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Edited Transcript of IPHI earnings conference call or presentation 2-May-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Inphi Corp Earnings Call

SUNNYVALE May 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Inphi Corp earnings conference call or presentation Tuesday, May 2, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Deborah Stapleton

* Ford G. Tamer

Inphi Corporation - CEO, President and Director

* John S. Edmunds

Inphi Corporation - CFO, CAO, VP and Secretary

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Conference Call Participants

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* Brian Matthew Alger

Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst

* Hans Carl Mosesmann

Rosenblatt Securities Inc., Research Division - Senior Research Analyst

* Harlan Sur

JP Morgan Chase & Co, Research Division - Senior Analyst

* Jorge Eduardo Rivas Reyna

Craig-Hallum Capital Group LLC, Research Division - Associate Analyst

* Joseph Lawrence Moore

Morgan Stanley, Research Division - Executive Director

* Karl Fredrick Ackerman

Cowen and Company, LLC, Research Division - VP

* N. Quinn Bolton

Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors

* Ross Clark Seymore

Deutsche Bank AG, Research Division - MD

* Tore Svanberg

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

* 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, ladies and gentlemen, and welcome to Inphi's First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would like to introduce your host for today's conference, Ms. Deborah Stapleton, Investor Relations. Ma'am, please go ahead.

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Deborah Stapleton, [2]

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Thank you, and good afternoon, everyone. Thank you for joining us today to discuss Inphi's financial results for the first quarter of 2017. I'm Deborah Stapleton, and with me today are John Edmunds, CFO; and Ford Tamer, our Chief Executive Officer. John will begin with the Safe Harbor. Then Ford will give you an overview of our business. After that, John will provide a financial summary of Q1 and the outlook for the second quarter of 2017. Then we'll be happy to take your questions. John?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [3]

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Thank you, 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 2017 and beyond, as well as projected growth and size of our markets and our customers, market share, new products and design wins and the integration of ClariPhy.

These forward-looking statements and all other statements made on this call, which are not historical facts, are subject to a number of risks and uncertainties that may cause actual results to differ materially. These forward-looking statements speak only as of today's call. We do not undertake any obligation to provide updates after this conference call. For further information regarding risk factors for our business, please refer to our registration statements as well as our most recent annual and quarterly reports on Forms 10-K and 10-Q, all filed with the Securities and Exchange Commission, accessible at www.sec.gov. Please refer in particular to the sections entitled Risk Factors. We encourage you to read these documents.

Also, during the course of this conference call, we may make reference to non-GAAP financial information. A reconciliation of this information is included in the press release and on our company website, at www.inphi.com. This information is not a substitute for GAAP and should only be used to evaluate the company's results in conjunction with corresponding GAAP measures. For this year in particular, you will notice that we're reporting based on continuing operations that are -- and that historical numbers in the press release have been adjusted to reflect the Q3 2016 sale of our memory business to Rambus. This is being done in accordance with GAAP rules for reporting discontinued operations. However, for convenience, we have included a reconciliation to the historical reports on our website for the 6 quarters ended June 30, 2016.

In general, the numbers we refer to in the conference call will be for continuing operations. Where we refer to numbers that are not from continuing operations, we will so designate.

Now to begin our review of the quarter, let me turn the call over to our CEO, Ford Tamer. Ford?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [4]

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Thanks, John, and thank you for joining us for Inphi's first quarter 2017 earnings update.

I'm pleased to report another strong quarter for Inphi, with record non-GAAP revenue of $93.6 million representing 16% sequential growth and 73% year-on-year growth. This is the fourth consecutive quarter of double-digit sequential revenue growth. After taxes, we achieved $0.44 in first quarter earnings per share, which represents 69% growth over Q1 last year.

We are ahead of plan on ColorZ, our 100 gigabit QSFP solution, for connecting data centers up to 80 kilometers apart as 1 mega virtual cloud. With this solid product roadmap, supported by new customers and new applications, we are increasingly confident of the potential of ColorZ for the data center interconnect edge, or DCI, 2-kilometer to 100-kilometer market. We also had many other exciting product and customer announcements in Q1, which we expect will continue to support Inphi rapid revenue growth in 2017 and for years to come.

Before discussing the new announcements, let me update you on our guidance for Q2. We are guiding revenue to be down 10% sequentially at the midpoint, primarily to account for inventory accumulation in China at our OEM system customers. The China inventory situation developed for us in April due to a pause in the buildout of long haul and Metro networks by the China telecom service providers. Based on our system OEM customer feedback, we currently expect the matter to bottom out in Q2 and recover some time in the second half of the year when spend for both national and provincial infrastructures resume.

Going forward, we are confident that the explosive growth of data and bandwidth will continue to drive Inphi's evolution to a more secular data movement interconnect business. We are in the middle of this transformation from our focus on long haul and metro markets to a more diversified revenue base from the addition of inter- and intra-data center markets.

Let me be specific. First, we continue to take share in long haul and metro markets for TIA and driver products during Q1. This is evidenced by a record quarter revenue from that business, growing 15% sequentially and almost doubling year-over-year. The share gains were primarily driven by new DCO designs in China and by a continued market transition to linear solutions where Inphi's TIAs and driver are well-positioned against our competitors.

We strongly believe that our new products are leading the market in performance, new module form factors and quality. In terms of performance, we announced the world's first 64 gigabaud, 600-gigabit release to production of our linear TIA and engineering sampling of our linear driver.

With respect to new module form factor, we announced a new 32-gigabaud, 200-gigabit linear TIA and driver chipset for CFP2-DCO or digitally coherent optics which have already achieved multiple design wins.

Finally, we raised the bar in quality by surpassing 25 billion hours of incident-free feed operation for our coherent TIAs.

Inphi is well-positioned to regain momentum in our TIA and driver business as the inventory situation clears up. In both same long haul and metro market segments, we continue to make progress with our coherent DSP solutions from our ClariPhy acquisition. We taped out a new low-power product in Q1 and intend to sample it to customers in Q2. We expect this to be a driver of Inphi's revenue growth in the second half of 2018.

Moving to our inter-data center market, our ColorZ solution was ahead of consensus in Q1, growing over tenfold from a small base in Q4 of 2016. We expect to continue to outperform our projections in Q2. However, while deliveries are ahead of expectations, we're still short of our tremendous customer demand. We have achieved our target module yields and are continuing to work on scaling the manufacturing capacity and supply chain for higher demand.

I'm also pleased to report we now have an additional large ColorZ customer that's currently in initial system validation. We expect this new customer to deploy in the second half of the year. The interest in Inphi's ColorZ solution continues to build. We had several very successful ColorZ demonstrations at the Optical Fiber Conference in late March in Los Angeles. The first demo was hosted in our booth with Arista and AVDA equipment. The second demo was at the Coriant booth with Dell and Coriant equipment. We'll continue to collaborate with these strong partners as well as multiple other Tier 1 system OEMs to bring ColorZ to market.

We remain confident that we have a substantial first-mover advantage in this DCI edge market, and we expect ColorZ to be a core Inphi platform for the next 5 to 10 years in new applications and new markets.

Finally, moving to the intra-data center market segment, our optic and silicon layer devices continue to perform as planned. This category includes gearbox, retimer and other physical layer products for both NRZ and PAM interfaces.

Also at OFC, we announced the world's first 16-nanometer PAM platform for intra-data center 50, 100, 200 and 400-gigabit links. We had several partners demonstrating working PAM modules in their suites. We also have Tier 1 design wins from cloud customers. You'll recall that PAM is a new modulation format that allows a customer to double the amount of data transmitted on each wavelengths, thereby, increasing capacity while saving power and cost. The Next Generation 6.4 and 12.8 terabit switches, which will begin to ship in production in the second half of 2018, will have PAM interfaces that align to Inphi's PAM solutions.

We are offering this PAM DSP to customers in conjunction with Inphi's companion linear TIAs and driver as a proven, tested and qualified platform solution. This approach reduces time-to-market and increases reliability and performance. We are confident that Inphi is supplying our customers with the best performance and lowest power PAM solution, which should position us to generate significant revenue in the second half of 2018.

We remain confident that Inphi is well positioned in the large and growing market for Data Center Interconnects with a solid team generating differentiated products that serve our Tier 1 customers and their growing needs.

Our system OEM customers expect the China long haul and metro market to recover in the second half of 2017, and we should have more visibility on this in the May/June time frame.

I thank our investors and customers for their support during this period and our team for their continued hard work and results. We're progressing through the expansion of Inphi's market focus, from service providers and cyclical growth to a broader customer base by adding inter and intra-data center segments. This transition, which we started working on 5 years ago should provide further stability and secular growth going forward.

Now let me turn the call over to John to discuss specifics of Q1 and our guidance for Q2. John?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [5]

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Thanks, Ford. Now let me recap the financial results. In the first quarter of 2017, Inphi reported revenues of $93.6 million. Revenues were up sequentially 16%. Core communications revenue was up in Q1, with growth coming from our market-leading amplifiers, drivers, optical physical layer products and DCI edge solution, ColorZ, now ramping ahead of plan.

You'll recall last quarter we defined our core communications products as the amplifiers drivers 10,40 and 100-gig physical interface products and ColorZ, all of which sell into the service provider and data center interconnect markets. Last quarter we described our potential to grow in core communications for the 2017 year in the range of 42% to 46%. Now with the inventory accumulation in China affecting our Q2 forecast, we expect that number to be somewhat smaller, in the range of 36% to 38% growth for the year in 2017. ClariPhy is still tracking to revenue in the range of $42 million to $45 million for 2017. When we add ClariPhy to other core business in Q1, the total makes up 88% of our revenue as compared to transport and legacy business, which was about 12% of our revenue in Q1.

As expected, the transport and legacy business declined about 9% sequentially and about 14% year-over-year. This is due to mix changes as well as annual price renegotiations that typically take place in Q1. We would usually see transport and legacy remain relatively flat each quarter for the balance of the year.

Gross margins on a non-GAAP basis in Q1 came in at 71.3%, which was down about 200 basis points from the 73.3% posted in Q4. This decline was a little stronger than the 30 to 70 basis points decline we had forecasted. Generally the decline was driven by the mix of product and reflects a relative surge in sales of packaged drivers in the quarter, which have good gross margins but not quite as high as the higher gross margins associated with our die-based solutions.

In Q2 2017, we expect the gross margins to be down approximately 80 to 180 basis points. Again, this is a function of mix in the quarter and reflects a higher mix of ColorZ products. These currently ship with some additional components grab due to typical new product/component introduction challenges. All in, we estimate non-GAAP gross margins for Q2 to be in the range of 69.5% to 70.5%. We expect gross margins to improve in the second half of the year as the inventory accumulation in China is resolved, yields improve, and we ship more high margin Inphi and ClariPhy products as part of the mix. We're confident that gross margins can remain comfortably above 70% for the year 2017 as a whole.

Q1 GAAP net loss from continuing operations was $11.3 million, which compares to non-GAAP net income for the first quarter of 2017 of $19.5 million. This $30.8 million improvement for non-GAAP reporting is derived by adding back the following recurring non-GAAP adjustments: stock compensation expense of $9.2 million; purchase accounting adjustments of $15.2 million; acquisition-related expenses of $1.7 million; and noncash convertible debt cost to amortization of $5.9 million, then also recognizing an additional tax charge for non-GAAP of $1.2 million. All of these adjustments then total $30.8 million being added to GAAP net loss in Q1 to arrive at non-GAAP net income for Q1 2017.

Non-GAAP operating expense for Q1, including the first full quarter of ClariPhy operating expense, totaled $45.1 million, which was about $700,000 below the midpoint of what was expected. This was due to a lower level of development project expense than what we had originally forecast.

Overall in Q1, we were able to deliver non-GAAP operating margin of 23.1%, which was slightly below the expected range of 23.5% to 24%. The main difference coming from the lower gross margins based on mix.

Interest income totaled $900,000 in the quarter, which offset the cash cost of the convertible debt. That cost came in at $1.2 million for the quarter with an annualized blended coupon rate of 0.972%, again, net carry cost of the convertible debt at about $304,000 for the quarter.

We had other non operating expense and income, including foreign currency gains of $107,000 that netted out to $67,000 of additional other expense. Using an effective tax rate of approximately 8%, we booked $1.7 million for a Q1 non-GAAP tax provision. We continue to think that an 8% rate is sustainable and a good rate to use for forecasting non-GAAP tax expense in 2017.

For GAAP tax expense, we booked a $452,000 expense against a loss implying a negative effective tax rate. This is because we are a taxpayer in Singapore but have losses in the U.S. and a full valuation allowance for book purposes, meaning we cannot reliably recognize the potential tax benefits of those U.S. losses.

We are currently forecasting the rate for the year to be roughly a negative 31%, however this rate generally changes through the course of the year.

Cash income taxes paid in Q1 2017 was $171,000, up from $133,000 we had paid in Q1 2016.

Non-GAAP net income for the first quarter of 2017 of $19.5 million or $0.44 per diluted share was down 6% sequentially from the $20.8 million or $0.47 per diluted share we reported in Q4. This was as expected and driven largely by the acquisition and integration of ClariPhy.

Now turning to the balance sheet. Overall cash was $393 million, essentially flat with Q4's balance of $394 million. We had cash flow from operations of $18.5 million in Q1 compared to $12.7 million in Q4, and compared to $13.1 million in Q1 one year ago. The $5.8 million sequential increase in cash flow from ops from Q4 to Q1 stems from being more efficient with working capital.

DSO improved from 56 days at the end of December to 51 days at the end of March. Inventory increased by $5.6 million in the quarter. This was net of the respective step-up in value from purchase accounting adjustments of $10.5 million at the end of December and $5.1 million at the end of March. As a result, inventory days, excluding the respective step-up adjustments, was 81 days at the end of December and 91 days at the end of March. The inventory growing by $5.6 million is primarily due to long-term investment in a particular capacitor that we have reason to believe will be supply constrained over the next 12 months.

Capital expenditures were $11.4 million in the quarter and an additional $4.3 million in software and IP licenses used for development. Overall, we also paid out a net $1.8 million in financing activities driven by buying restricted stock back from employees to satisfy payroll tax withholdings associated with vesting in the stock. In addition, we spent an additional $1.8 million in cash related to the ClariPhy acquisition, largely related to a remaining payment to some of ClariPhy's international employee option holders made in Q1 of 2017.

Now let me recap the business outlook for Q2 2017. I remind everyone again that the following statements are based on current expectations as of today and include forward-looking statements. Actual results may differ materially. We do not plan to update nor do we take on any obligation to update this outlook in the future.

Due to inventory accumulation in China, revenue is forecasted to be down in Q2 in a range for approximately 6% to 14%. We're down $5.6 million to $13.6 million. This will result in total revenue for the company of between $80 million and $88 million for Q2. The decline is driven largely by an inventory accumulation in China which was then exacerbated in April by a decision from a key OEM to consume inventory rather than to continue to carry it. Their decision was based in part on a delay in starting the provincial optical network rollout, otherwise referred to as Phase 13. The impact of this decision was felt both directly and indirectly through other module customers who also sell into that market.

Partially offsetting this decline is the data center-based ColorZ products continuing to ramp, in fact more than doubling in Q2 to mid-double digit revenue numbers.

We expect non-GAAP gross margin to be in the range of 69.5% to 70.5%. We expect non-GAAP operating expense to be in the range of $42.1 million to $42.6 million.

We are currently estimating the non-GAAP effective tax rate to be 8% for 2017. We are confident these components should then align, resulting in non-GAAP operating margin in the range of 18.1% to 23.1%. This should also lead to non-GAAP net income of between $13.3 million and $18.7 million, which on approximately 44.2 million estimated diluted shares would result in estimated non-GAAP earnings per share of between [$0.27 and $0.39] (corrected by company after the call).

We also estimate stock-based compensation expense to be between $11.8 million and $12 million. In addition we expect about $15.6 million to $15.9 million for purchase accounting and acquisition-related adjustments. We also expect $5.9 million in noncash amortization of debt expense.

Finally, these increases based on jurisdictional allocations should also generate additional tax charges of approximately $6.5 million. This would imply a GAAP net loss in the range of $21.1 million to $27 million.

GAAP earnings per share would then be a loss in the range of $0.50 to $0.64 per basic share on 42.2 million forecasted basic shares. A more complete reconciliation of the Q4 GAAP net income forecast is attached to the last page of the press release.

We will not update this outlook during the quarter until the time of the next quarterly earnings release unless Inphi publishes a notice stating otherwise. So please ask any questions you may have today during the general Q&A period.

And now, we'd be happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Tore Svanberg from Stifel.

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Tore Svanberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [2]

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A few questions. First of all, Ford, I realized visibility is probably not that great right now. But you did say you expect the recovery in China to happen in the second half. I'm just wondering what gives you that confidence at this point.

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [3]

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Thank you, Tore. So you're asking when the recovery will come back. We cannot, at this point, forecast the recovery timing because it's in the hands of our system OEM customers and their telecom service provider customers in China. What I could tell you is what our customers are telling us. Our system OEM customers are telling us they didn't expect the long haul and metro port to grow from 2016 to 2017. Our system OEM customers are also telling us to expect the recovery to begin in the second half of '17. However, visibility is limited, and we cannot, at this point, predict whether it's Q3 or Q4. Our system OEM customers are also telling us they'll have more accurate forecasts in the May to June time frame. Once the recovery occurs, we're confident that Inphi will be well positioned to benefit from that recovery due to our differentiated product and the leading market share in those markets, Tore.

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Tore Svanberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [4]

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Very good. And could you also update us on ColorZ, the capacity -- the revenue capacity you have? I mean, it sounds like it's ramping ahead of expectations. But you mentioned a second customer coming online in the second half. So what types of revenue capacity do you have at this point for that product line?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [5]

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So we've increased the capacity significantly from Q1 to Q2 and planning to continue to increase it towards Q3. The yields of the modules are where we'd like them to be at this point. So we're satisfied and happy with the module yields. We're still working with some supply chain component issues that could limit the upside growth. The demand is definitely here with the second customer now in system validation and many more customers interested in proceeding with deployment in the second half. So we're still very positive on demand. We're working hard to increase capacity and be it a step at a time, quarter at a time, Tore, we're working on increasing that.

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Tore Svanberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [6]

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Just one last question. Could you maybe us a little bit on ClariPhy and the competitive landscape there? I believe one system OEM at OFC talked about getting into the merchant DSP market. So if you could just update us on the dynamics there and especially competitive landscape that would be great.

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [7]

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Yes, we're getting ready to sample in Q2 a best-in-class power and highest integration from a feature and function point of view metro and long haul DSP in the market. We do believe that it should significantly increase the ClariPhy-coherent DSP market share just based on the design wins that we already have secured for those 16-nanometer products. So this new announcement at OFC does not impact the product we just sampled. We believe this new announcement at OFC will not have an impact until probably a couple of years from now. And in addition, we're very excited about what Inphi can impact -- yes, how Inphi can impact the ClariPhy product roadmap by taking it to 7-nanometer, helping with lower power designed in integrating our world-class SerDes IP into it and really getting synergies between the 2 teams. So still very positive on where this ClariPhy roadmap can take us and expecting a nice revenue increase in the second half of 2018, Tore.

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Operator [8]

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Our next question comes from Quinn Bolton from Needham.

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N. Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors [9]

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John, you went through the numbers pretty quickly. But if I heard you right, it sounds like your core communications business, you said, would grow 36% to 38% year-on-year, down from the prior 42% to 46%. Is that the right number?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [10]

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Yes, Quinn, that's correct. 36% to 38% for the core communications, including ColorZ, growing in '17 versus the core in '16.

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N. Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors [11]

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Got it. And so if I do my rough math, it sounds like 2017 revenue, given the range you expect for ClariPhy and the transport, probably comes out around $375 million, plus or minus, say, $5 million?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [12]

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Yes. We're not guiding to a specific number. But you could certainly pull the components together and come up with something in that range.

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N. Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors [13]

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Great. And then it sounds like ColorZ is tracking nicely ahead of plan. I don't know if you gave a number for March, I was hoping you could. But I think a quarter ago you thought it was going to be somewhere in the range of $4.5 million to $5 million. Did it exceed that level?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [14]

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Yes. It exceeded that for the March quarter.

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N. Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors [15]

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Okay. And we'll be double-digits then in June, you said?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [16]

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That's correct.

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N. Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors [17]

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Great. So it sounds like you guys had previously talked about a sort of $30 million target, sounds like -- for 2017, it sounds like you're tracking nicely above that for ColorZ, given your first half number's already put you probably more than half of that.

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [18]

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That's correct.

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N. Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst of Communication ICs and Consumer Semiconductors [19]

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Got it. Great. And then just moving over to the gross margin. You guys have been tracking through the 72% to 73% level prior to the ramp of ColorZ. Do you think you can get back to that level once you get through this inventory correction? Or will ColorZ sort of bring that level down a touch?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [20]

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I think -- not necessarily ColorZ but just the mix of products. ColorZ is certainly part of the mix. But just in this particular quarter, we had very good driver growth of gain share in the driver market, but we were shipping more package drivers than we had in the past. And relatively amount of die-based solutions that made up our mix prior to this quarter brought down the gross margin a little bit. So we do expect gross margins to improve in the second half just based on both mix of product and being able to sell more ClariPhy product and some of the higher margin Inphi product as well. So there's a number of factors that should keep the margin moving back up in the back half of the year, probably more in the 71%, 72% range, though.

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Operator [21]

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Our next question comes from Harlan Sur from JPMorgan.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [22]

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On the inventory overhang here, kind of near-term, I want to try to understand where the inventory pockets are? Are they mostly with your module partners or with your OEM customers? And I'm just wondering if the team has assessed module inventories with your systems OEM partners? I'm just trying to get a feel for if you guys have a good understanding of where total inventories are across the entire value chain, such that when demand does pick up, you anticipate a smooth transition?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [23]

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Thanks, Harlan. On the inventory depletion issue, you're asking about we were informed in April by a certain OEM customer of their intention to reduce inventory. And this decision, as you allude to, affected us both directly and indirectly at both the system OEM as well as through the module maker customers that we also service. So we've -- on the system, we sell directly to both system OEM as well as the module maker and, at this point, believe we have taken a good reduction in both the forecast of both the system OEM as well as the module maker. So we can walk you through the different details, maybe at a follow-on call, if needed.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [24]

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Okay, great. And on ColorZ, sounds like you guys have done a good job of ramping that program ahead of plan relative to, I think, our expectations for roughly about $30 million in revenue this year. And if we take into account the potential ramp of a second major customer, and if -- let's assume that your ColorZ program in general does exceed $30 million in revenues this year, I'm wondering, thinking about your capacity plans, could you support a revenue number, a program number that supports greater than $30 million kind of manufacturing life within this year?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [25]

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Harlan yes, we are working towards a manufacturing capacity plan that would support above that $30 million for the year.

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Operator [26]

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Our next question comes from Ross Seymore from Deutsche Bank.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [27]

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I wanted to get back to the inventory side of the equation. I know you have limited visibility, but the guidance range you gave is much wider, reflecting that lack of visibility, I'm sure. But can you just talk a little bit about what goes into the equation at the higher or lower end of the revenue guidance that you're giving?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [28]

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Well, Ross, I think it's really a function of the forecast that we have from our customers. So I think we feel comfortable at the midpoint, but as this quarter has shown, forecast is just that, it's a forecast. So we could have some business continue to get soft. We don't anticipate that. So we only have a lower end of the range. And then we do expect that business can improve at some stage, but it's never just one quarter. So it will probably take a couple of quarters before we're back to full steam again.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [29]

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And as that -- as we go through this correction, is pricing part of the equation to clear out the inventory? And does that have any implications for your gross margin?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [30]

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No. Pricing really isn't a factor at all. We've gone through and looked carefully at what's gone on with pricing through the first quarter and into the forecast for the rest of the year. And that's not an issue in terms of what we're looking at, strictly unit consumption as far as we can see.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [31]

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I guess my last question will be on the OpEx side of things. You guys have had great growth, longer term, and you always want to invest for the future and not overreact to any of these cyclical corrections. But what sort of levers can you pull on the OpEx side of it during tight revenue times like this to mitigate the impacts to the bottom line?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [32]

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We're certainly taking actions and we're only hiring critical employees at this stage for the balance of the year. And we're tightening our belts. So we do think we can save probably something on the order of about $5 million to $10 million in operating expense this year, maybe more than that if we need to. But we're looking at trying to continue to prosecute our development plans as well as keep an eye on the bottom line as we move through the year.

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Operator [33]

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Our next question comes from Timothy Arcuri from Cowen and Company.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - VP [34]

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This is Karl Ackerman on for Timothy. I just wanted to follow up on that last question regarding OpEx. So when I look at your second quarter guide, it does imply OpEx declining, I think, low single-digits sequentially. You touched on some of the actions that you could do to save on the OpEx in the second half of the year. But how do we also think about your ability to reduce OpEx as you balance increasing capacity yet also look to gain synergies on the R&D side from your recent acquisition of ClariPhy?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [35]

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Yes. We certainly are gaining synergies from that perspective as we integrate the company, and we will continue to look for those. In particular in the second quarter, we have some co-development funding coming in that's offsetting some of the R&D expense. So that's a part of the plan for the second quarter, and so that's what influencing that differential.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - VP [36]

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Got it. So I guess from a follow up perspective, so as we think about the second half of the year from an OpEx perspective, should we think about kind of a mid-40s level from here? Or is it a function of your opportunity to expand -- increase your capacity in the second half of the year? If you just help us out on OpEx, that'll be helpful.

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [37]

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Yes, we'll have some increases, Karl, from the second quarter, but we will stay in the mid-40s kind of range. So and be happy to help you after the call, understand the comment I made previously about the savings potential for the year.

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Operator [38]

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Our next question comes from Vivek Arya from Bank of America, Merrill Lynch.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [39]

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Ford, on this -- the inventory accumulation in China, is there a way to quantify that? And I think sort of along those lines, you mentioned this 36% to 38% core communications growth for 2017. Are you assuming a snap back in Q3? Or do you think it is prudent to sort of assume sort of flattish trends in Q3, but with more of the recovery in Q4? What I'm really trying to get at is this is not the first time your industry has gone through this kind of excess inventory issue. From your prior knowledge, how long do these things last? And is it better to be a little more prudent and assume that the recovery could be maybe 2 quarters out rather than 1 quarter out?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [40]

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Yes, Vivek, this is John. Thanks for the question. Generally speaking, we don't expect the full recovery in the third quarter or a complete snapback. But we would expect some level of recovery starting in the third quarter and then getting back to something closer to what we had originally forecast or the Street had forecast in the fourth quarter. So I think getting back to something along the lines of the first quarter in the third quarter, as an example, would be a relatively good goal and kind of a midpoint rather than thinking we can fully recover.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [41]

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Got it. And on ColorZ, good to see the strong ramp there and the second customer. The $30 million target you had before, was that inclusive or exclusive of this second customer? Because if you were to just maintain the low double-digit ColorZ number you had in Q2, and if you assume that it sort of stays at least that number in Q3 and Q4, you would certainly be above the target you had. But I just want to make sure if -- was that already inclusive of the second customer, or can that second customer present some kind of upside?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [42]

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Yes, the $30 million consensus number that we had discussed in the past really just represented one customer, our lead customer, Vivek. So the second customer would add to this. We also have interest from many other, both cloud and OEM customers for various applications for ColorZ. So the demand for ColorZ is significantly higher than the capacity. And right now, our focus is how to increase capacity to be able to meet that demand. So the upside for ColorZ is definitely here; demand is here. We're working hard to increase capacity to be able to meet that demand. And as we do, we'll be more diversified inside the inter-data center type of market to potentially help mitigate any service provider longer inventory issues.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [43]

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Got it. And just one last one, Ford. You mentioned China is about 40% of the optical market. So one part of the question is, how is the demand outside of China? And then sort of part B of that is, and my understanding has been that sometimes what you ship to China also goes outside of China in their export markets. So the domestic consumption is perhaps smaller than 40%. So if you could just give us some color around the demand trends that you are seeing outside of domestic China.

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [44]

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Vivek, this is John again. So I think if you look at Huawei, they, in their financial results, I'll say that about 40%, I think it's 41% is for domestic consumption. So Huawei does ship around the world and so do other people that we ship into in China. So there's a fair amount of business that -- where people manufacture in China and then it gets exported to other markets. So it truly is a global market that we're looking at here, and this is primarily focused on Chinese manufacturers. But it is a function of their demand. And so I think, to answer your question, we have had some other markets also have issues that have contributed toward the overall problem. But in general, the major issue has been the inventory accumulation in these Chinese manufacturing sites.

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Operator [45]

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Our next question comes from Hans Mosesmann from Rosenblatt Securities.

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Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [46]

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A question on the capacitors that you are buying. Is that for ColorZ?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [47]

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Hans, we did not mention capacitors. We mentioned we're increasing capacity for ColorZ.

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Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [48]

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Okay, my bad. I thought you were purchasing some products that were going to be constrained that's part of the supply chain.

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [49]

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Yes. These are not capacitors. There may be some components we are buying in the supply chains that are creating some capacity issues, but these aren't capacitors.

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Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [50]

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Okay. So what are these components? And just to kind of frame what types of products are involved here? My bad in assuming it was a capacitor. But if you can give us more granularity, that would be great.

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [51]

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Hans, this is John. We're mixing up 2 words here, I think. There's no issue -- these capacitors aren't related to the ColorZ product, first of all, to clarify your original question. And the buildup in inventory that we had is a function of making a long-term investment in capacitors related to another product that we sell, and it's a product that will sell well and continue to sell well for quite some time. So we want to make sure we didn't have a supply issue on that particular component.

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Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [52]

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Okay. And then one last one, just related. Are there any other components that you would need to perhaps buy in anticipation should there be more supply constraints or more severe constraints?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [53]

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Not that we're -- not that we anticipate a problem, as right now, we're not overinvesting. We are trying to improve the supply chain in various areas, but nothing specific like this particular investment that we made.

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Operator [54]

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Our next question comes from Richard Shannon from Craig-Hallum.

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Jorge Eduardo Rivas Reyna, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [55]

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It's actually Jorge on behalf of Richard today. So I was wondering if you can provide some more granularity on the issues in China. I mean, I understand that there's a buildup at your OEMs that impacts the components of modules. But if you can just -- given that the sheer reaction aftermarket of your shares would imply that the cycle is over and we certainly don't believe that, Can you just give us a little bit more detail? I understand that this is related to the delays of the next phase of 100-gig deployments. What is exactly causing the delay? Is it just red tape from the Chinese government? Or other elements involved in this?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [56]

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Jorge, this is Ford. Let me clarify this -- a little bit more on this inventory depletion issue that you're asking about. We learned in April our customer decision to reduce inventory. We did not know earlier on of their decision to consume inventory for a period of time rather than continue to carry that inventory. So it was only in April that we're made aware of their decision to reduce inventory. And we do believe that the burn off should happen in a quarter, however, given the lack of visibility, we're being cautious and that's going to against Q3 or and being careful on saying could be Q3 or Q4 recovery. We've had other vendors, like there was a vendor yesterday who discussed a very similar issue on the RF side of the world, so not on the communication or optical, but this was RF-specific, where they also discussed the same inventory buildup at that same major Chinese customer. And their view was that this was going to be a 1 quarter data issue that should be completed in the June quarter. Our markets are really long haul in metro networks. And yes, there has been a pause and a buildup of the backbone, both national and provincial backbones in China. And it's hard for us to tell you the exact timing just because that decision is in the hands of our system OEM customers. But again, I'd go back to our Q1 results demonstrate that we are taking share in TIA and driver. Our Q1 results demonstrate that we have some very differentiated product that we're working very closely with those Chinese OEMs as well as their customers on the telecom service providers, and again demonstrate that we're well positioned to benefit from the recovery when it comes back. So we do believe that as soon as we hear good news on that post getting released, we should see a pretty nice recovery for Inphi.

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Jorge Eduardo Rivas Reyna, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [57]

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Okay. Thank you, Ford. And then one last one on the computer market. With the announcement of Ciena willing to license its own DSP to other module providers and with Acacia and you guys, I'm wondering if you are seeing any other entrants in the market as the market evolves?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [58]

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So again, we do not believe the Ciena decision to license their DSP is going to impact any of the 3 established vendors, ourselves, Acacia or NEL, in the short-term. I mean the short-term the design wins are already won, the software is already being developed, the boards are being developed. We do not believe that Ciena's decision would impact any of the 3 of us in the short-term. Longer-term, this -- time will tell, we do believe that there's a huge advantage to purchase DSP from commercial DSPs under like ourselves, Acacia or NEL, as opposed to go to a captive OEM system. You're going to need to debug software on your system, you're going to need to have application engineers go work at the customer, customers. I'm not sure you want a competitor application engineers debugging your system. So we do believe it'd be a lot more -- it'd be a lot easier for our system OEM customers to work with a commercial DSP vendor like one of the 3 established vendor as opposed to a Ciena-type competitor.

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Operator [59]

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Our next question comes from Joe Moore from Morgan Stanley.

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Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [60]

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Following up on the last question. I guess that inventory situation that you discovered in April, was there anything that caused it other than just maybe demand not being as robust as people had thought. Was there any kind of a shortage situation where the customer had overstocked, or just any color that you can give us on where this extra inventory came from if it wasn't a demand shortfall in Q1?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [61]

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Joe, so if you look at the inventory buildup, it started occurring probably in the December and some of the Q1 timeframe, but it was the strategic inventory that was supposed to be kept. And what seemed to have happened in April is that, there was a decision that they did not need to keep that inventory anymore for a variety of reasons. Some could be geopolitical. This happened starting in late -- in sort of mid- to late April, we started seeing early signs in early April and they got increasingly clear through the next couple of weeks of April. So anywhere from April 10 to April 24 forecast, those couple of weeks, we saw some forecast being canceled based on the decision from the Chinese OEM vendor that they did not need to keep the strategic inventory. So I mean, that's -- there are potentially multiple reasons that we could surmise as to the cause of it. But you probably can come up with the same reasons. I mean, they -- well, not the reasons why they may not want to keep it, but it's just basically the decision to consume inventory as opposed to keep it for strategic reasons.

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Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [62]

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Okay. That makes sense. And then I guess, the situation has evolved relatively quickly. You gave a wide range for Q2, and yet your range for core comps for the year is pretty tight and does imply a good sequential recovery in the back half. Is that -- what gives you that degree of sort of precision on the full year? And is that because of the ColorZ ramp or is there some other element that we should take into account? Because it seems like you're not exactly clear on when the long haul metro businesses get better, but you're still forecasting to a pretty narrow range overall?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [63]

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Well, I think our confidence in the demand for ColorZ product and our ability to ramp the capacity through the course of the year is a big part of that, Joe. And other than that, I think we feel like we're being relatively conservative but trying to be realistic about what we can do in the back half of the year with growth in the product set so -- there's a combination factors. But it's a well-studied, analyzed number. It wasn't put together lightly.

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Operator [64]

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Our next question will come from Brian Alger from Roth Capital Partners.

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Brian Matthew Alger, Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst [65]

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A lot of questions have been asked. I appreciate you guys going through it all. You made a comment earlier that you didn't see an effect on pricing as a result of the inventory buildup. That seems a bit peculiar to me is as it tends to be the next year to drop whenever we've had these in the past for the industry when there's been a prolonged delay, I guess, in spending. Why is it that you don't believe pricing will be affected?

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [66]

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Yes, Brian, I think, we keep a fairly close watch on pricing in our forecasts. And I look to see whether pricing was a factor on our Q1 results or if it was a factor in the forecast that we have. So right now, as we sit here, we don't see pricing becoming a particular issue. In a lot of cases, we're sole-sourced in the particular design. So it's a function of those end customers deciding to go ahead and ship those particular modules. And if they do, they're going to be using our components to sell them. So we shouldn't see a lot of variabilities and a lot of hand-to-hand combat over particular component pricing. Even our analog components, if someone were to choose these, a different one -- it has different performance characteristics and has to be qualified in its own module. So it's not so simple to have 2 different components players for the same socket. So that's why we don't see this as much as you might in other markets, where it's really a commodity that could be replaced.

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Brian Matthew Alger, Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst [67]

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Got it. And that's helpful. And maybe a bigger picture question on this with the delay or the decision to work down the inventory. From an aggregate demand standpoint, for the amount of fiber that needs to be deployed or the amount of gigabits of traffic that needs to be supported, or the overall plan to support data growth within China, has anything changed from a fundamental long-term perspective?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [68]

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Brian, thanks for the question. We have not seen any change and the need for data or bandwidths. We have not seen a change in the need to continue to build long haul and metro networks to support their continued growth of data and bandwidth. So we're still confident that this will resume. We are also being told by our system OEM customers that they are still planning to grow the ports from 2016 to 2017. And if the support grows-- comes back, as they are predicting, then we should be able to at least do the numbers John is discussing or better. The problem right now is we obviously have taken a sharp correction and we're being gun shy about predicting this. So I think what you may be seeing here is a bit of conservatism on our part because we don't have visibility. So if the port growth from 2016 to 2017 grows, I think we should be in pretty good shape. And our system OEM customers are telling us this is what's going to happen. We just are a bit worried about being too aggressive on predicting this ourselves. So we're saying, look, May-June is what they're telling us they're going to tell us more about it. I'll be in Asia twice at least in the May-June time frame. Our -- (inaudible) would be there 2, 3 times. We -- our staff is going to be spending very -- a lot of time, as you can imagine. We spend a lot of time in the region, and we're going to spend even more time in the region trying to understand and stay close to the customer situation. But we'll get more data in the May-June time frame.

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Brian Matthew Alger, Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst [69]

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I appreciate that, Ford, I applaud the conservatism. I think it only makes sense to be cautious when you don't really know what the game plan is. Just one quick follow up with regards to the growth here. There's been a lot of talk about tenders or release of incoming projects here. With this OEM in particular. Is there a growth dependent upon the government subsidizing or the government paying for the deployment?

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Ford G. Tamer, Inphi Corporation - CEO, President and Director [70]

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The question I think you're asking is what is the timing of this tenders and whether their recovery at this particular OEM is tied to these tenders, right? As John mentioned earlier, those Chinese OEMs sell in China and as well as outside of China. So for the China growth, yes, they are depending on those tenders coming back. The picture that seems to be emerging right now is what's being called the Phase 12, that is a tweener that seems to be a resumption in the national backbone buildout, and that seems to be a small incremental spend on the national backbone. And this new tender, the China Mobile terminology is Phase 13 for those provincial backbone is the one that has -- that seems to have been pushed to the second half of the year. And again, we're hearing that we should get more specificity on the exact timing in a month or 2 time frame. So we don't have that visibility today, Brian. We should have it in a couple of months.

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Operator [71]

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And that does conclude our question-and-answer session for today's conference. I would now like to turn the conference over to John Edmunds for any closing remarks.

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John S. Edmunds, Inphi Corporation - CFO, CAO, VP and Secretary [72]

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Thank you for attending the call today. Inphi plans on attending the Jefferies Conference in Miami on May 9; the JPMorgan Conference in Boston on May 23; the Craig-Hallum Conference in Minneapolis on May 31; as well as the Stifel and Bank of America Conferences in San Francisco in the 1st week of June. Ford and I would like to thank you for joining us today, and we look forward to speaking with you again in the future.

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Operator [73]

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