Inphi Corp
Q4 2018 Earnings Call Transcript

Published: 30 Jan 2019

[Deb Stapleton:]

Good afternoon, everyone. We appreciate your joining us today to discuss the Financial Results for the Fourth Quarter of 2018. I'm Deborah Stapleton, handling Investor Relations for Inphi. And with me today is Ford Tamer, Inphi’s President and Chief Executive Officer; and John Edmunds, Inphi’s Chief Financial Officer. John will begin the call with the safe harbor then Ford will give you an overview of our business. After that, John will provide a financial summary of Q4 2018 and the outlook for Q1 2019 then we'll be happy to take your questions. John?

[John Edmunds:]

Thanks, Deborah. Please note that during the course of this conference call, we may make projections or other forward-looking statements about Inphi, including references to our prospects and expectations for 2019 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 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. Now to begin our review of the quarter, let me turn the call over to our CEO, Ford Tamer. Ford?

[Ford Tamer:]

Thanks, John, and thank you for joining us for Inphi’s fourth quarter and year-end 2018 earnings update. While the markets were volatile in late 2018, our Inphi business was solid and unwavering. We finished the year with revenue of $86.5 million in Q4, our third quarter in a row of double-digit revenue growth. Our solid performance was driven by the initial production ramp of PAM technology for 200G and 400G optical communication with U.S. cloud customers. In addition, the 23.7% non-GAAP income from operations in Q4 2018 further validates Inphi’s business model. It also tangibly demonstrates the effectiveness of the expense control initiative we launched last year. This resulted in EPS of $0.45, which exceeded the consensus estimate by $0.03 per share. While we experienced disruption in late 2017 and early 2018, we have realigned our business to match the environment. As a result, we recovered and grew in the second half of 2018. We put the train squarely back on the track. To put a point on that last statement let me say from the start for us it has been business as usual in China. We adjusted our outlook at last quarter’s earnings call and anticipated some seasonality in the first half of 2019 however as you are well aware the U.S. indited Huawei yesterday. Given the Huawei was a 14% direct customer in 2018, we have been and will continue to watch the situation and the ongoing trade talks closely. Actually, we have been working hard to diversify our customer base and business to a more global footprint, since the inventory correction in the China long haul and metro market in early 2017. Our diversification plan included three specific actions. Diversify into the cloud data center market, which is primarily U.S. driven. We have already moved our business from about 80% telecom in 2016 to less than 40% telecom in 2018, while increasing our data center to over 50%. Second less than our exposure to anyone customer in China by expanding our business to the other China based system OEMs and module makers. Based on business as usual, we believe our non-Huawei business to grow from about one third of our total business in China in 2017 to an expected two thirds in 2019. And finally, expand our current business with European and North American based system OEMs. Therefore, based on current circumstances, we expect that we can achieve the consensus seasonally adjusted estimate of $0.28 in earnings per share in Q1 2019 to be followed by strong growth in the latter half of the calendar year. Our plan is to be one of the fastest growing semiconductor companies in 2019 with strong operating profits. For the commentary portion of the earnings call, I’ll talk about the growth driver that will contribute to our 2019 revenue with four product lines of Inphi

[John Edmunds:]

Thanks Ford. Now let me recap the key financial results. In the fourth quarter of 2018, Inphi reported revenue of $86.5 million, which was up $8.5 million, or 11%, from the $78 million we recorded in Q3. Overall, we believe Q4 was the final step toward recovery and we're proud to recognize that we had 1% year-over-year growth in revenue in Q4 and 26% year-over-year growth in non-GAAP net income, which was $20.5 million in Q4 2018 compared to $16.2 million in Q4 2017. We also believe we are well positioned to continue to grow on an annual basis in 2019 with annual revenue growth forecasted to be in excess of 20% and annual non-GAAP net income forecasted to be – to grow more than 85% year-over-year. With that, let me address the details of Q4’s 2018’s performance. We will address our long haul and metro products as telecom going forward, which will include upcoming 5G ramp and future access products. Telecom products including coherent amplifiers, drivers and coherent DSPs represented 39% of the business in Q4 and was up 3% compared to Q3. At the same time, data center products including COLORZ, the Optical PHY business and data center TiAs and drivers represented 55% of total revenues. This was up $8.4 million, or 21% sequentially compared to Q3. The legacy transport business representing 6% was down 2% or 800,000 sequentially. In Q4 2018, GAAP gross margins were 57.2%, up from Q3’s 55.7%. This improvement reflects the absence of the final $300,000 charge for purchase accounting step up in value recorded in Q3. The GAAP gross margins include $9.7 million in purchase accounting and amortization of intangible adjustments and $700,000 of stock compensation expense whereas the non-GAAP numbers do not. Please see the reconciliations in the press release for more detail. Gross margins on a non-GAAP basis in Q4 came in at 69.3%, down 10 basis points from Q3. The Q4 gross margins continue to reflect additional inventory reserves as they did in Q3 resulting from forecasts for certain older technologies continuing to appear as if they will roll over a little faster than previously anticipated. Q4 GAAP net loss was $21.6 million. We then add back adjustments of $35.6 million of certain standard GAAP expenditures. The standard adjustments of $35.6 million for stock compensation, acquisitions, purchase accounting and convertible debt cost amortization, which compares to the $36.3 million recorded in Q3. There was also adjustments to other income reflecting approximately $100,000 gain on an equity investment and approximately $7 million impairment reserve on another private optical company investment where we had – which we had held approximately 4% in for some time. A significant portion of that company has recently gone into receivership in the UK and their future prospects or otherwise currently unknown. Finally, we adjusted for the associated additional tax expense by approximately $400,000 to arrive at Q4 non-GAAP net income of $20.5 million. The non-GAAP net income of $20.5 million for Q4 was up 50% from the $13.7 million for Q3 and it was up 27% from the $16.2 million reported in Q4 of 2017. Now let's look at the remaining components of non-GAAP reporting that led to this Q4 non-GAAP result. Non-GAAP operating expenses for Q4 totaled $39.4 million, which was down $1.1 million or 2.8% compared to the $40.6 million in Q3. We have been reducing our gross operating spend consistently over the last six quarters. Overall, Q4 non-GAAP operating income and margin has increased 52% sequentially from $13.5 million or 17.4% of revenue in Q3 to $20.5 million or 23.7% of revenue in Q4. Virtually all of the improvement is explained by higher revenue as well as operating expense savings. GAAP interest expense net of other income for Q4 2018 totaled $13.2 million expense. If you add back $6.8 million in accretion and amortization expense associated with convertible debt and a $6.9 million net impairment of investments, you will arrive at $0.5 million non-GAAP other income including interest for Q4. This is primarily driven by fixed income interest from our investments earning about 2.4% annualized offset by the cash coupon costs of the convertible debt, which blends to an annual cost of approximately 0.972%. The GAAP income tax expense for Q4 was a charge of $195,000, which represented an adjustment to the overall GAAP book benefit for the year of $8.2 million. Of this amount, approximately $6.7 million benefit was booked in Q1 of 2018 based on the release of evaluation reserve related to purchase accounting and the M200 product going into production. In general, we find the ongoing overall GAAP tax rate, which changes throughout the year based on a number of factors not always related to income to be difficult to forecast. The non-GAAP effective tax rate for Q4 came down to 2.6% based on greater international income. This brought the non-GAAP effective tax rate for all of 2018 to 3.5%. We continue to forecast the 2019 non-GAAP effective tax rate to be 5.5%. Worldwide cash income taxes paid in Q4 of 2018 was $56,000 primarily in Germany regarding the total world – bringing the total worldwide income taxes paid for the year to $2.16 million. Now turning to the balance sheet. Overall cash was $407 million at December 31st. This was up $11 million from the $395 million at the end of September, primarily due to higher cash flow from operations. Cash flow from operations in Q4 was $29.8 million as compared to $22.3 million in Q3. This represented an improvement of $7.5 million mainly generated by an improvement in GAAP net income plus add-backs. Capital expenditures were $7.9 million in the quarter, up from $6.2 million in Q3. Free cash flow also improved $17.7 million in Q4 compared to $10.2 million in Q3 2018. DSOs increased to 64 days at the end of December compared to 56 days at the end of September based on some deposits build in advance at the end of December for work to be done in a future quarter. As of this date of the earnings call, these additional amounts were all collected. Absent these billings, DSO would have been 59 days at the end of December. Inventory decreased by $1.1 million in the quarter due to a variety of factors as a result inventory days were 114 days or 3.2 turns at the end of December down from 130 days or 2.8 turns at the end of September. Now, let me recap the business outlook for Q1, 2019. 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 seasonally down by approximately $5.5 million or down 6% sequentially in Q1, which will also represent 35% growth, compared to Q1 of 2018. The sequential decrease in Q1 primarily due to seasonality and a softer outlook in both the data center and telco businesses in the first quarter of 2019. This would bring revenue to $81 million at the midpoint plus or minus one million resulting in revenue in a range of between $80 million and $82 million. For GAAP reporting in Q1 we are currently forecasting GAAP gross margins to be in a range of 56.5% to 57.8%. GAAP operating expense should be in a range of $60.5 million to 61.7 million. Absent non-income income related adjustments, we would expect the GAAP effective tax rate to be approximately a negative 1.6% to a negative 2%. That is a benefit against the loss to the extent we believe we can realize that benefit in the relevant jurisdictions. GAAP net loss would then be in the range of $21.8 to $22.8 million. GAAP earnings per share would then be a loss in the range of $0.49 to $0.51 per basic share on 44.45 million forecasted basic shares. A more complete reconciliation of the forecast of Q1 GAAP net loss and gross margin compared to forecast of non-GAAP net income and gross margin is included in the press release. For non-GAAP reporting in Q1 we are currently forecasting non-GAAP gross margins to be in a range of 69.5% to 70.5%. We expect them to improve by approximately 20 to 120 basis points, or to 70% at the midpoint. This is based on a stronger mix of gross margin in Q1 forecasted revenue mix. Now GAAP operating expense, non-GAAP operating expense to be in the range of $42.6 million to $44.2 million, this represents 10% sequential increase or about $4 million additional at the midpoint in Q1. The increase is comprised of approximately $1 million in annual payroll tax resets, $0.5 million to reset the accrual for company contributions to the 401k, $400,000 to reset the accruals for medical benefits and vacation, as well as $500,000 for additional headcount. And then a $1 million increase, $100,000 net increase for other line items, as well as a $1.5 million increase for a tape out – test chip tap out that'll be charged to R&D expense. We are currently estimating the non-GAAP effective tax rate to be 5.5% for Q1, 2018. We are confident that these components should then align resulting in a non-GAAP operating margin to be approximately 16.4%. This should also lead to non-GAAP net income of between approximately $12.7 million and $13.2 million. This will result in an estimated non-GAAP effect income per share of between $0.27 and $0.29 based on approximately 46.1 million estimated diluted shares. We will not update this outlook during the quarter until the time of the next quarterly outlook – 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'd be happy to take your questions. And one final note, let me note the Ford and I both have small 10b5plans pending to sell less than 5% of each of our respective personal shares in this quarter which may or may not execute in potentially additional quarters in 2019. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Harlan Sur from JP Morgan. You may proceed with your question.

[Harlan Sur:]

Hey, good afternoon guys and congratulations on this solid quarterly execution. On PAM forefront, given the growth in the datacenter segment in Q4, as you mentioned, it seems like you guys did about $38 million, $40 million in revenue last year, given in your prepared remarks. I think you said the team is on track to double PAM4 revenues this year and maybe if you could just verify that. This also kind of seems to correlate with the feedback that we have heard from many of your customers where it seems like you guys have won about two thirds of all of the kind of qualified 400 gig module opportunities out there. Would love to get your thoughts on, as you think about 2019 on the anticipated mix of revenues, Polaris 200 gig versus Porrima 400 gig in 2019 and maybe also kind of a rough mix of sort of Polaris-Porrima versus your Retimer products.

[Ford Tamer:]

Thank you Harlan. So this is couple of questions. So first, do we expect the revenue to double from 2018 to 2019 and now what is a higher base in 2018? And the answer is yes we do. So we do expect that PAM platform revenue, the DSP retimer, TiA driver to double in 2019 as compared to 2018 on a higher base. And we expect it to continue to increase significantly in 2020 and 2021. So that should be a very nice growth vector for us for the years ahead. As far as the mix between our 50 gig DSP Polaris, 100 gig DSP Porrima and our retimer Vega for 2019, we're looking at a Polaris being the majority – the larger piece of this was Porrima being second and the Vega being the third. And it's about a 45, 35, 20 type of mix.

[Harlan Sur:]

Great. Thanks for the insights there Ford. And then you guys have a lot of tailwinds this year and so thinking about some of those that you talked about, let's say in the long haul metro market, you've got your 45, 65 Gigabaud TiA and drivers around being into kind of 400 and 600 gig opportunities. Again, you guys have strong share, given the timing of service providers it seems like this is going to be more of a second half ramp, but wanted to get your views.

[Ford Tamer:]

Yes, thank you for that question Harlan. So we are excited to see the coherent part of our business going back to growth in 2019. And that's going to be driven by quite a few platforms. The largest grower in the next is our Coherent DSP already clarify acquisition our M200, which is a 100 and 200 gigabit product that's being deployed in line card as well as three different type of module, MSA, CFP and CFP2 applications. And then we're seeing that 64 Gigabaud TiA and driver, as you mentioned, being also a nice growth in the second half of the year, accelerating in the second half of the year along with platforms for 400 gigabit, 600 gigabit and 1.2 terabit from both merchant and captive if you wish DSP solutions.

[Harlan Sur:]

Great. Thanks Ford.

[Operator:]

Thank you. Our next question comes from Quinn Bolton from Needham & Co. You may proceed with your question.

[Ford Tamer:]

I think you're on mute. So you may want to un-mute.

[Quinn Bolton:]

Sorry Ford can you hear me?

[Ford Tamer:]

Hearing okay, great.

[Quinn Bolton:]

Okay great. Let me just echo my congratulations. And I'm wanted to follow-up on Harlan's questions around the PAM business. I think in the past you've estimated that there may be about a million PAM modules that ship in 2019. Just kind of curious what you think the total TAM would be or SAM would be for that? That one million modules that we kind of run the numbers it looks like your PAM business is going to roughly hit 75 million plus in 2019. And it would seem if they're only million modules you probably have the vast majority of that market share. But just wondering if you could kind of just size the market for us in 2019? And then I've got a follow-up on a coherent business.

[Ford Tamer:]

Quinn we did talk about that million port and in the past. And see like we'd end up with about a 65%, 70% share of that market to achieve the revenue numbers that we're looking for.

[Quinn Bolton:]

Okay great. And then maybe just a clarification, John I thought in your prepared script you had mentioned the coherent business might actually grow sequentially in the first quarter. And then I think in your guidance you said both datacenter and telco would be down. So just looking for that clarification, what do you expect the coherent business to do sequentially in the March quarter?

[John Edmunds:]

Both businesses will be down there, they're relatively slight. We're talking about the 5% or so overall, so these aren't large numbers. And of course the mix may shift through the course of the quarter. So I wouldn't bank on a one being in one position or the other. By the end of the quarter one could be relatively flat and the other could be down a little lower or vice versa.

[Quinn Bolton:]

Okay. Okay, great. Thank you.

[Operator:]

Thank you. And our next question comes from Tore Svanberg from Stifel. You may proceed with your question.

[Tore Svanberg:]

Yes, thank you and congratulations on this execution in a pretty tough environment. So Ford first question, and I think this becomes a really important one, especially now and we're about two months away from OFC. But how have the discussions been with your customer now that you obviously have very good working silicon both in Coherent and in PAM DSPs. Help us understand a little bit, what that means for your position of the next few years.

[Ford Tamer:]

Sorry, I think you're asking me two questions, what is our position on the PAM DSP and what's our position on Coherent DSP, is that correct?

[Tore Svanberg:]

No, it's more like having the capability to do both. How does that lead to discussions you have with customers right now in sort of the longer term roadmap?

[Ford Tamer:]

Okay. So the question is having the capability to do both a PAM DSP, as well as a Coherent DSP. How would that position us as a supplier for some of the major data center and telecomm customer, right?

[Tore Svanberg:]

Right.

[Ford Tamer:]

So if I look at the customer base, first looking at the cloud, obviously the cloud markets are migrating to PAM in a hurry. So we do expect in 2019 about 20% of the gray port inside data center to be PAM. By 2020, that number should increase to about two third and then by 2021 the war is over, it's about 80% PAM inside data center. And we're very well positioned on a 50 gig PAM DSP, 100 gig PAM DSP and 50 gig retimer having the widest portfolio of both DSP and retimer along with VCSEL driver, DMS driver, EML driver, silicon photonic and both TIA and driver when I say drivers. So it's TIA and driver for all of these different optics partners. And so the discussion was all the major cloud folks have been very solid as far as Inphi being a supplier for PAM inside the data center to their – through their module partner. So we obviously sell the components to the module partner who will in turn sell it to the cloud. But the cloud is a very tight discussion with us on roadmap of what the PAM – where the PAM needs to go. The same U.S. cloud and eventually China cloud supplier are the same ones that are engaging with us on discussion on ZR. So that ZR roadmap, going from a PAM 100G COLORZ today to a 400 gig coherent tomorrow, tomorrow being we'll sample it in the third quarter of this year and we'll go in production mid-2020. Those discussions are actually across the Board, across all of the same cloud customers. We’ve become strategic across both to inside data center as well as between data center furthermore, now that VR solution can go to ZR plus, then all of a sudden can go to 1,000 kilometers, then all of a sudden, we even are becoming more strategic, being a play for potential regional Metro and long haul regional Metro and long haul type of solutions. So as I look at that data center customer base having both PAM and coherent makes us strategic across the inside datacenter between datacenter and then even regional, metro and long haul. Now I forgot the telecom side of the business. What's interesting is, is almost the reverse. We started discussion with those folks based on metro and long haul type of discussions. First only discussing RTI and driver is all we had. And then we've added the coherent DSP that’s making us much more strategic across all of these net telecom OEMs if you wish. And some of them are choosing to continue to do their own roadmap at the high-end, but complementing their roadmap with immersion solution from Inphi at the sort of lower – not lower, but middle and if you wish. So we're seeing, for example, some of our top customers do their own 600 gig or 1.2T ASIC offering, competing with merchant solution from let's say Acacia or NEL, while adopting Inphi for the 200 gig metro, and even 100 gig long haul type solution where more the workhorse, high-volume base. Now those same silicon customers are now coming to us for 5G, which now is including PAM. So having the PAM solution is being again very strategic where that same long haul Metro telecom person, as they go to 5G, needs both coherent and PAM because they're not on mid haul and back haul application 4G and 5G are going to be created equal. And so you will have both PAM and Coherent. So I think having both of these, PAM and Coherent is going to be a very useful, strategic supply type of positioning for us as we move forward. So it’s a real long answer, but hopefully that addresses the question.

[Tore Svanberg:]

Yeah, no, Ford that was a great comprehensive response. I thank you for that. My follow-up question is a sort of linearity for this year, I know you obviously only guide one quarter out, but you also sound pretty confident in some of some of the consensus growth that moves up again this year. How should we think about the linearity as we move beyond this sort of seasonally weaker Q1?

[Ford Tamer:]

Thanks Tere. So John did go back five years and did an analysis of our seasonality for the first time for the second half of the year. And he found out that our second half is typically about 52% to 57% as compared to the first half. And so we expect that same 45-55 split if you wish for that year for the first half versus second half in 2019 as well.

[Tore Svanberg:]

Very good. Thank you and congratulations again.

[Operator:]

Thank you. And our next question is from Ross Seymore from Deutsche Bank. You may proceed with your question.

[Unidentified Analyst:]

Hi, I'd like to echo the congratulations. This is Ji for Ross Seymore. Ford you mentioned that Inphi is having good customer engagements for 5G for the backhaul. Can you explain if it's possible to see some pull in of that from 2020 into 2019 if the builds are happening a little bit and testing is happening a little bit earlier?

[Ford Tamer:]

Yes thanks Ji. So 2019 is really trials and early testing. We are seeing that being pulled in. So we're seeing that the trial and early testing being a bit higher than what we expected as far as volumes, but we do expect the ramp to still be in 2020. So we don't think the ramp timing has changed. But it seems like the trial and early testing has been more aggressive than initially anticipated.

[Unidentified Analyst:]

Thank you. And this question is for John on OpEx the company has done a good job in controlling OpEx. Past the Q1 step ups, how should we think about OpEx trending for the rest of the year?

[John Edmunds:]

We do have plans to add some headcount through the balance of the year. I think we’ll remain conservative through the first half and then you'll see some increases rolling into the second half. But I don't expect the year to be atypical or unusual in that regard.

[Unidentified Analyst:]

Okay. Thank you.

[Operator:]

Thank you. And our next question comes from Blayne Curtis from Barclays. You may proceed with your question.

[Tom O'Malley:]

Hey guys, this is Tom O'Malley on for Blayne Curtis. Congrats on the good results, particularly in this environment. Just first off on the 5G ramp I know there has been a couple of questions on it. And you're saying some testing is moving into 2019. Could you size that market for us? It may be too early for you to totally tell, but could you give us the figure in terms of TAM of what you think you can attack over the next several years and is that really going to be a material growth driver for you guys?

[Ford Tamer:]

Thanks Tom. Yes, we do believe it would be a sizable growth vector for us but really 2020. So the size in 2019 is a nice addition to the revenue, but it's not a major mover. It's good though to be part of those trials because those same customers then will take us to production. So we like being part of the trials but we expect a major revenue to be in 2020.

[Tom O'Malley:]

Great. And then switching gears a little bit here to datacenters and the PAM products, obviously there are some guys reporting here early in earnings you’ve seen some indications of slowing CapEx particularly in datacenters, how do you guys handicap that with you PAM products for this year and does slowing datacenter spent impact you or do you think the optical transition takes regardless of what they’ve spent.

[Ford Tamer:]

Thanks Tom. So 2018 was a very big year from a CapEx spent and so in comparison to 2018, 2019 looks like a bit of a deceleration as far as rate across, but there is still some growth. And we are seeing that being spent on the 200G and 400G, we are not seeing that 200G and 400G slowing down because as you know if any we were seeing actually are on track and according to expectations so any slowdown potentially could be in a 100 gig which we are not a part of it in a meaningful way.

[Unidentified Analyst:]

Great, thanks a lot guys.

[Operator:]

Thank you. And our next question comes from Mark Kelleher from D. A. Davidson. You may proceed with your question.

[Mark Kelleher:]

Great, thanks for taking the questions. I will continue the line of congratulations on a very tough environment. Is there any – have you seen any change in buying change in buying pattern from Huawei as the pressure builds on them?

[Ford Tamer:]

Thanks Mark. It's surprising it took us so long to have this question in the call. Thanks for asking it. As I said in my prepared remarks, we had not seen a change in behavior so far, after the indictment from yesterday, we're obviously in discussion with them and that may change. But in my prepared remarks we were discussing the pattern so far and all you've seen so far is inventory behavior – inventory levels that are slightly elevated from what we’d expect, but nothing too alarming. Moving forward, situations in flux and we were talking to them on a regular basis. We will closely monitor the situation.

[Mark Kelleher:]

And do you have any way to see any visibility into what product that you send to Huawei goes to China and what goes outside China?

[Ford Tamer:]

No, we do not have a way to track the products that go inside and outside of China. So that's not data that we have.

[John Edmunds:]

Mark this John. Mark, the one thing that you can look at Huawei does publish an annual report and I think the last one I looked at they had a mix of about 60% of their business in country and about 40% being exported outside of China.

[Mark Kelleher:]

Okay, great. And then just I wanted to understand the 5G rollout a little bit better, I will just clarify it a little bit deep. You’re going to participate in the back haul build out that will support 5G is that correct? That's the opportunity.

[Ford Tamer:]

Yes Mark, that's correct. We only are in the mid haul and back haul at this point we are not in the front haul base station. We are really in the infrastructure that supports the transport of the data behind the base station.

[Mark Kelleher:]

And is it would it be a fair assumption that build out – that back haul build out has to take place before you can deploy smartphones on it?

[Ford Tamer:]

No, I think it depends upon the operator. It depends on operators. Some operators are choosing to – could choose to deploy 5G handsets on old infrastructure, it won't give you the same speed, but still it would be “5G Handsets”. So it depends actually on the – you've seen all kinds of behaviors across the different handset and infrastructure equipment and mobile providers so it's not uniform across the globe.

[Mark Kelleher:]

Okay. And last question, just on the competitive environment on PAM4. Last quarter, you mentioned there were, I think you said four or five that were a couple a year or two behind you, is there any change in the competition there for PAM business?

[Ford Tamer:]

We still believe we're in a leadership position in the PAM. It's a large market so it will end up being multi-source, multivendor market. So we do expect competition and we do expect others to take share, but we are confident that we keep a leadership market share in that market.

[Mark Kelleher:]

Okay, great. Thanks.

[Operator:]

Thank you. And our next question comes from Wayne Loeb from Citi. You may proceed with your question.

[Wayne Loeb:]

Hi, thanks for taking my question and congratulations on the quarter. And I guess I'll pile on the Huawei questions and China questions a little bit. So is there anything you're seeing as far as the inventory levels in China compared to the rate of consumption, any analysis that you've done to build confidence that we won't have a repeat of a previous inventory correction? And is there any indications that anyone else in China maybe ordering ahead of looming sanctions or potential export ban?

[Ford Tamer:]

Thank you, Wayne. Good question. So first question after this inventory correction in the long haul and metro market primarily in China, and the – about a year and a half ago, we have instituted a very comprehensive program where we go out on the TiA side of the business and survey all our customer, the customer customers. So we've spent a very detailed amount of time understanding, for example on the TiA, not just the TiA inventory, but the ICR inventory and working with all the different partners in the supply chain and customers in the supply chain to make sure that we don't get a repeat of what happened in the past. And then we do the same on the driver. The driver is more direct contact with the customer directly. And typically we think the normal inventory in the channel is about three months inventory as I said in my prepared remarks or in my remark into one of the questions is we are seeing slightly elevated inventory level. We may have an extra month, so instead of three months we may be running it about a four months inventory right now, so not too alarming as of this point and we're not seeing one or the other OEMs in particular building more than the rest.

[Wayne Loeb:]

Thank you. One more question on this, for your Huawei business, what percentage of it is in the data center market versus the long haul and metro market?

[John Edmunds:]

Yes. The majority of our business with Huawei is in a long haul and metro, it's in the telco side. There's something that may lead to the data center market eventually, but they're not shipping yet.

[Wayne Loeb:]

Thank you.

[Ford Tamer:]

Wayne, this is Ford, the one increase in Huawei business has been on the 5G deployment. So the 5G deployment, we've seen an uptick there due to the trials that are ongoing.

[Wayne Loeb:]

Thank you very much.

[Operator:]

Thank you. And our next question comes from Paul Silverstein from Cowen, you may proceed with your question.

[John Edmunds:]

We cannot hear you. You may want to unmute the line please. Operator, can you help?

[Operator:]

Yes, one moment. Our next question comes from Fahad Najam from Cowen. You may proceed with your question.

[Fahad Najam:]

Hi, thank you for taking my question. I may have missed it, so I apologize if I'm asking you to repeat but can you remind us what Microsoft was in the quarter?

[John Edmunds:]

Fahad, we don't break out the numbers in the quarter, but since it will come out in the 10-K here in a week or two, I think we've already talked about Huawei being 14% of the total revenues in all of calendar 2018. Microsoft's been about 18% of the revenues in all of calendar 2018 and Cisco has been about 11% of the revenues in all of calendar 2018.

[Fahad Najam:]

Got it, thank you, appreciate that. So to my question in terms of the data center growth or I think in the past you've indicated that you expect data center to grow as much as 60% of total revenue and it seems like you had initially thought it would be in 2020 but the way you're seeing the business in the ramp inside the data center, would you say that it is probably more likely that you see this trend happening earlier in 2019 and how much of that data center – intra-data center is also being contributed by Microsoft excluding the ColorZ business?

[Ford Tamer:]

When you say Microsoft excluding ColorZ, most of the business who use Microsoft today is the ColorZ product line. We haven't, yet grown the business outside of ColorZ with Microsoft, so maybe answer the second question first. Most of the Microsoft business is expected to continue through the next 12 months to be primarily ColorZ. First step question are we okay there?

[Fahad Najam:]

Yes, got that, thank you.

[Ford Tamer:]

And then on the second question which is the percent of the data center in 2019, I think as – we just published a new presentation on our website and I’d refer you to that, where we are breaking up the percent of data center versus telecom. Let me find the slide number, its slide number 18. And you could see that, in slide number 18 of the presentation, we're saying, we ended 2018 at about 51% data center versus telecom. As we move into 2019, we expect that percentage to start growing towards mid-50%. So we're looking at probably closer to 55% data center versus telecom. But the telecom is going to have the Coherent DSP and the 64 gigabaud TiA driver showing some significant growth that will help that telecom business go back to growth. Plus we're classifying the 5G as a telecom piece, so those 5G trials I've been discussing would also grow will have to grow the telecom.

[Fahad Najam:]

Got it, appreciate it. Now, if I may ask one more question, it's a big longer-term view, big picture question. We’ve seen companies like Cisco, which are 11% customer of yours, acquire Luxtera, silicon photonics company and they have historically, Luxtera has claimed to have been working on building their own PAM4 DSPs, to the extent, how do you – how should we in the investment community be looking at the silicon photonics and prospective track to merchant supplier like you who are specializing in specific components or functions?

[Ford Tamer:]

Thank you, Fahad for that question. So we don't see this as a threat in a way that, we do not build modules inside the data center. So we supply components to module customers who then in turn, use our components to provide modules to the major cloud and other customers worldwide. So, as far as Luxtera having a PAM DSP, if, if they have a PAM DSP and it works as advertised, then we'd support Cisco with other components. On the other hand, if they would need a PAM DSP, we stand ready to supply the PAM DSP. So it's no different than any of the other customers we have, where sometimes they would choose to do their own components, sometimes they would choose to go to a merchant market for those components and we stand ready to support them either support some of the internal components or with our own components. So I'm not sure I'm answering it. Did I answer your question Fahad?

[Fahad Najam:]

You did. Thank you. Appreciate it.

[Operator:]

Thank you. And our next question comes from Richard Shannon from Craig-Hallum. You may proceed with your question.

[Richard Shannon:]

Well, thanks John for taking my questions, just a couple ones from me a while I didn't hear any commentary and I just want us to make sure, we've talked for the last few quarters about potentially gaining second significant ColorZ customer and I didn't hear any commentary, but I just wanting to see whether you expect to pull one in this year forward?

[Ford Tamer:]

Yes, so Richard. We as far as a second large cloud customers we do not believe we'd be able to convert a second large cloud customer to ColorZ. What we're seeing though is we're seeing a number of smaller contributions that could grow the business we said in the past, anywhere from 5% to 10% this year. And those would be mostly through OEMs that are servicing either the service provider or the ISP space or the enterprise space. So we're seeing now a good adoption from a few OEMs that could be a significant to the business and in 2019 would be just in 5% to 10% growth, but could then grow beyond this in 2020.

[Richard Shannon:]

Okay. Well that's helpful for that perspective. My last question, kind of a two-parter on PAM4 in response, one of your last questions about share expectations for calendar 2019, I think you said something like 65% to 70% share. First part of the question, is this a share you expect between Polaris and Porrima meaningfully different than that average. And I guess the second part is that you look past this year, any thoughts on competitive encroachments? I mean is that a number that they could below 50% in 2020?

[Ford Tamer:]

So first question is on the present share market share on Polaris versus Porrima versus Vega, we do believe that for 50 gigahertz PAM DSP, there'd be less competition in the short term. So we should have in a short term higher market share. In longer term we expect the contribution to – probably to be about the same. And then do we expect our market share to dip below 50% and 20%, it's too early to say. We believe we'll be able to maintain that over 50% share, but it's early to say. At this point, if you look at our market size that we talked in the past. We estimated that market size in 2020 to be $320 million. So in order for us to keep doubling, we'd have to maintain a share of about 50% which we believe we can do.

[Richard Shannon:]

Okay. Appreciate those perspectives. That's all from me for it. Thank you.

[Operator:]

Thank you. And our next question comes from Ross Seymore from Deutsche Bank. You may proceed with your question.

[JiHyung Yoo:]

Hi, this is Ji for Ross, just a clarification question for John. With the new segments, I think you mentioned in the prepared remarks that long haul and metro was renamed to I think long haul and telecom was there something that was moved out of that previously? What was included in that long haul? Metro was TiAs, drivers and then the Coherent DSPs. Is there something that was moved between the segments or was it a renaming of the segments?

[John Edmunds:]

No, we just renamed, there was nothing moved. We will include the 5G in those line items as we move forward. And then there may be some 5G business that’s in the data center line today, but we don't have plans to re-class that at this stage. So we'll probably just report 5G as part of telco moving forward.

[JiHyung Yoo:]

Okay. Thank you.

[Operator:]

And I am not showing any further questions at this time. I would now like to turn the call back over to Mr. John Edmunds, CFO for any further remarks.

[John Edmunds:]

Thank you, Josh. One clarification on the guidance for the quarter, I had talked about the components of increase in operating spending in Q4 – Q1 2019. And I referred to tape out expense of $1 million. I've received a note that that's really $1.5 million when you include the – the other ancillary costs related with a test chip tape out, so that's how you reconcile the $4 million in total. In addition, we'd like to let you know that we plan on attending the Morgan Stanley conference in San Francisco on February 26, as well as the optical fiber conference in San Diego in March 4th through the 6th time timeframe. Although this is a trade show focused on customers, we do meet with some investors who attend that conference. Ford and Deborah, I would like to thank you for joining us today and we look forward to speaking with you again in the future.

[Operator:]

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