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Edited Transcript of CAVM earnings conference call or presentation 26-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Cavium Inc Earnings Call

MOUNTAIN VIEW Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of Cavium Inc earnings conference call or presentation Wednesday, April 26, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Angel Atondo

Cavium, Inc. - Senior Marketing Communications Manager

* Arthur D. Chadwick

Cavium, Inc. - CFO and VP of Finance & Administration

* Syed B. Ali

Cavium, Inc. - Founder, Chairman, CEO and President

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Conference Call Participants

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* Anil Kumar Doradla

William Blair & Company L.L.C., Research Division - Analyst

* Blayne Peter Curtis

Barclays PLC, Research Division - Director and Senior Research Analyst

* Christopher Adam Jackson Rolland

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Gary Wade Mobley

The Benchmark Company, LLC, Research Division - Research Analyst

* Harlan Sur

JP Morgan Chase & Co, Research Division - Senior Analyst

* John Joseph Donnelly

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Joshua Louis Buchalter

Oppenheimer & Co. Inc., Research Division - Associate

* Matthew D. Ramsay

Canaccord Genuity Limited, Research Division - Principal and Senior Analyst

* Srinivas Reddy Pajjuri

Macquarie Research - Senior Analyst

* Vinayak Rao

Morgan Stanley, Research Division - Research Associate

* Vivek Arya

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Good day, and welcome to the Cavium, Incorporated Q1 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Angel Atondo, Senior MarCom Manager. Please go ahead.

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Angel Atondo, Cavium, Inc. - Senior Marketing Communications Manager [2]

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Thank you. Good afternoon, everyone, and welcome to Cavium's First Quarter 2017 Financial Results Conference Call. Leading the call today are Mr. Syed Ali, President and CEO of the company; and Art Chadwick, Vice President and Chief Financial Officer.

Before we begin, I would like to remind you that various remarks that we make on this call will constitute forward-looking statements for the purpose of the safe harbor provisions under the Private Securities Litigation Reform Act, and will be based on information currently available to us. We disclaim any obligation to update these forward-looking statements.

These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our most recent Form 10-K and Form 10-Q filed with the SEC, in particular to the section entitled Risk Factors, and to other reports that we may file from time to time with the SEC for additional information on these risks and uncertainties that could cause the actual results to differ materially from our current expectations.

In addition, during this call, we will discuss non-GAAP financial measures. Reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today, and we ask that you review it in conjunction with this call.

I will now turn the call over to Syed. Syed?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [3]

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Thanks, Angel, and thanks to everyone for joining us today. In brief, Cavium's first quarter revenue was $229.6 million, up 2% sequentially. Non-GAAP gross margins were 65.7%, and non-GAAP net income was $41.7 million or $0.58 per share. Art will discuss our Q1 financial results along with Q2 guidance in more detail shortly.

From Q1 2017, we will break up our revenues into 2 main infrastructure markets: the first is the Enterprise and service provider markets. This will include wired and wireless networking and communications, Enterprise storage, Enterprise security and the broadband markets. The second segment will cover the data center, which primarily includes data center servers, Ethernet switches, Ethernet mix and data center security.

Q1 is a seasonally softer growth quarter for the infrastructure business. In Q1, sales were up in both segments. In the Enterprise and service provider markets, we saw continued strength in the wireless infrastructure market, while other markets in this segment was stable to up. Sales into the data center were also up. Art will discuss in more detail in his section the break down.

Now as usual, I will go into the highlights of our product traction in the quarter. We continue to win significant designs for both our MIPS-based OCTEON and ARM-based OCTEON TX processor product lines. During Q1, we won several high-end OCTEON predesigns in the firewall and network security area. During Q1, we increased our penetration in both the mid-ranged 8- to 24-core and the lower end 2- to 4-core markets as our ARM-based OCTEON TX line gained design win traction.

A highlight of the quarter were the first ARM-based OCTEON TX processor design wins in 5G base station and storage for control plane applications. Our OCTEON Fusion-M 75xx shipments remains strong and ahead of our expectations. Our lead customer has continued to gain market share and access to new markets.

At MWC, we introduced the CNS73XX, the baby Fusion-M, which is a scaled down version targeting significantly lower price points, but with full macro base station features. Target markets include smaller towns in developing countries, rural areas, fixed wireless broadband and urban infill deployments. We are currently working with a few lead customers for this particular product.

With the impeding 5G transition, we are seeing increasing interest in our OCTEON, OCTEON Fusion-M and ThunderX product lines, as operators move to virtualize their existing networks. In order to highlight the broad solutions that we are providing to address this trend, we showcased the full [ONDOT] lab M-CORD NFV SDN fabric and the radio access network application running entirely on ARM-ThunderX servers and OCTEON Fusion-M at the MWC Show in Barcelona.

Our LiquidSecurity and NITROX security products continue to perform well. We have further increased our LiquidSecurity engagements in the hyperscale cloud markets with evals at 2 more cloud service providers. The benefits our LiquidSecurity products provide are highly differentiated and extremely valuable for several usage models in cloud security. Overall, we have a strong pipeline of customers at various stages of eval.

Our NITROX products continue to win designs in cloud security applications as well as in our traditional application controller and security gateway segments across multiple geographies. Overall, we continue to see strong need for encryption and authentication across data center and OEM customers.

Our LiquidIO II revenues continue to grow. We expect higher growth starting in the second half of 2017, with the production deployment of the 25-gig LiquidIO II card. We further continue to strengthen our pipeline of engagements by adding several customers in the teleco and hyperscale cloud provider markets.

Now moving on to the XPliant switch product line. In Q1, XPliant was awarded the Linley Group's Analyst Choice Award for Best Networking Chip of 2016. Cavium's XPliant Ethernet switch was selected as winner due to its customer programmability, which enables customers to differentiate their products through unique features and also enables in-field upgradability. In addition, Cavium announced a collaboration with Microsoft to showcase its SONiC network operating system compatibility at the OCP U.S. Summit. At OCP, SONiC was demonstrated running on XPliant-powered 32 x 100G platform from Edgecore Networks. We expect revenues to continue growing as our lead customer, Arista, ramps this year. In addition, a second announced customer, Brocade, which will become part of Extreme Networks, also started shipments.

Finally, in Q1 2017, there were a number of newsworthy items regarding ThunderX product line. We have started sampling ThunderX2 silicon and reference systems to select public, private cloud and HPC cloud customers. We also kicked off multiple ODM production server platforms based upon ThunderX2.

In January 2017, Bull, a leading HPC server vendor in Europe announced that they're building a sequana-blade based on ThunderX2 for their Mont-Blanc 3 HPC program. This program is part of the European Union's Exascale initiative, and positions ThunderX2 as a viable alternative to x86 servers even for Exascale computing.

In March 2017, at the Open Compute Summit, Cavium and Microsoft announced a collaboration to enable ThunderX2 based platforms for Microsoft as your cloud internal infrastructure. At the event, Cavium and Microsoft demonstrated a ThunderX2 based ODM server platform, running a Bing search workload on Windows server developed for Microsoft Azure's internal use. Microsoft and Cavium have been working together for the past 18 months to enable Windows server on our platforms.

Microsoft announced a long-term collaboration on current and future ThunderX products. They also indicated that with high performance server processors like the ThunderX2, which are very competitive with the latest generation of incumbent x86 processors, that they believe it can target a significant portion of their infrastructure, including applications such as high-performance storage, search, Big Data, machine learning and platform-as-a-service initiatives within the Azure cloud. This could not have been addressed by the first generation of ARM processors. We see this announcement as a strong validation of the potential of ARM servers in the cloud market.

I would now like to provide an update on the businesses acquired from QLogic. With our second full quarter of operations behind us, the businesses are operating extremely well and the product teams are continuing their focus on market and technological leadership, serving the connectivity needs of top Enterprise and data center customers worldwide.

We continue to hold a strong position, with all the world's major Enterprise server, storage and storage OEMs, and are strengthening our position across Cavium's cloud, Enterprise and OEM customer base. The storage products that include both market-leading fiber channel and Ethernet connectivity solutions, see continued success in new design wins and existing designs going into production at major OEMs.

In the March quarter, we racked up 18 new design wins, 2/3 of the wins were in storage system connectivity and 1/3 were in server connectivity.

We are seeing high activity and design win success in the storage system connectivity side of the market driven by all-flash arrays and faster connectivity options, such as 32-gig fiber channel and 25-, 50-, and 100-gig Ethernet. The new design wins are expected to start contributing to revenues in 2018.

Our Ethernet FastLinQ products have continued to gain market traction at major OEMs in Q1. We won several new designs at major server OEMs. Our engagements in the hyperscale, cloud, telco cloud, private and hybrid cloud and networking OEMs have increased significantly across all applications, given our broad and feature-rich product family across 10-gig, 25-gig and 100-gig speeds.

Our recent HPE and Microsoft Windows premium certifications announcements highlight the traction that we are experiencing in the Ethernet [net] market.

Now I would like to move on and give a brief outlook on the market environment that we are seeing for Q2. In Q2, we see a strengthening demand environment across our products. We expect the Enterprise and service provider markets to be up with broad-based growth along with accelerating demand trends in wireless infrastructure. We also expect the data center markets to be up in Q2, driven by new product ramps in our broad product line.

On that note, I would now like to turn the call over to Art Chadwick, who will provide a detailed discussion of Q1 financial results and guidance for Q2 2017. Art?

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Arthur D. Chadwick, Cavium, Inc. - CFO and VP of Finance & Administration [4]

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Great. Thanks, Syed, and thanks to all of you for joining us today. I'll first go through Q1 financial highlights and then provide guidance for the second quarter of 2017.

First of all, Q1 was a truly excellent quarter with record revenue and record non-GAAP earning. Revenue in the first quarter was $229.6 million, up 2% sequentially and up 125% over the same quarter last year due to both Cavium organic growth as well as the addition of QLogic.

Sales into the Enterprise and service provider market accounted for 77% of sales this quarter, while sales into the data center were 23% of sales. And to provide some context, that sales split was almost exactly the same in Q4.

Non-GAAP gross margins continued on an upward trend and were 65.7%, up 70 basis points from Q4. Non-GAAP operating expenses were $100.2 million, up 2% sequentially due primarily to beginning of the year employee raises and employment taxes.

Non-GAAP operating income was $50.6 million, up 3% from Q4. Operating margins were 22.0%, up 40 basis points from Q4. Net non-GAAP interest and other non-operating expenses were $7.6 million.

In March, we refinanced our term debt, which reduced the interest rate by 75 basis points, the original debt at a rate of LIBOR plus 300 basis points. The refinanced debt now has a rate of LIBOR plus 225 basis points.

Income tax expense for the quarter was $1.3 million or about 3% of non-GAAP income. The GAAP net loss for the quarter was $50.5 million or $0.75 per share. The non-GAAP net income was $41.7 million or $0.58 per share, up 5% sequentially.

For the detailed reconciliation between our GAAP and non-GAAP results, I'd like to refer you to the press release we issued earlier today.

But in summary, our non-GAAP results exclude $92.2 million in non-GAAP adjustment, which includes $29.0 million in acquisition-related amortization; $25.8 million in acquisition and product rationalization inventory charges; $25.7 million for employee stock-based compensation expense, which includes stock issued by Cavium as well as stock assumed from QLogic; $9.0 million in realignment and acquisition-related charges; and $2.7 million in acquisition-related debt refinancing cost.

To provide some insight into Q2 non-GAAP expenses, we expect acquisition-related amortization and stock-based compensation expense to be relatively flat quarter-to-quarter, but inventory charges will decrease substantially. When we acquired QLogic, the accounting rules required that we step up the value of the acquired inventory, and expense that stepped up amount as the inventory was sold. Now that most acquired QLogic inventory has been substantially sold through, inventory charges in Q2 will be nominal.

The quarter-end AR balance was $136.5 million, up from $125.7 million in Q4. DSOs were 55 days, up from 51 days in Q4 but still below our long-term model of 60 days plus or minus. Inventory at the end of the quarter was $100.5 million. This was down from $119.7 million in Q4, but due primarily to the noncash inventory charge this quarter.

In Q1, we paid down $86 million of our acquisition-related debt, and plan to pay down additional debt in Q2.

During the quarter, we generated $32.2 million in positive non-GAAP cash flow from operations. We made payments of $21.2 million towards EPNE and intangible assets and $14.0 million in net other payments. We finished the quarter with $132.4 million in cash.

I would now like to provide more specific guidance for the second quarter of 2017. We expect sales in Q2 will increase to between $237 million and $241 million, which as a midpoint, would be just over 4% sequential growth. Non-GAAP gross margins should expand by between 20 and 40 basis points, which as a midpoint, would be approximately 66%.

We expect non-GAAP operating expenses will increase between 1% and 2% sequentially to approximately $102 million. Interest and other nonoperating expenses are expected to be approximately $7 million. Income taxes in Q2 are expected to be approximately $1.5 million, increasing to between 3% and 5% of non-GAAP income in the second half of this year and to between 6% and 10% of non-GAAP income in 2018.

The Q2 non-GAAP share count is expected to be approximately 73 million shares. And based on those assumptions, we expect Q2 non-GAAP EPS will be between $0.64 and $0.66 per share.

And on that note, I'd like to hand the call back to the operator for our Q&A.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [5]

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Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Blayne Curtis with Barclays.

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Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [2]

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Syed, on the (inaudible) you guys had a very strong rank -- ramp with Fusion-M. As you look into June -- I was curious, the comment, is that more broad-based or is it just continuing ramp on Fusion-M?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [3]

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No, this is pretty broad-based, which includes our second large customer and couple of other smaller ones too.

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Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [4]

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Got you. And then, I just wanted to understand, you mentioned design wins of FastLinQ on the Ethernet side. What's the right trajectory to think about with those wins be revenue this year? Or is it really more next year when you would see Ethernet ramping?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [5]

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Yes, I think -- yes, some of the those -- some of the wins, especially on the Ethernet side, will start generating revenue along with the PureVu cycle, which starts, I think in the Q3 timeframe, I think, somewhere in the August, September timeframe. So there'll be start of revenue for those designs in the back half of this year.

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Operator [6]

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We'll take our next question from Anil Doradla with William Blair.

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Anil Kumar Doradla, William Blair & Company L.L.C., Research Division - Analyst [7]

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Just a couple of questions. Syed, you talked about Microsoft. You saw -- we saw the press release from the recent conference. Can you share with us, over the next 12 to 24 months, what kind of workloads would your solutions be employed for? Because, there's -- is it for internal IT or is it for the Azure system? Microsoft has done, what, up to 50% being ARM servers. So can you kind of rationalize some of that commentary that Microsoft is giving with respect to your solutions?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [8]

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I think, Anil, if you look at the press release itself and if you look at the presentations made, it pretty much covers all the questions you've asked. What are the type of workloads? I've also mentioned that in the script, which fit well. So other than that -- other than what we've said in the press, there's not a whole lot more to add at this point due to NDA and competitive reasons. But as we get more visibility, we will let investors know that.

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Anil Kumar Doradla, William Blair & Company L.L.C., Research Division - Analyst [9]

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All right. I was hoping to get something more, but that's okay. Now given Microsoft announcement of partnering with you, can you help us understand whether that has had a ripple effect, with other vendors in North America perhaps accelerating their level of interest and speeding up their level of interest in terms of engagement with you guys?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [10]

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Anil, I think the first and foremost point that this announcement has shown is that ARM servers are now very competitive -- the current generation of ARM servers are very competitive with the incumbent x86, even at the high end. And this validation, I think, will help get some of the other cloud vendors and other big customers to very seriously evaluate it.

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Anil Kumar Doradla, William Blair & Company L.L.C., Research Division - Analyst [11]

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Very good. And finally, one quick clarification. So we're seeing couple of guys talking about some weakness in China -- some optical weakness. Obviously you guys are talking about wireless, strength in wireless. Can you talk about what you guys are seeing in China? And obviously, India have been very strong. So I wanted to understand a little bit on that?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [12]

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Yes, regarding China, we're seeing reasonably healthy trends. One of the things to look at for us in China is that our major revenues there are on the Enterprise side, both at customers such as Huawei and Huawei 3 phone, for example H3C, and other customers there, a significant portion of our revenue is on the Enterprise side. And that -- and there are multiple new OCTEON III product cycles starting there. So essentially, we are seeing decent growth trends in that particular area. The other area, security, which, of course, is also doing pretty well. And on the Big Iron wired infrastructure, we do have some content, but not a whole lot of content. So overall, China -- and, of course, fiber channel is pretty strong in China also and growing very nicely. So overall, China for us, when we look into Q2, looks reasonably healthy and will grow.

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Operator [13]

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We next go to Vivek Arya with Bank of America.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [14]

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First question is on QLogic. Now that you've had it for a little bit more time. I had -- part A of the question is on the sales trajectory. Are you still comfortable with the assumption side that you had made when you acquired the asset. If you could talk a little bit more about customer traction and how we should be thinking about the sales trajectory. And then part B of the question, perhaps for Arthur, is on the gross margin contribution. Now that you've taken over the manufacturing side from Broadcom, how should we think about the gross margin contribution from the QLogic side?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [15]

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Vivek, yes, this is Syed. So overall, when we take a look at the market, and when we had done the acquisition, what we have said would be our primary growth drivers were Ethernet and the storage controllers. So for things like all-flash arrays. And at this point in time -- what it was, 7, 8 months into the acquisition, we actually see it's -- that the overall progress has been better than our expectations. So overall, from what kind of direction we had given for growth in terms of QLogic, we think that in 2017, we will exceed that. So we are pretty pleased with how things are going. On the fiber channel side, it's stable, but actually we're seeing some decent trends there that are showing a little bit of growth there too. So overall, it has come in at or above our expectations 8 months into the acquisition. Art, can you take over the...

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Arthur D. Chadwick, Cavium, Inc. - CFO and VP of Finance & Administration [16]

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Sure. And on the gross margins. Yes, when we acquired QLogic, as you know, we exercised the manufacturing rights. That allowed us to reduce the product costs there. Some of that cost reduction has gone to more aggressive pricing, which is helping us with market share, and some has fallen to the bottom line. But you'll see that our blended gross margins have actually increased pretty nicely since the time we acquired QLogic. If you go back to Q3 of last year, our gross margins on a non-GAAP basis, of course, were 64%. If you take it through 2Q -- by Q2 guidance, it'll have gone up 200 basis points in those 3 quarters, and some of that comes from improvement at QLogic, some comes from Cavium. And we set further gross margin improvement in the back half of the year, probably about 0.5 basis point a quarter, give or take. So we're seeing that improvement flow through, and that we feel very good about that.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [17]

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You mean 50.

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Arthur D. Chadwick, Cavium, Inc. - CFO and VP of Finance & Administration [18]

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50 basis points. What did I say?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [19]

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0.5 basis point.

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Arthur D. Chadwick, Cavium, Inc. - CFO and VP of Finance & Administration [20]

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I'm sorry, 50 basis points. My bad.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [21]

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Got it. And as I follow-up, Syed, what is the potential to gain further share at Freescale? For example, I know you gave us some color about the OCTEON TX. Can you discuss what is the help that it can provide in terms of gaining more share from customers who are still using a lot of older Freescale PowerPC type architecture?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [22]

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Yes, Vivek, in the embedded market itself, obviously, PowerPC has a pretty big market. But most of the market is in kind of the lower end 2- to 4-core. And for the next-generation, they will move to ARM -- primarily to ARM. Some of them have moved to our mid-space OCTEON, but I think the majority of them will move to ARM as we look forward. So as these come up for redesign sockets, that is where we'll have the opportunity to gain more designs for our OCTEON TX line, which we already have now from 2-core to 24-core.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [23]

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Got it. And just one last quick one. You mentioned 5G, I realize it's pretty early to start thinking about revenue contribution from 5G, but when do you think that it can start helping in terms of revenue? Is it a back half of next year kind of contribution? Do you see more engagement from telcos? Or you still think that they are trying to maximize their LTE footprint, so 5G is still some ways away?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [24]

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Regarding 5G, Vivek, I think there will be like almost 3 phases of deployment. We think the first phase will be actually fixed wireless. And as you can see, that announcements have been done by, I think, Verizon and AT&T, that they're testing currently fixed wireless broadband in a number of cities in the U.S. So we expect fixed wireless to be kind of the first deployment, starting, I would say, kind of mid-18-ish. And then the more classical handset -- 5G-based handsets and the classical wireless market is probably a '19 to '20 event. And then the third phase of the market, which has to do with things like autonomous driving, when there's a lot of data needs to be exchange between automotive, between different cars on the road and IoT, will probably be a year or 2 behind that. So there'll be phases. The first phase starting obviously, like I said, I would say mid-'18 to second half of '18, and then accelerating '19, '20, '21 for the next few years.

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Operator [25]

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We'll next go to Joseph Moore with Morgan Stanley.

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Vinayak Rao, Morgan Stanley, Research Division - Research Associate [26]

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This is Vinayak, calling in for Joe. I wanted to ask a question on Thunder. You might have seen some initial traction in China, right, with ThunderX, and -- but those guys have some domestic effort as well. So how do you feel about your competitive positioning there and how should we think about the revenue opportunity for you over the next couple of years?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [27]

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Yes, regarding the (inaudible) opportunity, whether it's in Asia or whether it's in the U.S., the primary -- larger volume of deployment is dual-socket ARM and we are the only dual-socket ARM in production today. The domestic efforts are more focused on single-socket up till this point. So whatever we have in play, we'll continue in that play, and then there is ThunderX2 coming online over the next few quarters, which should accelerate that deployment.

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Vinayak Rao, Morgan Stanley, Research Division - Research Associate [28]

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Got it. That's helpful. For my follow-up I wanted to talk about the fiber channel business. Like, can you touch upon some of the growth drivers you're seeing there as you move from 8- to 16-gig? And any update you have on 32-gig that would be helpful.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [29]

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Yes. So right now, when you take a look at the fiber channel market, like I said, it's stable to slightly up. And this year, we are in the transition from 8-gig to 16-gig. And right now, I would say in '17, the estimate is probably close to 50% 8-gig, 40% -- 45% 16-gig and 5% 32-gig. And then -- so 3 generations are shipping at the same time, if you will. And as we going into '18, those percentages obviously are going to change. 8-gig will drop a little bit, 16-gig will increase and 32-gig will also increase. So there is also an ASP uplift that happens as these transitions go from one generation to the other.

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Operator [30]

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We'll next go to Srini Pajjuri with Macquarie securities.

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Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [31]

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Just a question on the data center side. You said you're expecting new product ramps to drive growth in DC. I'm just curious as to which products are ramping that'll help in Q2? And also, if you look out to the next couple of quarters in the year, can you kind of rank order which product you expect to contribute the most in terms of the new product?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [32]

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You know, as with all new product ramps, right, it's difficult to predict which specific bundle be a little bit more or a little bit less. But we expect over the year that every one of our product lines or new products should grow nicely from Q2 right through the year. So there'll be contributions from every one of them and meaningful contributions.

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Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [33]

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Okay, got it. And then, Syed, you talked a little bit about 5G there, and I saw an announcement from AT&T talking about so-called 5G network, they're calling it 5G evolution. One thing that's interesting is that they're highlighting the use of small cells. I'm just curious as to understand your exposure to small cells and what product do you actually sell into small cells? And if you can also talk about the competitive environment with these small cells, that will be helpful.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [34]

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Yes, small cells deployments have been small. I think what AT&T is more referring to is micro-base stations. So if you to take a look at the type of products that we announced at MWC, which is the baby Fusion-M, which is a single-chip solution, it is a lower user count base station, but it has all the full features of the base station. So that is what is more required than a small cell, which really doesn't have the macro base station features. So we think we'll be very well positioned in that market because these smaller base stations will be used for in-cell deployments, so where there are holes or where the number of users are very dense, instead of throwing up full macro BTSs, a lot of these smaller micro BTSs or you can call them small cells or you can call them micro base stations, they will be deployed in reasonable volume we think.

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Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [35]

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And then in terms of your exposure in competitive environment play -- competitive landscape?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [36]

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In the micro-base station market, we are the only game in town as for the merchant silicon. Obviously, there'll be some customers who do their own ASX. But this is almost like a new category that we have created. We also have a small cell fusion product that we're already shipping to and have been shipping to for a couple of years. But we think that for 5G, the primary deployment will move to micro BTS -- to the micro BTS portion of the market.

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Operator [37]

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We'll next go to Kevin Cassidy with Stifel.

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John Joseph Donnelly, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [38]

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This is John Donnelly, on for Kevin. Could you put down the split between your Enterprise customers and cloud service providers, specifically for QLogic? And are you seeing any more pricing pressure in one market versus the other?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [39]

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Not really. I think we have broad-based solutions, both on the Cavium side and on the QLogic side for kind of the Enterprise and service provider markets. Obviously, the Enterprise is bigger right now, both for us and QLogic -- for QLogic soft products. But we are seeing. So for example, some of the end customers of QLogic, even companies like Reliance and their data center are deploying QLogic mix. So there are a number of cases where, either through servers -- a server OEM partners that we have, like an HP or a Dell, or direct purchase from us, we are seeing increasing deployment in that portion of the market.

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John Joseph Donnelly, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [40]

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Great. And I guess also in terms of paying off the debt, do you plan to continue to pay that off beyond the second quarter? Or is there a specific target that you're looking to reach there?

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Arthur D. Chadwick, Cavium, Inc. - CFO and VP of Finance & Administration [41]

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So the answer is, yes, absolutely. As I mentioned, we paid down $86 million in Q1. We're planning to pay more down in Q2. I didn't specify the amount yet, but we will pay more down in Q2. And we expect to pay down every single quarter. So we think that we can pay down this debt over the next couple of years.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [42]

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So I think the -- one of your questions is, are we going to pay and stop at some point? No, we don't have plans to say, "Okay, I've paid down 30%, and I'm going to keep carrying the balance as debt." We would like to continuously keep dragging it down. In some quarters, it may be a little bit faster, in some quarters, a little bit slower, but the ultimate goal for us is to take it to 0.

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Operator [43]

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We'll next go to Rick Shaffer with Oppenheimer.

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Joshua Louis Buchalter, Oppenheimer & Co. Inc., Research Division - Associate [44]

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This is Josh Buchalter on behalf of Rick. So in your prepared commentary, you mentioned LiquidIO was seeing strength at 25-gig. Should we -- is there any way we can interpret from your lead customer from this commentary because we (inaudible) reset to make a decision on it in the second quarter?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [45]

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It is our -- obviously, the designs are with our first lead customer, but the key thing in the 25-gig deployment is our content obviously is significantly higher. It is, I would say, more than 50% higher than the 10-gig deployments which we have already started over the past couple of quarters. So just the overall content grows up pretty nicely as we get into the back half of the year.

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Joshua Louis Buchalter, Oppenheimer & Co. Inc., Research Division - Associate [46]

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Okay. And then, regarding XPliant, how easy is it for your customers to implement your products versus your primary competitor? And I guess what I'm asking is, is it primarily your design wins are moving second sourcing or the new platforms are checkpoints winning on?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [47]

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When you take a look at the products that have been announced by the 2 announced customers, Arista and Brocade, these are very differentiated. And if you kind of go through their website, they actually have presentations and videos that really show and highlight the differences between the XPliant switches and the incumbent switches. So we basically are addressing different pain points, different problems than the incumbent. And obviously, at the end of the day, we are also a second source. There is no denying that. But the functionality and the programmability and the capabilities are pretty well differentiated between us. It's not just a me too product, which you can ship A or B. Some of the customers will prefer ours when they need more functionality out there.

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Operator [48]

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We'll next go to Chris Rolland with Susquehanna International Group.

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Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [49]

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Just a follow-up there on XPliant. So great wins on Brocade and Arista, but perhaps you guys can talk about where we go from here and what the design win pipeline looks like with some other customers?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [50]

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Sure. So one of the things you may have seen in the press, I think it was in Q4, is that HPE -- HP Enterprise will be also OEMing the Arista product. So that becomes the third channel which, I believe, has already started shipping initial samples through that channel also. So that will add on, on top, as we speak, if you will. And then, we have a couple of other vendors who are still in development, and when they finish development, I'm sure they will announce. And with switches -- switch product announcements, they typically announce the silicon vendor. So everybody will know when these things get launched. But I think our first 2 customers will ramp through the year and then like I said, the HPE channel opens up, couple of other new guys coming up, so we should have a good growth here from 2016 to 2017.

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Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [51]

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Great. It looks like contraction there. And then on your LiquidIO comments, can you perhaps talk about the split between 10-g and 25-g? I think you were talking about 60% higher ASPs for 25-g. What's that split going to look going forward? And then, ultimately, would you expect to sell as many units as 25 as 10?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [52]

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Yes, right now, the market primarily is 10-gig, right? Both for LiquidIO-type products and for the QLogic Ethernet mix. It's primarily 10-gig. 25-gig is starting. I would say this year is probably, I don't know, 10% of the total ports. Obviously, the revenue is higher just because the ASPs obviously are higher. So it's roughly about 10% of the ports. And we expect in 2018 that to become probably 30% of the ports. But also, on the other side of the equation, you have 1-gig deployments today that are moving up to 10-gig. So we are looking -- we have a very strong position in 10-gig actually. We are, I think, a strong number 2 to Intel in 10-gig, and that 1-gig to 10-gig -- so our growth will come not only just from the 10 to 25 and 100, our growth would also come from the 1- to 10-gig transition. So this, we expect, should be a very nice growth market for us for the next few years.

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Operator [53]

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We'll next go to Gary Mobley with Benchmark.

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Gary Wade Mobley, The Benchmark Company, LLC, Research Division - Research Analyst [54]

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Art, in the past, you've shared with us some metrics -- revenue metrics, with respect to mix and different organic growth rates for the different product lines. I think, if I'm not mistaken, you're expecting new product on the Cavium side of the business to represent about 25% of Q1 revenues. Is that about where you landed? And how do you see that unfolding for the balance of the year?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [55]

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Yes. I think that the new products, as you've seen, right, the OCTEON Fusion is a service wire product, so we've kind of put it back into the service provider side of the equation. And the other products that we have had, we've put into the data center side of the equation. But just as a back of the envelope, we are probably ahead of that number.

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Gary Wade Mobley, The Benchmark Company, LLC, Research Division - Research Analyst [56]

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Okay. And I think you've been quoting 20% organic growth rate roughly for the year. And I know there were couple of wildcards that were contemplated and it appears as though you might be trending maybe slightly above that. Is that a number -- growth rate, you still feel comfortable with? And could you share with us some of the factors that might perhaps drive some upside to that for the balance of the year?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [57]

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No. I think when we did the QLogic acquisition, we gave kind of rough estimates of what we expect the organic growth rate to be, and what QLogic to be. And we are at or -- in fact, the current Street numbers actually reflect that. And the fact that we're doing a little bit better than the Street numbers means that we are doing a little bit better on both side of the house.

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Gary Wade Mobley, The Benchmark Company, LLC, Research Division - Research Analyst [58]

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Okay. And Art, I know that in the past, you've always talked about how you expect your OpEx growth to be about half the revenue growth, and that fits with your Q2 guidance. But given the fact that you may have some perhaps some additional cost cuts on the QLogic side of the business, is that still the axiom that's going to hold for the balance of the year?

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Arthur D. Chadwick, Cavium, Inc. - CFO and VP of Finance & Administration [59]

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Yes. For the most part, I think that is true. We have talked about some additional cost savings with the QLogic acquisition. At this point, that's really coming from facilities integration. As you know, we're moving them to a more rightsized building around mid-year. That'll save us some cost. So OpEx, we firmly believe that we'll keep it below 1/2 the top line growth rate, and perhaps even a little bit less than that during the back half of this year because of those additional cost savings.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [60]

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Yes. And another thing that we are doing is -- one of the things that has happened now over the past few quarters is that our design win engagements have significantly increased. I would say the total design engagements that we've had in -- so far in '17 compared to '18 are maybe even greater than 50% higher. So the fact that we are working with so many potential designs, so many customers, we are also incrementally increasing our software, customer support, applications, that type of function, just because of the total volume of designs for every one of the products has increased substantially.

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Operator [61]

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We'll next go to Matt Ramsay with Canaccord Genuity.

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Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - Principal and Senior Analyst [62]

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Syed, I -- it's great to see the commentary on ThunderX2 on a go-forward basis with design wins. Obviously, there is now the ThunderX2 ARM core that you guys have developed internally, and one that you've recently acquired that, I believe, are both on the road map in the near term. Maybe you could talk a little bit about the traction of those 2 independently. And how you plan to segment the road map on a go-forward basis.

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [63]

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Yes, I think we've not publicly shown our road map and what we plan to do. I would just say, stay tuned, but we are working on both. So -- and they're for different types of applications we'll be targeting. So as we move closer over the next few months, we'll give some more visibility on that.

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Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - Principal and Senior Analyst [64]

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All right, fair enough. And then with some of the new revenue classifications, I guess the data center classification is now a little bit shy of a quarter of the business. As we move forward over the next, say, 3 years or so, how do you expect growth of the 2 new segments to play out? And are there implications for gross margin that we should think about depending on which grows faster?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [65]

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Now, that's a good question. In terms of the 2 segments, we expect the data center segment, as a percentage, should be the fastest-growing segment. We expect growth in both segments but the percentage growth is faster in the data center segment. So for example, that's going to be -- we gave you that we had roughly 77% and 23% in Q1, and both stages were similar in Q4. When we look out into Q2, the growth rates of data centers are higher than the Enterprise and service provider growth rates as a percentage, not in absolute dollars, because 77% is a lot more dollars than the 23%.

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Operator [66]

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We'll next go to Harlan Sur with JPMorgan.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [67]

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Just maybe a follow-up from the previous question, but on ThunderX with some of the new ARM IP that you've recently acquired, should give you guys a pretty solid performance boost, right? multithreading technology, I think, the acquired technology had good single core performance. Are you guys thinking about adopting multithreading, which really hasn't been a part of your architecture previously? And I guess 2 things, does this push out your ThunderX2 roadmaps a bit? Or would this be more kind of ThunderX3 implementation?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [68]

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I don't want to again -- since we have not publicly kind of announced, I don't want to get into details, but we will have a very competitive ThunderX2 product. And we have both sides of cores, so each one of them will go and address a certain segment of the market. So we believe that we will have a very comprehensive ThunderX2 product line.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [69]

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Great. And then as we think about the switching business -- obviously, you guys have gotten great traction with the XPliant, then the x80 product. And as I think about the competitive environment which is starting to heat up there, both public companies and private companies, and it seems the cadence of new product introductions is kind of every 12 to 18 months. Broadcom already has tomahawked 2 out there. You combine that with the ThunderX platform, where the cadence of new technology introductions is sort of maybe, again, sort of 18 months. As you think about -- and which to me is maybe a little bit more of an accelerated technology migration cadence than what you've previously seen on some of your embedded products like OCTEON and NITROX, I guess I'm wondering what is -- as you think about the resources to continue to drive this kind of cadence, can the team -- does the team still feel comfortable about driving the type of OpEx profile at a lower growth rate than revenues on a go-forward basis?

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Syed B. Ali, Cavium, Inc. - Founder, Chairman, CEO and President [70]

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Yes, I think when you take a look at actually cadences and -- in different technologies, there are announcements and there are real products, right? So when you take a look at real products, actually even Intel -- I think when you take a look at Intel and some of the other larger customers, they're actually slowing down the cadence as they move to 10, 7, 5. It's going to be a longer cadence, not a 12- to 18-month. I think, right now, some of the large competitors are staying 24 months, maybe even 30 months. So overall, again, we have a number of products and we've prioritized which products to get out when. So we will be able to execute on all products, and we will do it based upon our priority.

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Operator [71]

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(Operator Instructions) .

That concludes today's question-and-answer session. This conference will be available for replay after 5:30 PM Pacific -- today through May 26 at 5:30 PM Pacific. You may access the replay system at any time by dialing 1 (888) 203-1112 and entering the access code 8112580. International participants dial (719) 457-0820. That does conclude today's conference. Thank you for your participation.