Cavium's (CAVM) CEO Syed Basharat Ali on Q4 2015 Results - Earnings Call Transcript

| About: Cavium Networks, (CAVM)

Cavium, Inc. (NASDAQ:CAVM)

Q4 2015 Earnings Conference Call

January 27, 2016 05:00 PM ET

Executives

Angel Atondo - Senior Marketing Communications Manager

Syed Basharat Ali - Chairman, President & CEO

Arthur Chadwick - CFO

Analysts

Blayne Curtis - Barclays

Anil Doradla - William Blair

Rick Shafer - Oppenheimer

Quinn Bolton - Needham & Co

Matt Ramsay - Canaccord Genuity

Vinay Prabhu - Morgan Stanley

Shankar Subramanian - Bank of America

Christopher Rolland - FBR

Betsy Van Hees - Wedbush Securities

Suji De Silva - Topeka Capital Markets

Mark Lipacis - Jefferies

Krishna Shankar - Roth Capital

Sanjay Chaurasia - Nomura Securities International

Operator

Good day and welcome to the Cavium Incorported Q4 2015 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Angel Atondo, Senior Marketing Communications Manager. Please go ahead.

Angel Atondo

Thank you. Good afternoon, everyone, and welcome to Cavium's Fourth quarter 2015 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'd like to remind you that various remarks that we make on this call, including those about our future financial results, including revenue growth, revenues, gross margins, operating expenses, design wins, product plans, our competitive situation, market trends, and our anticipated growth and profitability constitute forward-looking statements for the purpose of the Safe Harbor provisions under the Private Securities Litigation Reform Act.

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 factors that could cause actual results to differ materially from our current expectations. These forward-looking statements speak only as of the date hereof and we disclaim any obligation to update these forward-looking statements.

In addition, Cavium reports gross margins, operating expenses, net income from operations, net income and basic and diluted income per share in accordance with the GAAP and also on a non-GAAP basis. Management believes that the non-GAAP information is useful because it can enhance the understanding of the company's ongoing economic performances. Cavium, therefore, uses the non-GAAP reporting internally to evaluate and manage the company's operations.

Cavium has chosen to provide this information to investors to enable them to perform comparisons of operating results in a manner similar to how the company analyzes its operating results. This full 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.

Additionally, the information we provide on this call regarding sales by market, involving certain management judgments, and to which markets these sales are assigned and usually consider that when analyzing such information.

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

Syed Basharat Ali

Thanks, Angel, and thanks to everyone, for joining us today. In brief, Cavium's fourth quarter revenue was $100.9 million, down 4% sequentially and essentially flat with the same quarter last year. Non-GAAP gross margins were 66.6% and non-GAAP net income was $16.5 million, or $0.28 per share. Art will discuss our Q4 financial results and Q1 guidance in more detail shortly.

Q4 revenues came in line with our expectations. Revenues into the service provider segment was down, with wireless infrastructure being down due to a product transitioning occurring at one of our three main customers.

However, we saw improving trends at our other two customers in the later part of Q4. Wired markets were flattish.

Revenues into the enterprise market were up incrementally, while data center was down as expected. Sales into broadband markets were also down.

In Q4, we continued our strong design win momentum across our product lineup. In our traditional networking and communications market, customer adoption of our OCTEON III and NITROX lines continued to be strong.

Last quarter, we started sampling our new security processor product line NITROX V that continued our established leadership in security processing, with over 300,000 ECC and a 100,000 RSA operations per second.

Design win momentum for the mid-range and 48 core high-end OCTEON III remained strong, with key wins last quarter in next generation wired line access, enterprise security and wireless LAN control applications.

Over 2016, we expect a number of mid-range and high-end OCTEON III based products to go to production at a number of customers, including at our largest US and China customers for networking and security equipment.

Next I’ll move on to discuss the status and progress we are making on our new products. Starting off with ThunderX products, Q4 2015 saw continued strong momentum for ThunderX, with very robust demand for production parts. We shipped to a large number of ODM and announced OEM customers who are now delivering production platforms to their end customers for HPC and cloud applications based upon ThunderX.

Multiple ThunderX OEM and ODM customers announced production availability of platforms based on ThunderX in Q4 at the Super Computing 2015 trade show.

Inventec, the world’s largest server ODM, announced a high volume rack mount platform based on ThunderX. This platform will be targeting Hadoop and cloud compute workloads.

Wistron announced a hyper-converged solution that supports both all flash platforms as well as mixed flash and HDD platforms based upon ThunderX.

GIGABYTE announced production availability of five different platforms, targeting cloud computing cloud storage, big data and high performance computing applications. Penguin Computing announced production availability and customer shipments of two different platforms targeting high performance computing and cloud storage for the financial sector.

E4 company, a European HPC supplier, announced production availability and customer shipments of ThunderX platform, targeting HPC applications.

These ODM platforms were developed for lead customers and now the ODMs are also selling these platforms more broadly to their other customers.

All large customer shipments are now being fulfilled directly by our ODM partners. Cavium also continued to lead the ecosystem enablement activities in Q4. Cavium SUSE and StackVelocity announced availability of the SUSE enterprise storage platform for SES cloud storage.

In Q4, we demonstrated multiple cloud infrastructure and scale-out applications on ThunderX

at various trade shows, including OpenStack Summit. SUSECon, ARM TechCon and Super Computing 15. These applications include SES, Nginx, MySQL, Cassandra and memcached.

At Super Computing 2015, ThunderX received Readers’ and Editors’ Choice Awards for Top 5 New Products or Technologies to Watch from HPCwire.

Moving into 2016, we continue to see strong demand and backlog for ThunderX. We also continue to be on track for meaningful volume shipments in 2016.

I’ll now move to discussion of our LiquidIO products.

I had mentioned in previous calls that we are working closely with two large lead data center customers. The two lead customers have now finished qualification and have made the decision to move to volume production.

We will ship initial prototype quantities in Q1, with production shipments starting in late Q2.

This milestone was achieved within two quarters of the first sampling of our second generation LiquidIO 2 product.

We also have sample two and are actively supporting bring-up and evaluation at more than five other customers worldwide, including major hyperscale and telco cloud providers.

As we have mentioned in recent calls, we expect the LiquidIO 2 product line to have a significantly large addressable market than our first generation product.

We had originally expected to see meaningful deployment from the second half of 2016, but now, we are starting to see production deployment that will start in Q2 of 2016.

Now moving on to the XPliant switch product line, we are working very closely with our

four lead switch OEM customers and bringing up and validating their XPliant switch platforms. We have also added a fifth OEM customer last quarter. We expect our lead OEM customers to announce and start shipping their products in the Q2 to Q3 time frame.

We also won two new embedded designs in edge and mobile core equipment. Overall, design traction continues to be very strong for the XPliant product line.

Now moving on to the, OCTEON Fusion-M family of products, as we have previously indicated, this next generation single chip base station and smart Radio Head silicon allows the creation of new and innovative macrocells, microcells and high performance solutions, in conjunction with ThunderX for the emerging Cloud RAN markets.

We are very pleased to announce that we have successfully shipped prototype quantities of the OCTEON Fusion-M family in Q4, and have also received our first production orders.

Q1 will be the first production revenue quarter for this product and we expect it to ramp nicely over the next few quarters. Our momentum in NFV and Cloud RAN, network clouds [ph] continues to grow, with multiple world-class operators using both the OCTEON Fusion-M baseband processors and ThunderX 48-core ARM processors.

Operators have been testing the Fusion-M and ThunderX for both new 4G architectures as well as emerging 5G technologies.

Our close engagement with operators has allowed Cavium to assess future trends, indentify new technology initiatives, and also adapt to market changes.

Moving on to LiquidSecurity, LiquidSecurity appliances are seeing strong data center traction. These products have market-leading features for cloud HSM deployments that require multi-domain and multi-tenant support along with high-performance key management and large key storage.

Several customers, including major hyperscale enterprise and telco cloud providers, are currently evaluating this product. We are pleased to announce completion of qualification at our lead hyperscale data center customer and we expect to ship first production units in Q2.

We expect revenue ramps in the second half of the year.

Now I'd like to move on and give a brief outlook on the market environment that we have seen for Q1. In Q1, we expect the access and service provider markets to be up primarily due to improving trends in the wireless infrastructure markets.

We expect the enterprise markets to be up incrementally, while data center will be down.

Broadband markets are expected to be flat to up. We also expect continued strong growth in our new product revenues. In summary, 2015 was a challenging year due to a sharp decline in service provider revenues which started in Q2. In 2015, our enterprise and data center markets held up reasonably well.

Looking forward to 2016, we are starting to see stabilization and growth return to the service provider markets, driven primarily by an improving wireless infrastructure market environment.

Additionally, new product ramps in our core OCTEON and NITROX product lines, combined with strong growth in our new products should help drive our growth over the year in enterprise and data center markets also.

On that note, I would now like to turn the call over to Art Chadwick, who will provide a detailed discussion of Q4 financial results and guidance for Q1. Art?

Arthur Chadwick

Great. Thanks, Syed, and thanks to all of you for joining us today. I'll first go through Q4 financial highlights and then provide guidance for the first quarter of 2016. Revenue in Q4 was $100.9 million, down 4% sequentially and essentially flat with the same quarter last year.

Sales into the enterprise and service provider market were $93.4 million or 93% of sales, down 4% sequentially. Sales into broadband and consumer were $7.5 million or 7% of sales, down 7% sequentially. We again had three 10%-plus customers this quarter. Sales to those three customers accounted for 48% of sales during the quarter, compared to 49% of sales in Q3.

Non-GAAP gross margins were 66.6%, up 70 basis points sequentially, due to favorable changes in product mix and continued product cost reductions. Non-GAAP operating expenses increased during the quarter due to continued investment in new product development, customer support, and to ramp new products into production,

In addition, we expanded both our San Jose and Massachusetts facilities during the second half in 2015, to support 2016 and future growth.

As a result, Q4 non-GAAP operating expenses were $49.9 million, up 8% sequentially.

Non-GAAP R&D expenses were $35.3 million, up from $33.0 million in Q3 and non-GAAP SG&A expenses were $14.6 million, up from $13.3 million in Q3.

Non-GAAP operating income was $17.3 million, or 17.1% of sales. Income tax expense was $354,000. The GAAP loss for the quarter was $1.0 million or $0.02 per share.

The non-GAAP net income was $16.6 million, or $0.28 per share. Non-GAAP results exclude $17.6 million in non-GAAP adjustments, comprised of $12.8 million in employee stock-based compensation expense, $3.8 million in amortization of acquisition-related assets, and $1.0 million in XPliant transition expenses.

The quarter-end AR balance was $68.7 million, up from $61.7 million in Q3. Customer orders were slightly more back-end loaded this quarter than usual which resulted in DSOs of 63 days, up from 54 days in Q3.

Inventory was $47.0 million, down slightly from $47.6 million last quarter.

During the quarter, we generated $15.3 million in positive cash flow from operations.

Investment in PP&E totaled $10.1 million, which included new product production masts [ph] test equipment, and facilities infrastructure.

We had $2.1 million in capital lease and technology license payments and generated $1.1 million from stock option exercises. As a result, our cash balance increased $3.7 million during the quarter and we ended the quarter with a net cash balance of $134.6 million.

I would now like to provide more specific guidance for the first quarter of 2016. As I had mentioned, we expect sales into the access and service provider market to be up, due primarily to improving trends in wireless.

Sales into enterprise should be up incrementally, while sales into the data center will be down this quarter. Sales into broadband are expected to be flat to up incrementally. In addition, we expect continued strong growth in new product revenues this quarter.

As a result, we expect first quarter sales to be flat to up 2% sequentially, which would put Q1 revenue between $101 million and $103 million. Gross margin should improve approximately 100 basis points, plus or minus, due to continued favorable product mix and continued product cost reductions, which would put Q1 non-GAAP gross margins between 67% and 68%.

Operating expenses will increase due to beginning of the year employee raises and employment taxes, as well as continued spending to ramp new products into production.

Non-GAAP operating expenses are expected to be approximately $53 million in Q1. Non-operating expenses are expected to be approximately $250,000 for the quarter. Income taxes are expected to be about 5% of non-GAAP income or approximately $800,000 in Q1.

Income taxes for the balance of 2016 expected to be between 6% and 8% of non-GAAP income. The non-GAAP share count in Q1 is expected to be approximately 60 million shares. Based on those assumptions, we expect Q1 non-GAAP EPS will be between $0.24 and $0.26 per share.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we'll go first to Blayne Curtis with Barclays. Your line is open.

Blayne Curtis

Hi, good afternoon, guys. I was wondering you talked about orders to get [indiscernible] late in the quarter, I was wondering if you could point to what specific areas are you seeing any improvements? And as you look into the guidance, you kind of have two moving factors, you have new products up and then you have some of these transitions, I was wondering if you could quantify those two, the new products still on track to what you kind of laid out last quarter and how much is the headwind from the transition?

Syed Basharat Ali

Yes. So, let me address the second question first and that is the new products versus the downwind then data center. The new products are actually tracking right to where we expect them to be for the quarter, so we are very pleased about that. In regards to the pickup, on the [indiscernible] side specifically, we saw improved booking trends at our other two customers other than the customer that is having the transition starting in the second half of Q2 and obviously continuing through Q1. We also saw some incremental improvements in the enterprise side of the equation.

Blayne Curtis

Got you. And then just finally, when you talk about Thunder, and you’ve had product in the market now for over six months, I was curious in terms of your visibility into those ramps, you seemed very confident that you’ll get some actual revenue, more meaningful revenue later in the year, can you just talk about your visibility in terms of timing of when those stamps could be?

Syed Basharat Ali

We’ve already started shipments, as I talked about in the prepared script, to a number of our announced customers and to the ODMs who are shipping to many unannounced customers. So overall the validations have been going pretty much on schedule and hopefully we should be able to have some good news over the next quarter or so as the evaluations finish and deployment decisions are made for 2016.

Blayne Curtis

Great, that’s good.

Syed Basharat Ali

Thanks, Blayne.

Operator

And will go next to Anil Doradla with William Blair. Your line is open.

Anil Doradla

Hi, guys. A couple of questions, so, Syed, if you look at the past several quarters obviously your enterprise has been holding up well, you’ve had volatility around the wireless and all that stuff, given whatever is going on in the macro front, and I mean we are having many moving parts, how do you look at the health of the enterprise business in the course of 2016? And in other words, how much do you depend or how much offsetting factors do you have there against a weak to bad macro environment?

Syed Basharat Ali

Anil, I think overall for our enterprise markets, they held up pretty well in 2015, and we expect them to continue to grow in 2016 primarily driven by things like new product ramps in our existing customers on OCTEON III products. We have a number of products on the OCTEON III line, mid-range and high-end that are just starting to go to production. So we expect a good growth in the enterprise segment because of this. Overall, the macro has not been great, but I think the new products – shipments of these new products will help drive growth in the enterprise segment of the market.

Anil Doradla

Okay. And did I hear it correctly, Syed, where you said that one of the customer that was transitioned to the hub with the March quarter will be done with it?

Arthur Chadwick

Yes, I think the answer there is data center is going to be down in Q1 as we talked about in the past and that’s all baked into our guidance, but we do expect that to come back in Q2

Anil Doradla

Okay, great. Thanks a lot, guys.

Syed Basharat Ali

Thanks, Anil.

Operator

And we’ll go next to Rick Shafer with Oppenheimer. Your line is open.

Rick Shafer

Yes. Thanks, guys. So I had a question, you guys have a lot going on, Syed, you did a great job running through all the new product, all the new greenfield ramps you have going on this year, I mean, do you feel you’re scaled appropriately from sales and support perspective, what do you see that as any kind of curve on your top line at all? I mean is it realistic to keep thinking that OpEx should be growing about half your top line or does the need to be moved up?

Syed Basharat Ali

Yes, I think overall you’ve seen over the past couple of quarters that we have ticked up OpEx just to provide adequate support both on the engineering side and in the front support side of the equation to these five new product lines along with a whole bunch of new customers. So obviously having some more would definitely help, but we think we are doing a good job in terms of managing the increase well. Overall, again, I think on an annual basis, again on a quarter over quarter -- on an individual quarter basis, things may vary, but year over year, I think we can still maintain the goal that we have to have OpEx grow at less than half. And as you’ll see towards the Q2, moving into Q2 and over the balance of the year, sequential growth percentages improve that will be able to maintain this despite spending incrementally more on OpEx.

Rick Shafer

Okay. And then a follow-up on the Thunder question, I guess I’m always [ph] looking forward to the sort of second-half ramp you guys have talked about, can you give any color maybe regarding your relative level of confidence in that ramp? I mean, has it changed at all over the past two or three months, are there any metrics you could provide in terms of expected revenues or [indiscernible] probably not, but or maybe talk about customers or regions where that are going to be doing the most heavy lifting this year for you?

Syed Basharat Ali

Yes. So ThunderX is actually coming in pretty close to our expectations, at or maybe slightly above. Going from Q4 to Q1, we will be – our current expectations on backlog is, ThunderX is going to be somewhere 60% to 70% sequential growth compared to Q4. So overall though the numbers are relatively small, the growth sector is pretty strong. So overall I think from overall general expectations, we’re pretty much at or maybe even slightly above where our expectations were maybe a quarter ago.

Rick Shafer

Okay, thanks.

Syed Basharat Ali

Thanks, Rick.

Operator

And we’ll go next to Quinn Bolton with Needham & Co. Your line is open

Quinn Bolton

Hi, Syed. I just wanted to follow up on Rick’s question around the new products, it sounds like they’re on track, I was just wondering if you could make that comment all the way out to the second quarter but I think in the past you said you thought that the new products could reach high-single digits to 10% of sales or is your on track really more around the comments that Thunder our new products would be 1% to 2% of sales in that fourth quarter? And then I’ve got a follow-up.

Syed Basharat Ali

Yes. So, what we’ve talked about [indiscernible] conferences is for our new product contributions or contribution of new product revenues to be kind of mid single digits in Q1 rising to high single digits to 10% in Q2, and with the current backlog that we have, we are right at that number for Q1, obviously Q2 still has to play out, but we are right at that number.

Quinn Bolton

Great. And then just the second question was I guess a little surprised to hear that the top three customers were still roughly 10 percentage of the last quarter, I know you talked about that transition, your largest [indiscernible] customers, I guess I had thought that customer would come down, did you see a change in the top three customers, or perhaps it was the hub transition effect a little bit delayed in the December quarter, you’ll see a bigger impact in March?

Syed Basharat Ali

Yes. Art, do you want to take that?

Arthur Chadwick

Yes. So, Quinn, the top three customers remain the same, but there was some change between those individual customers, we obviously don’t announce exactly what each customer did. Data center was down a little bit, but our wireless was actually up a little bit incrementally in Q4. Q1, as we mentioned data center, is expected to be down.

Syed Basharat Ali

And overall, I think in our last earnings call, you talked about the fact that a large data center customer would have a smaller impact in Q4, with a bigger impact being in Q1. So that has essentially kind of played out to our expectations.

Quinn Bolton

Great, thank you.

Operator

And we’ll go next to Matt Ramsay with Canaccord Genuity. Your line is open.

Matt Ramsay

Thank you very much. Syed, there has been a few new announcements in the China server market with respect to ARM servers over the last I guess three or four months, I think it’s generally understood that perhaps China will be a market that would adopt a different architecture for servers maybe more quickly than some other geographies, we’ve seen Intel

getting in partnership with the Tsinghua group [indiscernible] Qualcomm signing some deals over there to invest with some partners in China. Have you noticed or seen any difference in the environment in China around the reception to Thunder, how is the attraction there, any update on China would be really helpful? Thank you.

Syed Basharat Ali

I think we’ve kind of mentioned this in the past, Matt, that the reception to Thunder in international markets, specifically China is very strong and we continue to see a momentum building up in the markets and obviously demanding up in these international markets for ThunderX. Having said that, as we have said in the past, that roughly kind of half our customers are US-based customers who are doing evaluations, the other half our international customers, including China. So overall I think we are seeing I would say a stronger interest as the ecosystem has come together, as the various ODM platforms have come together, and commercial product is being shipped, we see customers picking up platform much more seriously and looking at really deploying it in more applications than what they initially thought of.

Matt Ramsay

All right. Great. And then a question for Art in follow-up, obviously some really strong gross margin guidance and if I’m not mistaking the vast majority of the five new products that you guys have outlined that will ramp through the year are potentially accretive to gross margin, obviously depending on the macro, but maybe if you could walk us through the puts and takes to gross margin as these new products ramp in a little bit additional color, would be really [indiscernible]? Thanks

Arthur Chadwick

Sure, absolutely. Well, as I mentioned, we do expect a non-GAAP gross margins to improve in Q1 over Q4, somewhere around a100 basis points, give or take and that is due to a favorable product mix and continued product cost reductions. But in regards to a new products kind of across-the-board, these are generally higher end products that have gross margins that are either at or above our corporate average margins, so we do expect that as the new products ramp through the course of the year, you will get an expansion on a gross margins and we should get some type of modest upticks on a quarterly basis throughout the year, that’s how we are seeing it right now.

Matt Ramsay

All right. Thanks very much, guys.

Syed Basharat Ali

Thanks.

Operator

And we’ll go next to Joseph Moore with Morgan Stanley. Your line is open.

Vinay Prabhu

Hi, this is Vinay calling in for Joe. Syed, the first question is on wireless, like obviously wireless market is coming back, could you just provide us any color by geography and more importantly, like how are the LTE deployments going on in India?

Syed Basharat Ali

Yes. So, regarding the wireless infrastructure upticks, our customers ship to pretty much across the world, right. So it’s a little bit difficult to kind of point to which specific areas are there, but anecdotally we are hearing from them that China is improving on the wireless infrastructure side of the equation. So that is one area. And India is another area that is mentioned as increasing shipments to – that would be shipped to in Q1. So we don’t have exact visibility, but China and India come up in these conversations as upticks to the overall demand that they are seeing.

Vinay Prabhu

Got it. For my follow-up, turning to XPliant, you just talked about your added a fifth OEM customer, how should we think about the overall market opportunity for you guys in XPliant and more importantly as we look at the back half of the year, how should we think about the ramp?

Syed Basharat Ali

Yes. So the overall market opportunity, if you take a look at the switch market and the reports that are out there on the market size, the merchant silicon market is roughly in the high hundreds, so $700 million, $800 million to a $1 billion market. So we believe that over the next few years as the transition goes from 1 gig to 10 gig to 25 gig to 40 gig to 100 gig that a large portion of that market is going to be addressable by the XPliant product line. We have some pretty big names who are going to be launching products over Q2 and Q3, so we start to see first product shipments in Q2 followed up with production ramps and Q3 and Q4. Overall, that product line is seeing very, very good traction. Other than the five OEM customers, we’ve also talked about two new embedded guys who also have designed XPliant in. So the market opportunity is significant in a market position seems to be very significant too. If you take a look at last year, mid of the range, people said, you guys are one quarter late or two quarters late behind the leader, but due to both our execution, we are almost at par now, if not completely at par in terms of production release of the silicon. So we feel very good about this particular market and our potential in this market.

Vinay Prabhu

Got it. Thank you.

Syed Basharat Ali

Thanks.

Arthur Chadwick

Thanks.

Operator

And we’ll go next to Vivek Arya with Bank of America. Your line is open.

Shankar Subramanian

Hi, this is Shankar on behalf of Vivek. I just want to follow up on the ThunderX commentary you gave, obviously a lot of customers evaluating and your products have gained traction, can you talk about the main push back when you look at, when you pitch ThunderX versus the incumbent products, like which cases are you winning, which cases we’re not what is the reason that is provided?

Syed Basharat Ali

Yes. So I think we’ve talked about this, Vivek, in our previous earnings call is that we do very well in a class of applications that are very conducive to parallelization, we have 48 versus our competitors have a lot fewer cores. The applications that are parallelizable, we do very well in. Applications that have a high packet throughput that of security requirements, we also do very well in. So applications such as MySQL for example or SQL-based applications, Hadoop, data analytics type applications, Nginx, web serving applications, SES, storage applications, these are applications that our customer benchmarks have shown that they are very, very competitive. And, of course, in the HPC area where you have huge clusters and where the workloads are parallelizable, we’ve also done very well. So when you take a look at it, we are already shipping to customers and our customers are already shipping to their end customers on kind of the first wave of products, on their first generation wave of products out there. So in many of the other cases, typically what has happened is, they brought us in for one particular application, but after seeing very competitive performance, have decided to benchmark us for a second, they found that definitely get very good performance, they go to the third. So we’re actually starting to see an expanded interest in ThunderX rather than for the just the first particular application that they looked at to encompass more applications in the data center and that is a good thing for us. So essentially gain, we’re seeing very strong revenues growth on ThunderX, even though off a small base. But looking at all the valuations out there, many of them and some of the more critical ones are almost coming to the end. So their correction shipments are primarily determined by when their ODM finishes the EVT and the DVT of their production servers. So we’re starting to feel increasingly confident in this market now.

Vivek Arya

Got it. And a follow up on the XPliant market, the overall TAM you said, is that an incremental TAM to the existing switch silicon market, or is it your taking share away from the incumbent?

Syed Basharat Ali

I’m only talking about the merchant silicon market. The ASIC market is roughly the same size, so the total market size is roughly double.

Shankar Subramanian

Got it. Thanks.

Syed Basharat Ali

Yes.

Arthur Chadwick

Thanks, Shankar.

Operator

And we will go next to Christopher Rolland with FBR. Your line is open.

Christopher Rolland

Hi, guys. Thanks for the question. It looks like you guys are making some progress with Fusion-M here, what kind of impact might we see in Q1? And then also, because it is scalable, where do you think you’re going to be getting the most traction first, will it be small cell, or you think more towards the macro side?

Syed Basharat Ali

Yes. The initial traction is with our lead customers, so most of the revenues are going to come from there for the next few quarters. So essentially OCTEON Fusion-M revenues in Q1 will be well over $1 million and they will go ahead and increase again substantially going into Q2 as the product transition takes hold for that particular. So overall, the first deployment again is primarily driven by lead customer and it is in macro base stations. Would you see a bunch of announcements coming out from us over the next few months regarding the deployment or test deployments at major service providers all around the world that they are being used more for a Smart Radio Head rather than for a macro base station. Servicing some pretty wide interest, but most of our revenue, like I said, is pretty much going to come from our lead customer.

Christopher Rolland

Okay, great. Thank you. And then also as we look out through the year, are there some events that you’re going to be focused more on in terms of new product launches and customer announcements, I mean should we be looking more at Mobile Congress, or Open Compute or HPC, ODA, in terms of cadence of new product launches or customer announcements, what can we sort of look at in terms of these venues?

Syed Basharat Ali

Now if you take a look at our product lineup right now, it’s certainly larger than what it was a year ago. So the major conferences for us obviously some of them will remain where they were before, like Mobile World Congress, Computex, OCP, HPC, pretty much all these ones that he mentioned, but you’ll also see us in other supporting conferences. So, this year when we map it out, all of these should be interesting ones for us as our new products go ahead and start building traction in the new markets that we have addressed.

Christopher Rolland

Thanks so much.

Syed Basharat Ali

Thanks.

Operator

And we’ll go next to Van Hees with Wedbush Securities. Your line is open.

Betsy Van Hees

Thanks, good afternoon. I guess On a question on ThunderX, Syed, you talked about that you are on track for meaningful revenue contributions, is there an inflection point that we’re going to see Q2 or Q3 or Q4, I was wondering if you could sort of help us understand when the meaningful revenue contributions? And I apologize if I missed this, but on the last conference call, you said that ThunderX would – you to about $1 million to $2 million, I was wondering if you could hit the target?

Syed Basharat Ali

Yes. So as we talked about it, again, I said that in Q1 we will increase it significantly, I think 60% to 70% is what we have in backlog already. The numbers though are small, are getting into 2% to 3% range where which is what I would call a meaningful addition and Q2, hopefully, they will ramp from even that number.

Betsy Van Hees

Okay. Thanks so much. And then when I look at the inventory levels, it looks like days of inventory went up slightly, but inventory dollars went down, and so I was wondering if that was related to new products or the transition of your largest data center customer?

Arthur Chadwick

Well, that a lot of factors that go in there. You’re right. Our inventory went down slightly and that was on slightly lower sales in Q4 over Q3, but we’ve got a lot of new products that are ramping, so we are going to start building inventory, more inventory with our new products and you will see inventory increase through the course of the year as we increase our sales to the course of the year.

Syed Basharat Ali

Yes. I think also an additional comment, I think in Q1, you will see an uptick in inventory as we prepare for these five new products to start shipping in higher production quantity. So we expect an uptick in inventory in Q1.

Betsy Van Hees

Thanks so much.

Syed Basharat Ali

Thanks, Betsy.

Operator

And we’ll go next to Suji De Silva with Topeka. Your line is open.

Suji De Silva

Hi, Syed. Hi, Art. I apologize, I missed this. But did you clarify for the first quarter what you are in the violet segment specifically to do and if it is improving, do you think that is sustainable? And did that large customer transition specifically impact wireless infrastructure? I didn’t quite get that.

Syed Basharat Ali

Yes. So there are kind of two pieces to this, to your question here, Suji. So if you take a look at our product transition of one of our three big wireless infrastructure customers who is transitioning from OCTEON II to the Fusion-M, we took a reasonably big hit in Q4 for that and it’s a much smaller effect in Q1. But overall, we expect wireless infrastructure to be up in the mid single-digits in Q1 compared to Q4.

Suji De Silva

Okay, great. That’s helpful. And then on ThunderX, as it does grow out here, do expect it to be driven by a few customers concentration in the initial revenue ramps or will it be diversified? And would you be willing to give us some of new product percent of revenue mix 12 months out that would kind of give us a sense of where this can lead to?

Syed Basharat Ali

Yes. So 12 months out is a long time, but definitely we expect new product revenues as a percentage of overall revenues keep picking up nicely sequentially quarter over quarter and become a significantly larger portion of our revenues exiting this year.

Suji De Silva

And from customers, do expect concentration or the diversification?

Syed Basharat Ali

Yes. There will be some concentration, I think two or three of our customers will probably account for 50% of our revenues in the earlier stages, but as more customers ship, that percentage will come down.

Suji De Silva

Thanks, Syed. Very helpful.

Syed Basharat Ali

Thank you.

Arthur Chadwick

Thanks.

Operator

And we’ll go next to Mark Lipacis with Jefferies.

Mark Lipacis

Hi, thanks for taking my questions. On ThunderX, you mentioned the ecosystem, could you give us a little more color on that? What’s going on on the software side there, your customers have to make a whole brand-new investment in the software in order to get applications up and running? Are there companies that are forming that or doing the software, or the customers starting from scratch, could you provide some color on that?

Syed Basharat Ali

Yes, actually over the last year, the ecosystem has come in pretty nicely. So when you take a look at what is the software ecosystem we need to bring up a server, at the lowest level is the BIOS VMC, right. And AMI which does it both for Intel and for ARM, has a very nice solution on the market. So, the BMC BIOS issues with all the control and management is very, very similar to what the Intel infrastructure BMC BIOS features and their functionality is. The next piece is the operating system. So if you take a look at the operating system, we’re pretty much every Linux operating system known to man that has been ported over to Thunder. So, for example, you can go ahead and look at both the open source distributions, like Fedora, like CentOS, like FreeBSD. So many of these are already available and they are available upstream, you don’t have to take the operating system from us. And then you have the second part of the Linux operating systems which are supported Linux operating systems, like Red Hat for example. So Red Hat Linux 7.10.2 [ph] is available now on ThunderX, that’s a first version that is available. Canonical Ubuntu, they have like 55,000 software packages, including the operating system and that is available on Thunder. So essentially once the operating system is deployed and all their support software essentially will work on it. So the look and feel of the ThunderX server when you boot up a Canonical Ubuntu, or a Red Hat operating system, the look and feel is the same, the menus are the same, the fonts are the same, it looks identical. And then on top of that, you have the Java toolkit, if you look at Oracle Java, and Red Hat’s OpenJDK, they both run on ThunderX. So for Java applications, which will form a reasonable amount of -- which will drive a reasonable amount of revenue on ThunderX as they are available and supported by the two major vendors. The tools for example are all standard GCC tools. So essentially, the tools, the compilers, the operating systems all of these are together now, and you can get these from upstream distributions. You don’t have to individual companies and ask, give me a software. This is completely upstream, completely open source and freely available to everybody. So overall, what we’re finding is that, as this ecosystem has come together, our customers then have to compile their application, their x36 application, compile it for Thunder or compile it for ARM and they are able to run pretty quickly on a ThunderX platform. And then obviously depending upon some of the nice features we have, they can go ahead and optimize the product to get improved performance from the time that it comes up. So overall, the process from kind of start to finish is shrinking as this ecosystem has become much more hardened.

Mark Lipacis

Yes. That’s great, and very helpful color. Thank you. And then one last question on XPliant, where are you winning with that, is there a class of box that you being particularly successful there? That’s all I have. Thank you.

Syed Basharat Ali

Yes. And Mark, with the XPliant, many of our customers, they are launching -- they will be launching products both for the rack and for the spine, and this is very interesting development. So when you take a look at it, we have different versions of the chip that are good for ToR, and different versions of the chip that can also be adapted into spine applications. So normally if they needed to use our competitors’ products, there are two different chips that would have traditionally been used, but right now, they can have one product that addresses both top of the rack and spine. If you take a look at it right now, most of our applications are in these two classes of end-users, but we’re also starting to see the embedded market in terms of being designed into kind of Edge routers, and into equipments such as the EPC mobile core type equipment for SDE [ph].

Mark Lipacis

Excellent. Thank you very much.

Operator

And we’ll go next to Krishna Shankar with Roth Capital. Your line is open.

Krishna Shankar

Yes. Syed, will the revenue contribution from the five new products be relatively well-balanced as you say it gets to the for our 10% to 15% of revenues for the entire year, will it be well-balanced or will ThunderX and XPliant be the major contributions?

Syed Basharat Ali

We think there will be very good contributions and meaningful contributions from all products, but we expect ThunderX to be the single biggest contributor.

Krishna Shankar

Okay. And then can you make any comments on China? We’ve seen different reports on sort of the macro uncertainty impacting demand in China. What do you see in terms of China in terms of the different market segments there, enterprise, data center, wireless infrastructure, what are you seeing out there?

Syed Basharat Ali

Regarding the wireless infrastructure, as I’ve addressed in this particular call, there is definitely an uptick there. But overall, in terms of the macro, even though it’s not great, we don’t see it quite as that as some of the other companies have reported. But that may be due to the fact that we have some new products starting to ramp in the wired and networking infrastructure. So overall it’s not great, but it’s not as, I think, as bad as some of the other companies in the semiconductor have reported.

Krishna Shankar

Okay. As LiquidIO 2 and Liquid Security 2 addressing the same data center customer, or is it different customers and is it targeting a larger market versus the previous versions?

Syed Basharat Ali

Yes. So both these customers address the similar data center customers for sure. But one of the comments I think I’ve made before in a couple of calls and we’re starting to see that more and more is we’ve got a number of guys who for evaluating Thunder, and as they evaluate Thunder, as they get good performance, and as the validations look good, what they do then this for the x36 portion of their data center, they start evaluating LiquidIO. So LiquidIO 2 becomes a nice tag on to them. Once they do that, we have customer starting to look at Liquid Security and the switch. One of the things that you’re finding is, with one product making a headway, one product being evaluated having the highest interest, it starts expanding to one or two or even three of the new product lines. Similarly, for our OCTEON Fusion-M customers, the fact that the OCTEON Fusion-M also has a good application in a Cloud RAN style architecture, that pulls in ThunderX interest and ThunderX proof of concepts and ThunderX validation. So we are releasing a lot of synergistic pull-through, we enter with one and before we know it in three to six months, two or even more products of a new products start being evaluated.

Krishna Shankar

Great, thank you.

Syed Basharat Ali

Thank you, Krishna.

Arthur Chadwick

Thank you, Krishna.

Operator

And we’ll take our final question from the side of Sanjay Chaurasia with Nomura. Your line is open.

Sanjay Chaurasia

Hi, Syed.

Syed Basharat Ali

Hi, Sanjay.

Sanjay Chaurasia

I also have one question on ThunderX, I thought I’ll beat it down a little bit more. Based on the workloads you indicated, it seems like you focus is HPC and big data kind of application, and I was just wondering that is it that you first-generation ThunderX chip is 28 nanometer and many other hyperscale customer may want to wait FinFET next generation chip, is that why those workloads you not mentioning, could you give us some color how that dynamics is playing out?

Syed Basharat Ali

Yes. I think, Sanjay, we’ve talked about it before, right, that when you take a look at applications that we see very good traction in the type of class of applications that I mentioned in answer to one of the other questions, these are definitely more parallelizable. I don’t think customers buy semiconductor technology, they don’t say I want a 28 nanometer part or I want a 20 or a 14. Whatever product you have regarding performance and architecture, and cost and power, they see how that generation fits. Obviously our next generation product is going to be much, much more competitive and will be able to address a significantly larger portion of the market. So if you take a look at HPC, if you take a look at data analytics, if you take a look at storage, if you take a look at database, SQL is more of a database, a database sort of application. These are the class of applications that our current architecture does very well in. As they moved to our next generation Thunder, we will certainly expand that fairly significantly into where we can play in.

Sanjay Chaurasia

That’s great, Syed. One question, if I look at your growth in 2015, I would say that’s the slowest growth, with the exception of 2012, was as your average growth of roughly 25% to 30% year on year, as we look into 2016 and 2017 with several product ramps coming, do you see yourself getting back to that kind of growth rates in 2016 and 2017?

Syed Basharat Ali

Overall, in the semiconductor business right, it is a cyclical business, if you have taken a look at our last six years, seven years, we’ve had kind of three great years and one crappy year. And 2015 was not a great year by any stretch of imagination, because we had no new products going into production, no new volume products going into production, and we had a significant debt deceleration in the service provider segment. So when you take a look at it overall, year-over-year, we were down – we were up like 6% to 7%, whatever that exact number is for the year, but our service provider segment declined by roughly 10%. So if the service provider had even been flat, our year-over-year growth rates would have been somewhere between 15% and 20%. So having said that, looking into 2016, we believe that moving on to Q2 and beyond that we should start seeing an acceleration in the year-over-year growth rates driven but in a large portion by the new products and by a much smaller portion by improving trends in our current markets.

Sanjay Chaurasia

Great. That’s very helpful. Thanks, Syed.

Syed Basharat Ali

Thanks, Sanjay.

Arthur Chadwick

Thanks, Sanjay.

Operator

Thank you for joining us today ladies and gentlemen, this does conclude today’s program. Today’s program will be available on replay. That replay dial-in number is 719-457-0820, Passcode 3703254. Once again the replay numbers 719-457-0820, Passcode 3703254. We certainly do appreciate everyone’s participation today. This does conclude today’s program. You may disconnect at any time. Thank you for joining us.

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