Then I'll turn the call over to John for the financial report. Revenue for the fourth quarter came in at $85.7 million as compared to $80.9 million in the same quarter one year ago. This represents a year-over-year increase of 6%. Despite the headwinds, we delivered 70.3% non-GAAP gross margin and 20.1% non-GAAP operating margin. After taxes, we achieved $0.37 in fourth quarter earnings, $0.01 better than consensus estimate, and as compared to $0.47 in the fourth quarter of 2016. We generated $29.1 million in cash from operations in Q4. Despite the continued market challenges, I'll discuss next, I'm proud of what our team achieved in 2017. Total revenue for 2017 was $348 million, a 31% increase over our 2016 revenue of $266 million. Even on an organic basis, without the ClariPhy acquisition, we grew revenue 18% from 2016 to 2017. This positions Inphi as one of the largest, fastest-growing revenue companies amongst our peer for the semiconductor industry. And I meant fastest growing. We delivered 21.2% non-GAAP operating margin for 2017. On a non-GAAP basis, full-year EPS for 2017 was $1.52 as compared to earnings of $1.51 per diluted weighted average common share for the full year of 2016. As you have undoubtedly heard by now, the inventory correction for optical components in China long-haul and metro market is continuing. This is a situation we and others in the industry have experienced for the past few quarters. And we now know it's more significant than we initially expected. We believe the situation has been created by four factors. First, the 100-gig long-haul and metro build up resulted in a market growth of a strong 60% compounded annual growth rate from 2012 to 2016. Now, as the 100-gig long-haul and metro market is maturing, analysts expect that growth rate to slow down to around 20% to 25% annually. Second, because of the inventory situation, the year-on-year price declines were slightly higher than in prior years. Third, the inventory build up that happened from mid-2016 to 2017 created a large issue for our core business, especially in the TiA segment. However, we're seeing signs that Q1 may be the bottom as customers are trying to ask us for increased demand in Q2. And finally, the transition from gold box driver to surface-mount packages has created a large average price reduction in an overall driver business that has not been offset by unit growth. While these factors are impacting Inphi business, some of them are also impacting our entire industry. In addition, we're notified a few days ago that our lead second customer for COLORZ will not move forward. This is due to their own reasons, unrelated technology or production maturity of COLORZ. Even though this delays the incremental COLORZ revenue ramp to the second half of 2018, we remain confident in the incremental applications and customers for COLORZ that I'll describe later in my prepared remarks. Based on this, we now expect our Q1 revenue to drop by about $25 million from Q4. About 40% of which is already built into most of the street estimates. Roughly, 60% of this drop is related to continued inventory reduction in long-haul and metro. While visibility remains limited, we have recently heard positive requests from some of our customers for increased demand starting in Q2 for our long-haul and metro business. We expect that Q1 2018 will be the bottom and that Q2 revenue would be up sequentially for coherent TiA and driver, and for our overall business. We also remain confident in the many growth sector for Inphi, resulting in accelerating revenue in the second half of 2018. This is based on new design wins for four classes of product. First, PAM DSPs with associated linear TiA and drivers inside U.S. cloud data centers driven by AI, Infiniband and Ethernet networking applications; second, M200 coherent DSP ramp in Europe, Asia and U.S.; third, the ramp of Inphi's 400-gig coherent TiAs and drivers worldwide; and fourth, continued growth of COLORZ in the second half of the year in U.S. and China. Let me now discuss our business highlights. First, we continue to experience robust deployment for our COLORZ product at Microsoft for 80 kilometer DCI edge application. Microsoft has now rolled out COLORZ in multiple regions with consumption in the 10,000 unit range in Q4. As we move to the second half of 2018, we expect other customers to begin deploying COLORZ. We have new OEM and cloud customers testing COLORZ variants for DCI edge, campus and service provider aggregation application. We are also working hard on the next generation 400-gig ZR coherent product to promote a wider adoption in an even larger overall addressable market for COLORZ in 2019. Finally, we're still planning for the COLORZ family to be a core offering for Inphi for the next decade in a growing array of applications and new markets. Next, let me turn over to discuss the solutions for inside the data center where we also have had a very good year in 2017. Our 50-gig PAM Polaris platform continues to gain traction. This platform comprising our lowest power PAM DSP and associated lowest power linear TiA and driver offers the market a compelling, proven, high-performance solution. The market responded very well to this offering. Throughout 2017 we have gained credibility and design win momentum. We saw similar enthusiasm for our Vega family of PAM Gearbox and Retimer DSPs for system line cards. We expect to start generating revenues in Q2 and report double-digit revenues for 2018. Next month, we plan to sample our new 400-gig PAM DSP, also referred to as single-lambda PAM for low power 400-gig QSFP-DD and OSFP modules. This platform already has strong traction because it's now the fourth generation of PAM from Inphi. And because of the credibility and momentum, we've already built with first-generation PAM powering Microsoft Azure regional gateway architecture with COLORZ, as well as success with follow-on products, Polaris and Vega, at key U.S. cloud customers. Finally, let me turn over to our long-haul and metro coherent market. We continue to be the market leader in the merchant coherent TiA and driver markets where China is by far the largest customer at nearly 70% overall share. We had reported at a recent financial conference over 70% share for coherent TiA and over 50% share for coherent driver. While we're impacted during a correction as is currently the case, we should also benefit when consumption levels return to sustainable levels. Unit shipments of TiA were down in Q4, but we anticipate And we anticipate they'll be even lower again in Q1. Just to give you a frame of reference, our combined coherent TiA and driver business was down in Q4 2017 to about 45% of the highest revenue we achieved in Q1 of 2017. Based on recent customer request for more inventory in Q2, we expect Q1 to be the bottom at about 25% of Q1 2017 levels. We currently believe that business can be up more than 50% sequentially from Q1 2018 to Q2 2018 based on our strong position and award winning product quality. Also on the brighter side for long-haul and metro, in Q4, we began shipments to customers of our final production version of the Inphi M200 high performance, low power 100-gig, 200-gig coherent DSP for high-density applications. We expect to begin commercial ramp of the M200 in the second half of this year. As the M200 begins to ship in production and we ship a higher mix of amplifiers again, our non-GAAP gross margin mix should return to the low 70% range in the second half of the year. We also expect many DCO and ACO offerings to be on display at the Optical Fiber Conference, or OFC, with Inphi's 45 and 64 Gigabaud TiA and driver, as well as the M200. Our Q1 guidance demonstrates that our business is dependent on a few large customers. Because of that, we have focused for several years on diversifying our business by entering the growing cloud inter- and intra-data center market. In 2017, we generated 34% of our business from that data center segment and we're confident that this will continue to grow to be approximately 45% in 2018 and over 50% in 2019. As a result, we expect to emerge from this period as a stronger, more solidly positioned company with more customer diversity. As Winston Churchill said, never, never, never give up. We continue to build a very successful company here. Q1 is not the new normal. We expect to grow sequentially in Q2 and we remain optimistic that the revenue growth will accelerate in the second half of 2018. This is based on the right leading customers telling us that we're continuing to build the right differentiated products for them at the right time in all three of our growing large market segments. As a demonstration of that, Inphi recently won an award from Huawei for quality and we also recently won an award from InnoLight for technical innovation. We have strong cash reserves. In light of the market conditions, let me assure you that we'll act with financial responsibility, taking all the actions that will protect our long term future. Of course, we're also focused on improving our forecasting and large account management. Let me suggest the following milestones for investors to anticipate. First, look for a resumption of our coherent TiA and driver business in Q2 as a concrete sign of resumption of growth in China. Second, again, beginning in Q2, we should see the start of the PAM ramp with associated TiA and driver inside data centers. Third, in the second half, witness the ramp of the M200 Coherent DSP, the coherent 400G TiA and drivers and new customers for COLORZ. Fourth, look for sequential revenue growth throughout 2018. And fifth, and finally, we expect to restore operating margins to reasonable levels in Q3 and Q4 and for the overall 2018. With that, let me turn over the call to John to discuss more details. John?

[John S. Edmunds:]

Thanks, Ford. Now, let me recap the key financial results. In the fourth quarter of 2017, Inphi reported revenues of $85.7 million. Revenues were up 6% year-over-year and up sequentially 1.4% from Q3. Core communications products, including amplifiers, drivers, 10-gig, 40-gig and 100-gig optical PHY products, coherent DSP and COLORZ overall were up about $3.5 million to 86.1% of total revenues compared to 83.2% which the core represented in Q3. The revenue from data center products including COLORZ and optical PHYs were up sequentially by $7.3 million due primarily to shipping samples of our new PAM4 Polaris and Vega components, as well as some IP licensing. However, long-haul and metro products including the coherent DSP declined sequentially by $3.8 million. This despite the fact we shipped an incremental several million dollars in new M200 DSP samples. The transport and legacy products were 14% of revenues, down about $2.1 million from the 17% reported in Q3. They are expected to decline by about $2.3 million in Q1. They will also decline $3.1 million on average starting in Q2 due to the end of life programs announced last year and will average $6 million to $7 million per quarter in the latter three quarters of this year. Gross margins on a non-GAAP basis in Q4 came in at 70.3% which was about 80 bps below the midpoint of our guidance. The annual – the higher rate of decline was primarily due to a mix of product including fewer high gross margin die-based amplifiers shipping in Q4. In Q1 2018, we expect gross margins to be down approximately 240 bps based on a less favorable mix of products. This includes in Q1 a lower volume from Q4 of higher priced higher margin samples. In addition Q1 includes the effect of annual price decreases being initiated, as well as less relative licensing revenue than Q4. All-in-all we estimate non-GAAP gross margins for Q1 to be in the 67.4% to 68.4% range. While I might also expect about 150 bps to 200 bps less in Q2 due to mix; in contrast in the back half of 2018, we will be shipping the new coherent DSP, the M200, which will buoy the gross margins on an improved mix back up to 72% to 74% range, leaving us to average roughly 70% for the year. In Q4 2017, the GAAP gross margins were 62%, but include purchase accounting adjustments and stock compensation. Please see the reconciliations in the press release for more detail. Q4 GAAP net income from continuing operations was $0.1 million. We then add back standard adjustments of $28.8 million of certain GAAP expenditures and the associated tax benefits of $12.7 million to arrive at Q4 non-GAAP net income of $16.2 million. The $28.8 million of adjustments compares to $28.9 million for the same adjustments in Q3. These are primarily for stock compensation, purchase accounting related to acquisitions, and convertible debt cost amortization. The associated tax benefits and the related income tax effects of these adjustments of $12.7 million in Q4 compares to $11.5 million in Q3. Please see the reconciliation in the press release for more detail. The non-GAAP net income of $16.2 million for Q4 2017 was up 2.5% sequentially, compared to the $15.8 million reported in Q3. Now, let's look at the remaining components of non-GAAP that led to this Q4 non-GAAP result. Non-GAAP operating expenses for Q4 totaled $43 million down $0.4 million from Q3. We have been reducing our gross operating spending over the last two quarters. To demonstrate that you have to look at Q2, Q3 and Q4 operating spending. And as we have discussed before, you have to make an adjustment and add back $3 million in net NRE R&D expense offset in Q2. So, on that basis, the gross spending was down approximately $1.7 million in Q3 and an incremental $0.4 million to Q4, or a total of $3.8 million for 4.2% sequential decrease in the second half of 2017 spend rate versus the first half. Overall in Q4, we were able to deliver non-GAAP operating margin of $17.2 million or 20.1%. This was down from the 20.5% in Q3 mainly due to lower gross margins. Year-over-year non-GAAP operating margins of 20.1% in Q4 of 2017 were down from the 28.9% posted in Q4 of 2016. Of this 8.8% differential, 5.8% was from the organic business. This was due to 3.5% lower organic revenues in Q4 and 2.7% lower organic gross margins in Q4 compared to Q4 of 2016. The remaining 3% differential in operating margin represents the ongoing P&L investment for the net cost to complete the new metro based coherent DSP products as part of the ClariPhy acquisition. Interest income totaled $1.3 million in the quarter and covered the cash cost of the convertible debt, which was also $1.3 million. The convertible debt was – has a blended annual coupon rate of 0.972%. Otherwise, we had other non-operating expense of $72,000 for the quarter which is what is reported on that particular line. The GAAP income tax expense was $11.8 million tax benefit against a pre-tax loss of $11.7 million resulting in positive GAAP net income of $0.1 million. This included absorbing approximately $18 million in mandatory redemption tax due to the new 2017 U.S. Tax Law. Under the new law, the company will also be subject to the new Global Intangible Low-Taxed Income tax or GILTI tax in 2018. However currently, we're estimating a low level of international income in 2018 and therefore this will result in a low incremental additional tax on international income. This is only for non-GAAP tax reporting. For GAAP the deductions from stock compensation expense will drive U.S. tax losses that will absorb any additional new tax law expense in the near term. In general, we find the ongoing overall GAAP tax rate to be difficult to forecast. Not to mention the rate changes as we move through any given year based on a number of variables. We brought the non-GAAP effective tax rate slightly – or down slightly for the year to 7.4%, which means we benefited from using a catch up rate of 5.3% in the fourth quarter leading us to book $0.9 million for the Q4 non-GAAP tax provision. We are reasonably confident that an 8% rate is sustainable for the balance of 2018 including any GILTI tax from the new tax law. The tax accrual for 2017 also generated an additional $29 million in net operating loss on NOL, bringing us – our U.S. federal NOL to total of approximately $115.8 million. We also have approximately $98 million in additional NOLs available to us from acquisitions. However, their use is restricted for any given year but available over time. Cash income taxes paid in fiscal 2017 was $2.2 million primarily in Singapore up from $0.2 million in 2016. This compares to $5.3 million of non-GAAP tax expense accrued for 2017, which in addition to the cash payments includes accrued current and deferred tax expense. Non-GAAP net income for the fourth quarter of 2017 was $16.2 million or $0.37 per diluted share, which was up sequentially from the $15.7 million or $0.36 per diluted share we reported in Q3. Year-over-year the $16.2 million and $0.37 compared to $20.8 million or $0.47 for Q4 of 2016. The differences in net income and EPS are the – are for the same reasons we gave in the non-GAAP operating income explanation. Now turning to the balance sheet. Overall, cash was $405 million at 12/31 which was flat with the $405 million balance at 9/30. We had cash flow from operations of $29.1 million in Q4 as compared to $18.6 million in Q3, and compared to $12.7 million in Q4 one year ago. The $10.5 million sequential increase in cash flow from operations from Q3 to Q4 comes almost entirely from better working capital management. Capital expenditures were $6.5 million in the quarter. We also had separate additional payments of $3.3 million for software royalties and IP. In addition, we had approximately $7 million used in financing activities primarily buying shares back from employees via the payment of tax withholding based on RSU vesting. DSO improved from 77 days at the end of September to 71 days at the end of December, due primarily to more robust collections. Inventory decreased by $2.9 million in the quarter. As a result, inventory days, excluding the respective step-up adjustments, was 108 days or 3.3 turns at the end of December, as compared to 119 days or 2.9 turns at the end of September. Now let me recap the business outlook for Q1 of 2018. I'll remind everyone again that the following statement 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 down approximately $25.7 million in Q1. This would bring revenue to $60 million at the midpoint, plus or minus $2 million. Of this decline, approximately $13.7 million is in long-haul and metro due to inventory absorption, a seasonal decline including the impact of annual price renegotiations, as well as the lack of several million dollars of coherent DSP M200 samples that we shipped in Q4. In addition, approximately $9.9 million is in the data center, about half of which is reflected in an expected reduction in PAM samples and IP licensing. The other half was a sudden loss of business, now expected with the second lead customer for COLORZ – with COLORZ. The remaining $2.1 million reflects an expected seasonal decline in transport and legacy. We anticipate this will result in total Q1 revenue to be in the range of $58 million to $62 million. We expect non-GAAP gross margins to be in the range of 67.4% to 68.4%. We expect non-GAAP operating expenses to be in the range of $41.8 million to $44 million. We're currently estimating the non-GAAP effective tax rate to be 8% for Q1 2018. We are confident these components should then align resulting in a non-GAAP operating margin in the range of approximately negative 2.6% to negative 4.7%. This should also lead to non-GAAP net loss of between approximately $1.6 million and $2.6 million. This would results in estimated non-GAAP loss per share of between $0.04 and $0.06 based on approximately 42.8 million estimated basic shares. For GAAP reporting for Q1, we expect a GAAP net loss in the range of $21.5 million to $22.7 million. GAAP earnings per share would then be a loss in the range of $0.50 to $0.53 per basic share on 42.8 million forecasted basic shares. A more complete reconciliation of the forecasted Q1 GAAP net income compared to Q1 non-GAAP net income is included in 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 news stating otherwise. So, please ask any questions you may have today during the general Q&A period. On a personal note, you may see me selling stock in the next couple of weeks. I have options expiring which I have to exercise by the middle of March and a large tax bill coming in April. So, those are the reasons for my selling of stock. And now, we'd be happy to take your questions.

[Operator:]

[Operator Instruction] And our first question comes from Quinn Bolton of Needham & Company. Your line is open.

[Quinn Bolton:]

Hey, guys. Thanks, John, for going through the sort of the breakout of that step down from Q4 to Q1. I was hoping just, could you again talk us through the data center business, the $9.9 million reduction. It sounds like it's the split, but go through that detail specifically, is there any decline that's stated in COLORZ with your lead customer in the March timeframe?

[John S. Edmunds:]

Yes. Quinn, thanks for the question. The $9.9 million reduction in the data center, about 50% of that we said was going to be the result of PAM samples and IP licensing, not recurring in Q1 that took place in Q4. The other half is really a reduction of what we – of COLORZ revenue that we anticipated getting from a second lead customer in Q1 which just fell out in the last couple of days and we had to make that adjustment. So, we decided to just try to call Q1 the bottom and grow from Q1 to the succeeding quarters.

[Quinn Bolton:]

So, understanding that you had anticipated a second customer ramping in Q1 that you no longer will see ramp, the business with your lead customer, is that – maybe it sounds like that's got to be down about $5 million, right, so it's half of the $9.9 million, and total COLORZ bucket comes down by roughly $5 million quarter-to-quarter?

[John S. Edmunds:]

It's a little less than $5 million that would be down, that's correct.

[Quinn Bolton:]

Got it. Got it. And then, just looking longer term, obviously, I know you're not giving any revenue guidance for the full year, but you talked about a greater than 50% sequential increase in the coherent TiA and driver businesses in the second quarter given some of the visibility you're starting to see. Do you think, I mean, it still looks like with the slow start in March, you're probably looking at a down year in 2018 versus 2017 from a revenue perspective?

[John S. Edmunds:]

Yes. 2018 would most likely be down from a revenue perspective. We do expect growth in the back half, but we'll see if that unfold in the course of the year and see where we get to.

[Quinn Bolton:]

Great. Thank you.

[John S. Edmunds:]

Okay. Thanks, Quinn.

[Operator:]

And our next question comes from Tore Svanberg of Stifel. Your line is open.

[Tore Egil Svanberg:]

Yes. Thank you. Question for Ford. Ford, can you just go through some of the math again for the long-haul, metro TiA and driver business for Q1? And I assume that, that is specifically what you're saying would be up 50% sequentially in Q2?

[Ford G. Tamer:]

Yes, Tore. I'm saying the TiA and driver coherent business is expected to be up 50% from Q1 2018 to Q2 2018.

[Tore Egil Svanberg:]

And you said that it was – it would be – Q1 will be down 45% from Q1 of 2017. Did I hear that right?

[Ford G. Tamer:]

No. I said that Q4 of 2017 was at about 45% of the Q1 2017 level, and that Q1 2018 was about at 25% of the Q1 2017 number.

[Tore Egil Svanberg:]

Okay. Very good. And my second question was on COLORZ. So you talked about obviously not having that second customer here in the first half, but you did talk about the second half. And you even mentioned geographically in China. So should we expect cloud customers in China to use COLORZ or is that in reference to something else?

[Ford G. Tamer:]

Tore, you're absolutely right. We are working actually closely with Chinese cloud customers on COLORZ. The dynamic there is the 400-gig ramp is probably slightly behind in China compared to U.S. cloud. And so we've got a larger long-haul opportunity in China to gain traction for COLORZ.

[Tore Egil Svanberg:]

Very good. Thank you.

[Ford G. Tamer:]

Thank you, Tore.

[Operator:]

And our next question comes from Harlan Sur, JPMorgan. Your line is open.

[Harlan Sur:]

Good afternoon. Thanks for taking my question. You guys talked about receiving positive requests from some of your customers for increased demand starting in Q2 for long-haul and metro products. Are these hard orders that you guys are receiving or is this just looking at forecasts from customers? I'm just trying to figure out how concrete the demand pool is.

[John S. Edmunds:]

Yeah, Harlan. This is John. They're a combination of discussions with customers who are coming to us saying, hey, we're going to start to need more inventory. So start planning on the build cycle because for the III-V materials, the build cycle can be quite long sometimes, as much as 20 to 25 weeks. And so, those are where those conversations begin. In some cases, we are beginning to book orders for Q2 and they're still at a fairly low level, but they'll build up through the course of the next month or so. And I think that's why people try to give us advance notice of what their needs are going to be.

[Harlan Sur:]

Great. Thanks for that. And good to see that the team is still on track to ship Polaris in Q2 to one of the big cloud customers. This PAM transition is looking to be a pretty significant upgrade cycle starting in the back half of the year with the launch of Tomahawk 3. Most of the major cloud guys, based on what we know, are going to be adopting Tomahawk 3 pretty aggressively. So, I guess, for the mainstream Ethernet switching upgrade cycle, which should start back half of this year beginning of next year, can you guys just tell us, are you already starting to qualify your 200-gig and 400-gig solutions with the cloud titans in anticipation of this ramp and what's been the feedback so far?

[Ford G. Tamer:]

Thank you, Harlan. This is Ford. Good question. We have been in qualification with a major U.S. cloud customer since Q1 of last year. We shipped this Polaris 50-gig PAM for 200-gig and 400-gig modules in February of 2017. We've been in qualification since that time along with module customers and their customer customers, meaning the U.S. cloud. We anticipate the first application to be an AI application, independent of Tomahawk 3. So, it will not be dependent on Tomahawk 3. The second application will be a Infiniband application, again, independent of Tomahawk 3. And the third application is our Vega product with retimers that will go along with a captive switch ASIC from a major network OEM. So again, independent of Tomahawk 3. And then the fourth application will be then related to Tomahawk 3 which we expect to be later in 2018. And then as we get into late 2018 and early 2019, then we expect a next generation of PAM which is our 400-gig PAM which I also mentioned in my remarks to start ramping towards the end of this year early next year.

[Harlan Sur:]

Great. Thank you.

[Operator:]

And our next question comes from Paul Silverstein of Cowen. Your line is open. If your phone is on mute, please unmute your line. Mr. Silverstein, your line is open.

[John S. Edmunds:]

Latonya, why don't you move to the next caller, and then Paul can get back in if he can figure out – get his phone working.

[Operator:]

Certainly. Our next question comes from Ross Seymore of Deutsche Bank. Your line is open, Ross.

[Ross C. Seymore:]

Hi, guys, can you hear me?

[Ford G. Tamer:]

Yes, we can. Thanks, Ross.

[Ross C. Seymore:]

Can you hear me?

[John S. Edmunds:]

Yes, Ross, we can hear you. Thank you.

[Ross C. Seymore:]

Just double checking. So, I wanted to go back to the second COLORZ customer that was supposed to ramp, any more color you can give on what happened there. And generally speaking, what gives you the confidence in the others ramping in the second half if this one seemingly got so close to launch and then decided to stop?

[Ford G. Tamer:]

Yes, good question, Ross. This is Ford. I think, it's a combination of factors on their end that could be related to CapEx, not related to technology or production maturity of COLORZ. The second one could be related to the fact that they currently have a 100-gig solution that's currently being in use. And the timeframe for COLORZ would have been between now to the ramp of 400-gig and they ultimately judged that the timeframe was too short to deploy the 100-gig and they kept going with the current 100-gig solution they have. Even though COLORZ would have provided better cost and better power, better density type of advantages. So, on some of the other customers, and this specifically first application was a campus application. For the follow-on customers, we're actually working with applications that are DCI edge. So this would be 80-kilometer application where the benefits of COLORZ are very clear. And we've actually uploaded couple of slides from the Azure Ignite conference that happened in September 2017 from Mark Russinovich keynote, who is CTO for Azure, to our website. So in our corporate presentation, you could find couple of these slides. They very clearly show the power, density and cost advantages of COLORZ for this DCI-type application. We also have now found a new application of COLORZ for service provider aggregation, where we can aggregate a whole bunch of traffic into some of the service provider transport boxes, and that's very appealing in developing market geographies. And we're working with couple of OEMs on that type of applications. That's a new application of COLORZ. And finally, we're working with enterprise OEM system vendors to work with their customers in the application of COLORZ for enterprise. So we've got a range of new applications for COLORZ that keep us very confident that we'll see a increase of growth in the COLORZ revenue for the second half.

[Ross C. Seymore:]

Okay. Thanks for all those details, Ford. And one follow-up for you, John, on the OpEx side of the equation. Obviously you guided for the first quarter, but considering where the revenues are starting for the year, how are you thinking about the trajectory and how tight you're planning to run OpEx as we progress through 2018?

[John S. Edmunds:]

Thanks for that question, Ross. We are anticipating OpEx to be lower and that we can find ways to conserve costs through the course of the year and that we might be able to be down overall for the year by something in the 3% to 4% range. But we'll keep working on that and see where we get to.

[Ross C. Seymore:]

Great. Thank you.

[Operator:]

And our next question comes from Vivek Arya of Bank of America. Your line is open.

[Adam Gonzalez:]

Hi. This is Adam Gonzalez on for Vivek. Thanks for taking my question. Just wondering, you didn't really talk much about ClariPhy. I'm just wondering if there's any impact there from the broader slowdown. And just wondering what your expectations are for growth moving forward in that business? And if they've changed at all over the last several months? Thanks.

[Ford G. Tamer:]

Yes, thank you, Adam. The ClariPhy situation remains the same as we had discussed the last earnings call, which is we're making progress with the new M200 product because it's low power, because of its performance, because of its applicability to pass through 20 (42

[Adam Gonzalez:]

Got it. Thanks. And I guess my second question is just how are spending trends outside of China? I guess that 30% of the bucket that you didn't really talk about?

[Ford G. Tamer:]

There, I think we're seeing those market progress. We're working very closely with a major European OEM or a few European OEM, but one major one that is – that has a significant share as well as the couple of North American customers that are moving forward. And we see that to be more again, steady compared to the China – the China challenges we've seen.

[Adam Gonzalez:]

Thanks.

[Operator:]

And our next question comes from Hans Mosesmann of Rosenblatt. Your line is open.

[Hans Mosesmann:]

Yes. Thanks, sir. Let me ask a question. Ford, one of your competitors said last night that they are seeing form factors shift in China from long-haul to more metro kind of form factors. Can you comment on that? Are you guys seeing that? And then, I have a follow-up. Thanks.

[Ford G. Tamer:]

Yes, Hans. The comment was referring to a change from long-haul where you would expect that gold box driver to a metro where you expect to surface-mount technology driver and we're seeing the same type of impact. This was one of the factors that I mentioned in my prepared remark that makes the situation more challenging, Hans. And you said, you had a follow-on question?

[Hans Mosesmann:]

Yeah. And just to clarify, the primary customer for COLORZ is going to be down nearly $5 million sequentially in Q1?

[John S. Edmunds:]

A little less than $5 million, Hans. And as we said we had other business that we had planned to be able to book and are only finding out recently that we're not going to be able to book in Q1, that would have covered that in the COLORZ sector.

[Hans Mosesmann:]

Great. Thank you very much.

[Operator:]

And our next question comes from Dave Kang of B. Riley FBR. Your line is open.

[Dave Kang:]

Thank you. Good afternoon. The first question is can you provide any kind of color or the product mix as far as COLORZ DSP versus TiA drivers?

[Ford G. Tamer:]

Dave, do you mean a mix between the coherent DSP and the TiA driver or...

[Dave Kang:]

Or if you can just break out – if you can break out COLORZ and DSP separately?

[John S. Edmunds:]

Dave, we aren't going to break that out separately. We're just talking about the long-haul and metro products, and the datacenter products as a group as each separate groups, but we're not planning to break those out separately.

[Dave Kang:]

Okay. Fair enough. And, just wanted to make sure that I think TiAs in China excess inventories will be depleted by the first quarter. What about drivers, were they depleted in the fourth quarter? I think that's what you implied in the previous earnings call?

[Ford G. Tamer:]

Yes, Dave. This is Ford. The driver inventory was depleted in the fourth quarter and we've seen that growth resume.

[Dave Kang:]

In the first quarter?

[John S. Edmunds:]

Dave, yeah, just to clarify. The growth resumed in the fourth quarter, and then we do have seasonal weakness in the drivers in the first quarter.

[Dave Kang:]

Got it. Got it. And then, you talked about second quarter pickup. What about – as – going back to China again, what about the second half, how should we think about the pace of recovery? I mean, your competitor that reported yesterday, they were expecting sort of a modest recovery. What's your view as far as second half is concerned?

[John S. Edmunds:]

So, Dave, I think, Ford has already commented that we'd see about a 50% recovery, incremental increase in revenues in the second quarter. And then, we would expect to see half again as much again in the third quarter – half again as much of that increase again in the third quarter, and then a similar sort of increase in the fourth quarter. So, we'd see this coming throughout the year as a strengthening over time.

[Dave Kang:]

So, with that...

[Ford G. Tamer:]

John is referring to the TiA and driver business.

[Dave Kang:]

Right. Right. And then with COLORZ resuming growth in second half as well, then perhaps, we could see maybe year-over-year growth, maybe not third quarter growth, perhaps by fourth quarter?

[John S. Edmunds:]

You're asking about year-over-year growth, I think, the...

[Dave Kang:]

Yeah. Yeah. So, fourth quarter, the one that you just reported and the fourth quarter this year.

[John S. Edmunds:]

Yeah. I think it's possible in the fourth quarter, Dave. Third quarter is – it would be a question of I think how robust the business gets through into the back half. It's certainly possible for us to have year-over-year growth in both the third and fourth quarters. But I think it's more likely in the fourth quarter, but possible in the third quarter.

[Dave Kang:]

Okay. And then, going back to the second quarter pick-up. So, when do you expect to get those orders for second quarter to grow like 50% for your drivers and TiAs?

[John S. Edmunds:]

So, I explained a little earlier, Dave. We have – we have some orders for Q2 already on the books and we'll – but it's at a low level and we'll begin to book more as we – over the next probably month, month and a half or so. Typically, when we announce the quarter, overall for the business, we're about 60% or 70% booked for the given quarter. And then for Q2, it would be similar. By the end of April, we'd expect to be about 60% to 70% booked.

[Dave Kang:]

Got it. Thank you.

[John S. Edmunds:]

Okay.

[Operator:]

And our next question comes from Richard Shannon of Craig-Hallum. Your line is open.

[Richard Cutts Shannon:]

For John, thanks for taking my questions as well. Maybe a question for you, Ford, on the M200. I wonder if you can give us a sense of the breadth of customer win success that you're seeing, how many of those do you think will be generating revenues in the second half of the year?

[Ford G. Tamer:]

Sure. So, if you take out on the sort of 70% market that we had discussed prior on the TiA and driver, to get to 70% you take out Ciena and Infinera, that's two captive customers for the TiA and driver. When it comes to DSP, Infinera buys an ASIC from outside. But for the sort of merchant standard product, there is Huawei, ZTE and FiberHome in China, and there is Nokia in Europe, and there is Cisco in the U.S. as the next five customers. We have three of those five that are engaged with us actively towards ramping in the second half. And so, those are the big five outside of the two Infinera and Ciena we had called captive in the past. And then there is quite a few smaller customers such as Agilent, Fujitsu and others and you see we're engaged with some of those ones as well. So, we have a – and in addition finally, we have engagements with module customers. So, we have couple of module customer building DCO with the M200. So, we have, I would say, a half a dozen between OEM and module customers very actively working on designs, both line cards and DCO with the M200. And those will all go to production in second half of this year.

[Richard Cutts Shannon:]

Okay, perfect. Great detail there. Thanks for that, Ford. Second question from me, regarding the single-lambda PAM4, if I remember correctly, you call that one Vega. Wondering if you could give us a sense of the competitive situation there. I know it's kind of early in the sampling stage. So, it's hard to say, but wonder if you could give us a sense of what you're seeing there.

[Ford G. Tamer:]

Sure. Richard, thank you for the question. Let me clarify our road map. So the first product we shipped is a product called Polaris that has been shipping since Q2 of 2017 – I'm sorry, February of 2017, the second months of 2017. And that's a 50-gig PAM that can be used for both 200-gig and 400-gig module. And this was in response to Harlan's question where I responded that this will grow first in the IA application, second in Infiniband application, and then eventually along with Tomahawk 3 type applications. Our second product is a retimer, and that's what we call Vega. So Vega is still a 50-gig PAM product and that's a retimer that goes on line cards. And that again in response to Harlan's question, that's the one that I said will go on the line card to be designed next to a captive switch ASIC from a large system OEM. And we're starting to get actually more traction right now. We've closed a few more designs since. So we probably have three to four system OEMs putting that retimer on the line card next to the switch. Then the third product, which is the 100-gig PAM, also referred to single-lambda PAM, that's what's called – that we haven't announced it yet, so = I'm not going to disclose the name or the announcement date, but that's what would be used to build 400-gig, both QSFP-DD and OSFP modules, and that's the third one I discussed in my prepared remarks. That's also having excellent traction. So, we have multiple design wins for all three of these generation of products, and very excited about Polaris ramping starting in Q2, followed by Vega in the second half, and followed by the last 100-gig PAM single-lambda product towards end of this year into early 2019.

[Richard Cutts Shannon:]

Okay. Just to follow up quickly on that last point there, Ford. So do you have design wins specifically for the single-lambda yet or is that still too early to say?

[Ford G. Tamer:]

Yes, we have multiple design wins for the single-lambda product.

[Richard Cutts Shannon:]

Okay. Perfect. I think that's all the questions from me. Thanks for all the detail, Ford.

[Ford G. Tamer:]

Thank you, Richard.

[Operator:]

And our next question comes from Tore Svanberg of Stifel. Your line is open.

[Tore Egil Svanberg:]

Yeah. Thanks. I just had two follow-ups. First of all, I'm still a bit surprised by this sort of feast and famine quarter-to-quarter, Ford. So, is there anything else that you can add as far as I mean, did your customers just want to completely draw down inventory of certain products? Just trying to understand a bit better this sort of constant feast and famine behavior.

[Ford G. Tamer:]

Tore, thank you for the question. So, the question is trying to understand really the Q1 drop as compared to Q4 or possibly Q2, right? And I'm assuming, Tore, you're referring to the fact we're saying we're going to grow 50% sequentially in the TiA and driver business from Q1 to Q2, right? And the fact we're confident that this growth will happen from Q1 to Q2 at this kind of rate. Hence, sort of implying a feast or famine was this big drop in Q1 and the recovery in Q2, is that the right question?

[Tore Egil Svanberg:]

Yes, correct.

[Ford G. Tamer:]

Okay. A simple, maybe, answer is we and others in the industry have been reporting these type of challenges in the market for the past few quarters. And it seems like different players in the market have all had a bad quarter somewhere along the way where you basically stopped fighting it and then sort of cleared up the deck and started from a new base and grew from there. So, it's pretty much where we are. I mean, we have been fighting those challenges now for the past few quarters, and Q1 is the bottom. As you could see, expect a substantial recovery from Q1 into Q2 for the TiA and driver business along with a growth in the other businesses and get back on track from there. So, I could go back to the four factors that I went back in my prepared remark, Tore. But basically that gap between 100-gig to 400-gig – so, the 100-gig is what grew that market from 2012 to early 2017. And then we have a bit of a lull until that 400-gig starts again in 2019. And actually starts in the second half of 2018 into 2019. So, that's factor number one. Fact number two, the inventory situation where we and others have had been selling ahead of demand into that market for the past few quarters. And really the price transition this year has been slightly higher than the usual price declines that we've seen in prior years. Because there was a higher inventory situation, we and others competed probably more fiercely to maintain these sockets and to maintain the market share, and hence I think the OEM customer probably enjoyed a higher price reduction in Q1 than they would have typically otherwise have received. And again, that is factored into our Q1 decline. And I think finally, this whole transition from gold box driver to SMP that is the last factor. So, you put all these together, Tore, and that's what probably creates that feast or famine.

[Tore Egil Svanberg:]

That's very helpful. And the other follow-up was just on COLORZ. So, with your largest customer there being down less than $5 million in Q1, is that just a seasonality factor, and do you expect that to start resumption of growth in Q2 or is that also more of the second half growth?

[Ford G. Tamer:]

No. We do expect some growth in Q2, Tore, it's more or less seasonal. It's an order of timing for them in construction builds and things that they're doing in their data center. So, we have to kind of adhere to their schedules and wishes as far as it goes.

[Tore Egil Svanberg:]

Okay. So, I mean, COLORZ hasn't really had any seasonality in the past, right? So, should we start thinking about maybe Q1 being sort of a seasonally lower quarter for COLORZ?

[Ford G. Tamer:]

Well, we probably need another data point or two of experience to really suggest a trend. But certainly, you can always think about whether construction builds and the timing of projects in Q1 sometimes are a little slower because people are making plans and they just got their capital budgets approved and so forth so.

[Tore Egil Svanberg:]

That's really helpful. Thank you.

[Ford G. Tamer:]

Yeah.

[Operator:]

And our next question comes from Joe Moore of Morgan Stanley. Your line is open, Joe.

[Joe L. Moore:]

Great. Thank you. Yeah. I just wanted to follow-up on this – the volatility in the TiA driver business. And I guess if you could frame it in terms of where you think consumption is, is that Q2 level that you are covering too, is that kind of the level of base consumption and Q1 reflects further inventory drawdown or just anything that you can give us where we're obviously below some level of true consumption, if you have a sense for where that consumption level is in the Q1 timeframe?

[John S. Edmunds:]

Joe, this is John. I think we'll see some recovery as Ford pointed out, it's fairly healthy off of Q1 – a very low Q1 in the amplifier and driver businesses, so we'll see some recovery in Q2. And I think it's more the Q3 plateau where that business gets back above $30 million or so, that's more or less a sustainable state that may grow modestly from there.

[Joe L. Moore:]

Okay, great. And I guess, I mean, it seems like it's been hard for you and for everybody to get visibility into how much inventory is actually there over the course of the last four quarters or five quarters. How comfortable are you now that you sort of have your hands around that situation and that – I think, you showed some data at the conference late in Q4 that sort of showed the path of consumption versus your shipments, do you think at this point we're sort of – have pretty good visibility into where we are with that, and that's why you can guide for that ramp back up from Q2 and beyond?

[John S. Edmunds:]

Yeah, it's a combination of factors that lead to our confidence. But one certainly was our – we went and did a lot of research. It's difficult to do because you've got multiple supply chain levels to go track down for amplifiers that might go in as part of an assembly or a module and then get consumed by the system manufacturer at a top level. So, it's really knowing what that system manufacturer is consuming, that we have less visibility, and we have – I don't know a good half or more customers that will be taking TiAs that we'll be selling into those customers. So, the primary difficulty for us is knowing how big that consumption was. As you recall, we took a pretty good drop in revenues in this area in the second quarter last year. I think, it was as much as $25 million or so. And we would have thought that would have led to inventory absorption. But as we found out later, based on hearing reports from market analysts about consumption levels, that drop also was coincident with the drop in consumption by the system OEMs. So for Q2 and Q3, really weren't absorbing TiAs. We just start really in Q4 with another drop in our volumes by roughly $10 million or so, and continue to have a slightly higher level than that into Q1. So these are the first two real quarters of inventory absorption taking place since the first quarter of last year when revenues began to drop.

[Joe L. Moore:]

Great. That's very helpful. Thank you very much.

[John S. Edmunds:]

Thanks, Joe.

[Operator:]

And our last question comes from Quinn Bolton of Needham & Company. Your line is open.

[Quinn Bolton:]

Hey, guys, just wanted to clarify because I've got some questions coming out of the MACOM report last night, and some of the comments they made about CWDM4, cannibalization of LR4, you guys don't have a lot of data center module or datacom module exposure, but I think you do ship some CDRs. Can you give us some sense, what's your direct exposure today in terms of CWDM4 or LR4 as a percentage of your total datacom or your total revenue base?

[Ford G. Tamer:]

Yes. Thank you, Quinn. Our exposure on the CDR is really in short 2 kilometer-type of offering inside data center, we've got some LR4 – we don't have an exact breakdown of that mix. It's not a large piece of that business though.

[Quinn Bolton:]

Okay, great. Thank you.

[Operator:]

And now, I'm showing no further questions from our phone lines. I would now like to turn the call back over to John Edmunds for closing remarks.

[John S. Edmunds:]

Thank you, Latanya. So, Inphi plans on attending the Piper Jaffray Local Optical Conference in Santa Clara on the February 21; the Morgan Stanley Conference in San Francisco on February 26; and an Optical Bus Tour with Cowen and Company in Santa Clara on either the March 6 or 7. We'll also be meeting with investors with Needham and Stifel formally at OFC and informally at OFC. So, that will be on March 13 and 14. Remember OFC is really a trade show, not an investor conference, but we'll be happy to try to help people to the extent we're able to when we're there. Again – Ford and I would like to thank you – and Deborah would like to thank you for joining us today. And we look forward to speaking with you again in the future.

[Operator:]

And ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day.