Acacia Communications (NASDAQ:ACIA) Q3 2016 Earnings Conference Call November 10, 2016 5:00 PM ET
Monica Gould - Investor Relations
Raj Shanmugaraj - President and Chief Executive Officer
John Gavin - Chief Financial Officer
Benny Mikkelsen - Chief Technology Officer
Vijay Bharadwaj - Deutsche Bank
Paul Silverstein - Cowen and Company
Dmitry Netis - William Blair
Doug Clark - Goldman Sachs
Tal Liani - Bank of America
Alex Henderson - Needham & Company
Tim Savageaux - Northland Security
Greetings and welcome to the Acacia Communications Inc. Third Quarter 2016 Earnings Conference Call. At this time, all participants will be in a listen-only mode [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host Ms. Monica Gould, Investor Relations for Acacia. Thank you. You may begin.
Thank you, Tim, and good afternoon, everyone. Acacia Communications released results for the third quarter fiscal 2016, ended September 30 2016 this afternoon after market close. If you did not receive a copy of our earnings press release you may obtain it from the Investor Relations section of our website at ir.acacia-inc.com. This call is being webcast live and replay will be available on the Investor Relations section of our website.
With me on today’s call, are Raj Shanmugaraj, President and Chief Executive Officer; John Gavin, our Chief Financial Officer; and Benny Mikkelsen, our Chief Technology Officer and Founder.
Before I turn the call over to Raj, I'd like to note that today's discussion will contain forward-looking statements based on the business environment as we currently see it and as such does include certain risks and uncertainties. Please refer to our press release and our SEC filings for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today’s discussion.
Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. In addition to U.S. GAAP reporting, we report certain financial measures that do not conform to Generally Accepted Accounting Principles. We believe these non-GAAP measures enhance the understanding of our performance. Reconciliations between these GAAP and non-GAAP measures are included in the table found in today's press release.
And with that, I'd like to turn the call over to Raj.
Thank you Monica. Good afternoon everyone and thanks for joining us today to discuss Acacia's Third Quarter Financial Results and other business updates. I will provide an update on the macro aspects of our business, the markets we serve and some of our recent achievements and will then turn the call over to John Gavin who will provide a more detailed review of our financial performance and outlook. Our mission at Acacia remains the same - siliconization of the optical interconnect. We have taken bulky customized expensive components requiring pizza box sized line cogs and shrunk much of that functionality on to two chips, namely our Digital Signal Processor or DSP ASIC and Silicon based Photonic Integrated Circuit or Silicon PIC.
We have achieved industry leading speed, density and power efficiency with our products and are seeing increased adoption of our siliconized optical solutions across the high growth markets that we serve, namely the Data Center Interconnect or DCI and Metro Market. Of these DCI is the highest growth market that we serve and ACD Research projects that this market will grow at a compounded annual growth rate of approximately 32% between 2015 and 2020. New mega data centers spread over metro areas create the need for significant interconnect capacity driving 100G, 200G, 400G and higher speeds. In Q3 like in Q2 we saw demand increase for our product in the DCI market and currently expect this demand will continue to grow in Q4 and beyond. On this front, we were very pleased to see that one of our largest customers ADVA Optical Networking recently announced that they have been ranked number one in Ovum's latest DCI global market share report. We believe that the use of our product by our customers enables them to gain share in the DCI market. You may have also seen that Facebook recently announced a significant contribution of the open package DWDM architecture to the Telecom Infrastructure Project also known as TIP.
The announcement stated that Facebook used open system hardware and software products incorporating Acacia's AC 400 product to deliver a complete disaggregated hardware and software optical networking platform that is expected to revolutionize the industry. We are very happy to partner with Facebook to deliver this solution based on our AC 400 high performance configurable flex rate module which met Facebook's high capacity and flexible service requirement.
Moreover, the open and disaggregated nature of the open packet DWDM architecture will enable other service providers to adopt and deploy this platform which the effect will create additional opportunities for Acacia. We are very pleased with the adoption of our products in the DCI market to date. We have seen significant year-over-year growth in the DCI market both from our original eight customers and from our newer customers. We see the web scale cloud and content providers building DCI networks deploying both Network Equipment Manufacture or NEM platform as well as Open Optical Line System platform.
We believe that we are well position to provide innovative optical interconnect solutions in both of this models. Turning to the metro market. Growth is being driven both by major broadband investment in China with the government China broadband initiative and by US carriers who are now focusing on updates to their metro networks. We see continue demand in the China market as carriers transition from back bone and provincial back bone network build out to provincial metro and access network in 2017. We believe this investments and upgrade will continue to drive service provider spending in the metro market. There our CSPDCO had seen wide market adoption driven by cost power plug ability and integration benefit of our DCO solution.
In the long haul market, increasing global customer demand for high speed network connections has driven web through our cloud and content providers to build out subsea network. We sell our DSP ASCI and Silicon PIC based Optical Inter Connect to leading subsea NEMs to connect some of the most challenging and complex optical networks in the world and also to NEMs who deploy these products in long haul terrestrial networks. Based on this customer engagement, we see continued demand in these markets.
Now I would like to discuss some of our customer dynamics and provide an update on our revenue diversification effort. First, it's important to note that many of our customers offer a wide range of network equipment solutions ranging from handset and mobile to optical, some of which are growing faster than others. We predominantly supply equipment that is deployed in the highest growth market. As such slower growth in other end markets should not necessarily be interpreted as a slowdown in the overall growth of the 100G and above optical market. Although our sector has a history of seasonality in the fourth quarter due to cloud and content providers reluctance to disrupt their network traffic during the peak holiday season. We currently do not anticipate any slowdown in the long term demand from our customers.
We have been executing well on our land and expand strategy; during the 12 months ending Q3 2016 we've successfully grown our customer base from eight in 2011 to more than 25 and have also made good progress in ramping sales to our newer customers. In the third quarter revenue from these newer customers rose 37% sequentially compared to 11% sequential growth from our original eight customers.
As was the case in Q2, in the third quarter two of our newer top tier customers were among the top five contributors to our revenue. We're also diversifying our customer base by ramping customers in the traditional switch router market as well as new Chinese network equipment manufacturers.
I'd now like to provide an update on our product development efforts and the continued traction that we're seeing with our newer products. Our technology leadership has already allowed us to establish a significant presence in the CFP-DCO market. We had able to innovate rapidly and have introduced a new purpose built DSP ASIC every year since 2011.
We recently announced that we have product sampling our coherent CFP2-DCO module which incorporates our new low power DSP ASIC based on 16-nanometer CMOS technology. The CFP2-DCO module offers a pluggable solution with four times the faceplate capacity of the CFP-DCO modules that we're currently shipping in volume. This capacity increase is achieved by reducing the width of the module by a factor of two and doubling the maximum transmission rate from 100G to 200G.
The CFP2-DCO form factor is currently being standardized by the Optical Internetworking Forum and has been gaining industry momentum. It is Acacia's extensive expertise in designing low power DSP ASIC technology and silicon photonics and our culture of innovation all under one roof that has enabled us to deliver high-performance pluggables in a small form factor like CFP2 which we believe further extends our position as a market leader in the pluggable coherent space.
The optical networking industry currently supports two different pluggable coherent architectures. Digital coherent optics or DCO modules incorporate the DSP ASIC internally and have a digital host interface similar to client optics, making it simpler to design into a host card. Analog Coherent Optics or ACO modules require that the DSP ASIC be outside the module on the host board and have an analog host interface. With the introduction of our CFP2-DCO module, Acacia is now able to offer both DCO and ACO solutions in the same form factor with similar capacity. In addition because our CFP2-ACO can be integrated with DSPs from another store we expect this product to expand our market opportunity by allowing us to engage with customers using in house solutions. We are in the process of transitioning the manufacture of our CFP2-ACO module to our low cost contract manufacturer in the Far East and expect to ramp to high volume production in the first quarter of 2017.
Additionally we recently announced the introduction of a new long haul version of our CFP-DCO product which extends the reach of our CFP-DCO modules to 2,500 kilometers with 37.5 gigahertz pacing providing greater capacity of the long haul link while maintaining the small form factor and power efficiency.
Switching to our financial performance we are very pleased by the performance of the company in Q3. In the third quarter total revenue increased 107% on a year-over-year basis to a record $135.3 million primarily driven by an increase in sales of our 100G CFP-DCO products as well as volume production of our 400G product family. At the same time our non-GAAP gross margin rose to 47.2% from 38.6% on a year-over-year basis. And we recorded non-GAAP net income in the third quarter of $40.9 million compared to $9.4 million in the third quarter of 2015. These results demonstrate the strength of our business and operating leverage in our model as well as the strength that we are seeing in the 100G and above optical market.
In summary, we are very pleased with our strong financial and business performance and our ability to scale to meet growing customer demands. We believe our success is a testament to the strength of our disruptive technology and the execution from our talented employees. We have appropriated those multidisciplinary teams with extensive expertise in optical systems, digital signal processing, large scale ASCI design, silicon photonic integration and systems software and hardware design all under one roof which we believe provides us with a significant competitive advantage in solving the optical interconnect problem. We believe our disruptive technology has already started to transform cloud content and communication networks and we feel this is just the beginning. We are continuing to invest in our R&D organization to introduce innovative products beyond our CFP2-ACO and CFP2-DCO to further help our customers meet evolving global optical network capacity demand.
With that said, I'll turn the call over to John for a more detailed review of our financial performance and our outlook for the fourth quarter.
Thanks, Raj, and good afternoon, everyone. I'll start by reviewing our financial and operating performance for the third quarter, and then provide our outlook for the fourth quarter before opening up the call to questions. We are very pleased that our results once again exceeded our expectations.
Total revenue of $135.3 million in the third quarter of 2016 rose 107% from revenue of $65.4 million in the third quarter of 2015 and increased 16.4% sequentially. This growth was driven by continued strong global demand from metro and DCI network build outs.
In particular, we saw a increased demand for our metro focus 100G CFP-DCO and our 400G DCI focused products. In Q3 we continued to add additional production capacity for our 100G CSP DCO product and we're able to increase our CSP DCO shipments as a result of our ongoing production scaling effort with our Far East contract manufacturers. We also completed a transfer of our 400G DCI products to a contract manufacturer and initiated our volume ramp which will continue to Q4. We continued to see strong demand from China due to the sustained build up related to a 100G and above optical network and we are executing our strategy of diversifying our customer base in China. During the quarter revenue from newer customers outside our original eight 2011 customers grew 81% year over year and 37.2% sequentially compared to a 117.3% year over year and 10.8% sequential growth for our original group of eight customers. Growth from our newer customers outside our original group of eight customers represented 25% of our revenue in Q3 2016 and we expect to see that percent of quarterly revenue increase as more of these newer customers begin their volume ramps in Q4 2016 and during 2017.
GAAP gross margins increased to 46.8% in the third quarter from 38.5% in the prior year period. Non-GAAP gross margins which exclude the impact of stock based compensation expense rose to 47.2% in the third quarter 2016 from 38.6% in the third quarter 2015. This year over year increase is primarily due to the continued shift in our revenue mix to products that contain a vertically integrated silicon technology. Our gross margins also benefited from our progress and further ramping on manufacturing in lower cost regions during the third quarter, our gross margin can fluctuate based on quarterly mix, the introduction of new products and the impact of pricing changes. Over the long term we continue to expect non-GAAP gross margins to improve and be in line with our long term range of 48 to50% driven by further vertical integration into our silicon building blocks and our ongoing focus on reducing manufacturing cost.
Operating expenses in the third quarter totaled 26.5 million or 19.6% of revenue compared to 12.6 million or 19.3% percent of revenue in the prior year period. Non-GAAP operating expenses which exclude the impact of stock based compensation expense were 20.3 million in the third quarter or 15% of revenue compared to 12.4 million or 19% of revenue in the third quarter of 2015. R&D expenses totaled 15.1 million or 11.2% of revenue in the third quarter 2016 compared to 9.4 million or 14.4% of revenue in the third quarter of 2015. The increase in R&D expenses primarily related to higher personnel cost, silicon foundry expenses and prototype development cost. As we noted on our previous earnings call, we expect fluctuations in our quarterly R&D expenses due to the timing of silicon development cost and the associated development expense is to prototype and qualify new products. We continue to invest in our technology roadmap and we're making progress with the products that we expect to come to market during 2017 and 2018.
As Raj had mentioned earlier in his remarks, we recently announce that we started sampling our CFP2-DCO module. We believe that our CFP- DCO module which is powered by our six DSP ASIC will extend our market position in the DCO pluggable market segment. SG&A expenses were $5.2 million or 3.8% of revenue in the third quarter of 2016 compared to $3 million or 4.5% of revenue in the third quarter of 2015. We plan to continue to expand our R&D and SG&A organization as we scale our business to support the many growth opportunities ahead of us.
Over the long term, we expect non-GAAP R&D and SG&A to increase as a percent of revenue to be in line with our updated long term target range. Based on our increased revenue scale and the operating leverage inherent in our model we have decreased our long term targets for non-GAAP R&D 22% of revenue to 17% to 19% of revenue and non-GAAP SG&A from 6.9% of revenue to 6.8% of revenue. Third quarter operating income increased to $36.8 million or 27.2% of revenue up from $12.6 million or 19.3% of revenue in the prior year period.
Non-GAAP operating income in the third quarter was $43.5 million or 32.2% of revenue up from $12.8 million or 19.6% of revenue in the third quarter of 2015. Our non-GAAP operating income results excludes $6.7 million of stock based compensation expense. Over a long term, we expect a non-GAAP operating margin to be in line with our new long term target range of 23% to 27% up from our previous target of 20% to 24%. Adjusted EBITDA in the third quarter of 2016 was $46.2 million up from $14 million in the third quarter 2015 driven by our expanded gross profit on the year-over-year incremental revenue, the operating leverage and our business model.
Our effective tax rate for the third quarter declined to 5.7% from 27.5% in the prior year period. Our non-GAAP effective tax rate for the third quarter is 6.3% down from 26.4% in the third quarter of 2015. This was primarily due to our continued scaling of our operations in Ireland our principle foreign operating subsidiary. We anticipate our non-GAAP effective rate to fluctuate somewhat over the next six to twelve months as we continue to scale our operations in Ireland. Over the long term, we expect that our non-GAAP effective tax rate will be in line with our updated long term target range of 9% to 12% which is down slightly from our previous target of 10% to 14%.
Net income increased to $34.9 million or 25.8% of revenue up from $8.8 million or 13.5% of revenue in the prior year period. Non-GAAP net income rose to $40.9 million or 30.2% of revenue from $9.4 million or 14.4% of revenue in the third quarter of 2015. Based on a fully diluted weighted average share count of 40.7 million shares; this translates to diluted earnings of $0.86 per share and non-GAAP diluted earnings of $1.01 per share. We expect that non-GAAP net income as a percent of revenue would be in line with our new long term target range of 21% to 25% which is up from our previous target of 18% to 22%.
Now, turning to the balance sheet; we ended the quarter with cash and cash equivalents of 175.6 million and no debt. We generated 21.4 million of cash from operating activities in the third quarter and we also completed our follow-on offering raising approximately 115.7 million of net proceeds in the beginning of the fourth quarter. The proceeds of this offering further strengthen our balance sheet and together with available cash provide us with additional financial flexibility to pursue our growth objectives and expand our product offerings.
With that I'd like to turn to our outlook for the fourth quarter of 2016. As we discussed in our Q2 earnings call we've seen in the past two out of three years, that Q4 can be our lowest growth quarter during the year. In two of those three years Q4 was either flat or lower on a sequential basis. We believe this is due to cloud service providers not wanting to disrupt their network traffic during the peak holiday season and other fiscal metric pressures that are evaluated quarterly and more critically at year end. Outside of typical Q4 seasonality factors we're seeing continued strong demand for our products; and do not currently anticipate any slowdown in long term demand.
As noted in our earnings press release in the fourth quarter of 2016 we expect total revenue to be between 136 million and 141 million representing year-over-year growth of 98% to 106% and 2.4% sequential growth at the midpoint of guidance. We expect non-GAAP net income to be in the range of 36 million to 39 million and non-GAAP diluted earnings in the range of $0.85 to $0.92 per share based on anticipated 42.3 million diluted shares outstanding.
As Raj mentioned we continue to make good progress on our revenue diversification effort, by introducing new products and ramping the new customer groups. Several of our newer customers are in the early stages of integrating our interconnect technology in their products and we're starting to see growth in Q4 and we expect to start seeing more growth from these and other of our newer customers continue into 2017 and beyond.
Overall the third quarter was another exciting and strong quarter for Acacia across a number of business areas; for the second quarter in the row we exceeded our financial and operating expectations. We see continued strength in the core demand drivers of our business including metro and DCI markets; and we're seeing newer customers outside our original group of eight customers continue to grow the business they're doing with us.
We believe we're positioned in our current product offerings and our roadmap products in our development pipeline to be able to continue to take advantage of future growth opportunities. We believe that continued investment in R&D including planning for the increased cost associated with each next generation silicon technology, is critical to our ability to rapidly innovate and introduce next generation products to the market. We also believe that the integration into our products of additional internally developed functionality will enable us to achieve higher gross margins that are in line with our long-term gross margin target.
As I highlighted earlier, we have assessed our long-term financial model and based on several factors including the overall market strength that we were seeing the operational leverage and our business model we have increased our long-term targets for non-GAAP net income and non-GAAP operating margin.
Q4 was another record quarter for us in terms of shipments and business execution and we look forward to the opportunities that lie ahead in Q4 and beyond.
I will now turn the call to Tim to open up the call for questions, after which Raj will wrap up with some summary remarks. Thank you, Tim?
At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Vijay Bharadwaj, an associate analyst.
Yes, thanks. Hi Raj, John. These are solid results here. It seems like holiday seasonality is mostly driving in on the December quarter revenue guide the earnings trajectory even seems strong here. To help us understand the seasonality factors that we need to pay attention to heading into 2017 and then also any education on the CFP2 product cycle. What are the primary demand drivers from your OEMs and then customers for CFP2 both DCO and ACO? Thanks.
So, Vijay let me take a crack at just addressing the first part of your question and then move to the second piece. On the first one it's always clearly if you look at a year-over-year growth of 107% in Q3 and the midpoint being 95 % to 100% is not really a bad growth for us but having said that I think if you look at the overall where we are seeing strength and where there is some seasonality we've seen strength in both the DCO CFP product as well as the AC400 product in DCI applications. We are seeing demand from all three markets with mainly the metro and the long haul and the data center interconnect markets. We do see some level some of the content and cloud providers pushing out from Q4 beyond they are not wanting to upgrade their networks in the middle of peak season and that's as a few of them it's not like a segment problem but as we see some of that but it is offset by our new products the AC400 as well as the new customer growth that I talked about that as that we have grown 37% sequentially.
In terms of the ACO and DCO products so I think the ACO we said we are we started sampling it earlier this year we have started the transition we are moving to high volume manufacture and so we plan to ramp high volume in Q1 of 2017. It's sampled to customers both with Acacia DSP as well as with people who don’t have who were using other DSP. And in terms of the DCO CFP2 it is just sampling right now and I think if you look at the cycle time we would be ramping in the first half of next year. Now since the -- it uses the same photonic integrated circuit which we have demonstrated we can manufacture in high volume we anticipate these volumes to be for us to be able to scale the support both the ACO and DCO product.
Vijay this is John, I'll try to add to what Raj said around seasonality. If you look at when we talked about those two years out of the last three where revenue was either flat or down sequentially those were the '13 and '14 fiscal years and if you look at what happened in '15 we actually had an increase in that particular quarter that was driven by some of the growth that was happening in the build out in China and in this year, we still can see continuing to happen as well as we are seeing now the benefit of adding the new customer base to our business and those folks are definitely ramping their volume over Q3 into Q4.
So I think , there is seasonality to your point about how it would affect 2017 there is seasonality that we've seen in that fourth quarter but the last two years at as we're guiding it now and aswe saw it in '15 we have broken that in terms of being able to be up from Q3 not by a lot from a sequential growth rate but it's not down which is what the trend was in '13 and '14 but that's because of our increased number of customers and number of products that we've been bringing to the market and that's helped our overall diversification there and helped un in terms of growing not going backwards in terms of growth rate in Q4.
Thank John, Raj very helpful.
Our next question comes from the line of Paul Silverstein of Cowen and Company, please proceed with your question.
Thanks, I hope you're giving me in a couple of question but my first. Were there any supply constraints that impacted revenue in the quarter that you're expect to impact revenue in the next quarter?
Hey Paul it's John how you doing? Yes so I can handle that it's in Q3, what we did in Q3 was we are able to continue to ramp the 2 CMs, party CMs that we brought on board to help us ramp the 100G CFP DCO product and very successful quarter there in terms of getting incremental capacity and we were very close to being where we needed to be in terms of overall capacity needing and matching the demand equation.
Where we did meet those expectations were in the 400G the AC400 products, that product is a newer product as you know and it is in the process of ramping and I said in my prepared remarks we handed that off and transferred that into the contract manufacturing days in Q3 and as such we are working with them to continue to ramp that particular product and we'll continue that ramp to Q4.
John based on the demand you're looking at now do you anticipate that there's any demand that you will not be able to address those things that you're ramping that you'll leave on the table in Q4.
We'll continue to investment in that ramp Paul for the AC400 product I think we'll be in very good shape for the demand for the CFP side of the product. Now we have those two CMs now that are really ramping up and able to meet demand there so. So I think we'll have continue challenges in ramping the AC400 product but having said that, we've made some really good progress early here in Q4 in that transfer and the ramp process but demand is strong is there and so we will have some challenges there I think in Q4 as well.
Let me ask some more if I may. One, I understand demand is pretty strong across the board in optical for you and your peers but would [indiscernible] DCO coming first half of next year if I heard you correct, do you think there is any customers that you know the class Osborne effect that are pushing off that you would have expected to otherwise purchase that are waiting for that to shift. And I am hoping as you can give us some color if you said before if I apologize but any color on 10% customers and top five customers versus pretty good.
Paul, we are -- we started sampling and we know some of the DCOs, CFP2s are easier to integrate so because they have a digital interface. So while it is easier to do so. We are not seeing at this point people pushing out or customers pushing out CFPs deployment waiting for this there are several customers waiting to get the CFP2 DCO product. So but it's not we don’t believe that there is any overlap or push out because of that particular product.
And then on your top customers?
Yes so on the top customers as we said, the only thing we can share today is that two of our newer customer top tier customers are in there top five range but as they cross the 10% threshold we'll be glad to share but we are not sharing anything today.
One other point to clarify from what Raj said. In Q3, we did have two of the newer customers in the top 10 in the top five excuse me, top five and it was one of those customers who is the same customer in Q2, and in additional customer came in for the first time in the top 5 in Q3.
John I appreciate and did you just say how many 10% customers you had?
For the quarter it was two.
Okay. I appreciate. Thank you.
Our next question comes from the line of Dmitry Netis of William Blair. Please proceed with your question.
Thank you, then Raj for taking on the question. Just wanted to follow-up actually on the previous question as far as the two 10% customers can you guys tell us. I think you break it out in the queue. Are you able to give us the numbers so what those two customers were as the percent of revenue?
Yes Dmitry that's in the queue is well but we can give that to you it was 35% and 28.3%.
And those are the same customers you've always had as top two. Is that correct?
Okay, very good and then John can you give us a breakdown on the geos as well as far as the North America and EMEA and China goes or Far East goes?
Unidentified Company Representative
Yes, in terms of what Dmitry? In terms of overall revenue for the quarter or in the breakdown?
Yes, that's correct. Just revenue..
Yes, hold on a second. I think was John as looking I mean part of what Dmitry just to clarify when we ship to address in Asia or EMEA it's their contract manufactures customers from Europe and North America have CMs in China so it's really doesn't mean that it is ending up in Chinese carrier locations. So we have to take that a little bit with a pinch of salt in terms of the geographic ship to address does not necessarily mean like for example what our customers may tell, it doesn't mean that we're shipping to those regions to the end carriers there.
That's a good point, thank you for that.
So, in terms of rough geographic breakout Dmitry it's I believe Asia Pac is around 44% to 45%, that would include China and other countries; North America was roughly 24% and EMEA was about 30% to 32% or so, we'll double checking it.
Okay, that's helpful and then I wanted to touch on the OpEx, that's more of a broader question for me, I know you raised your operating targets, you came in obviously in Q3, you outperform on the operating expense quite nicely which kind of fell all to the bottom line, sounds like given the midpoint of the guide in Q4, you will come in at about 18% of sales, where you told non-GAAP operating expense budget; so just thinking out and given the sort of how you lowered your R&D, your expectations as far as the target model goes and G&A, how should we think about the OpEx on a non-GAAP basis going into '17; are we here sort of looking at 20% plus of revenue, OpEx is 20% plus of revenue or is it going to be below closer to that 18%, you ended 2016 with or will end 2016 with, so any color on there would be really helpful?
Yes, so Dmitry. So, in terms of the updated long term model that we just talked about on the prepared remarks, when we originally did that long term model it was early in 2016 and we had not seen the kind of growth that occurred for us in 2016, so from the planning perspective as you start to plan out the out years, you know our revenue bases obviously was lower; therefore our operating expenses had a higher percent in the model; as we've seen the revenue grow in 2016 and then we plot that out into the outer years to come up with the long term revision; we noticed that our spending assumptions were coming in line with what we had planned but obviously off of a higher revenue base that now means the percent are lower. So, when we looked at that we thought that we would adjust those and make those set of adjustments in the model. In terms of operating expense in terms of next year, what we'll see next year is some of the investments that we're making now in the next silicon technology node so as you know those investments each new technology generation are increasing and in the first half of the year next year we're going to start to see some of those development costs with silicon expenses come to fruition or the next level of DSP technologies that we're developing and PIC technologies that we're developing. So, you'll see some uptick in the absolute spending numbers in terms of where we'll be next year and that's how we'll bridge the gap between where we're today and the OpEx percentages compared to where the lower end of the long term model is.
Okay, I guess maybe last question for Raj, it was kind of bigger picture as you look into the kind of the wired box opportunity with Facebook that you mentioned how you guys are thinking about the kind of other web skill guys jumping on this band wagon and anyway to kind of size this opportunity if you guys give us thought of what could be kind of a direct business to those guys if they were to come in and buy this so their datacenter is going forward, any color. I know it's difficult probably to size it but how are you thinking about this opportunity going forward and when will that become a real opportunity as far as meaningful revenue contribution are we still a year away or is that really happening as we see?
Yes, so good question Dmitry and as you said that it's a little more difficult to answer but let me add some color to it first of all we don’t directly market heavily to the web scale guys to be able to sell directly because we do sell to customers who sells to the web scale guys and so to a large extent we sell a lot of network equipment manufactures platform to our customers platforms that end up in web scale guys and that's still the vast majority of the revenue and of course as you've seen in the case of Facebook there is the white box as well as there are net of instance that web scale guys developing their own custom device so there is some pull they come to us to say while we are developing either a white box or a custom solution and they want to use our product and so when there is a pull then of course we have to participate in it because our customers are not in that mix at that point in time so it is a little sensitive for us we don’t market directly to them but we do support the pull coming from our customers and to that extent we have some engagements with the web scale guys.
We do talk to all of them on a very regular basis in terms of what their network needs are so that we can be developing our products for them but we see two models continuing to happen which is the NEMs model where we sell to the NEMs and they sell to the web scale guys and then of course there are other pieces that there is pull there, either white box our customer equipment our product goes directly to the web scale guys.
Now as it pertains to the Facebook announcement itself it is early stages I think it's there has been a lot of work groundwork that has been done in terms of designs investments to designs but I really are not going to comment on the timing of this but we are anticipating we currently anticipate this to be in 2017 level of revenue but again I'm not going to get into how big and how soon and so on.
Okay that's very helpful. Thank you very much. Keep up the good work guys.
Dmitry before you go I do want to circle back with the on the exact numbers percent wise on the geo breakout. Americas was 19%, EMEA 34% and APAC was 47%.
Excellent. Thank you.
Our next question comes from the line of Doug Clark of Goldman Sachs. Please proceed with your question.
Hi, thanks for taking my questions. The first one I wanted to touch on is actually a bit of the customer concentration issues as well. The 10-Qs out so we can get a pretty detail look at what those customers are. What strikes me and what I want to get your response on is the three big customers that have been in that way for the past few quarters were still 69% of sales which is basically is the same that it has been for the past two quarters during the year as well. So I'm wondering if you can give a little more detail on to that diversification and then related to two out of those three big customers one already got it for pretty significant sequential declines in the fourth quarter so I am wondering as we looking in the fourth quarter I am should we really see a material ramp up in the new customer revenue contribution to kind of offset some of those potential decline?
Yes so good question let me take a crack at it Doug and maybe John can chime in. As we said the customer concentration while there is not an addition of another 10%. We made two references; one is that we've added two top tier customers in to our top five which was not the case before. It was in Q2, but not before that. So we are happy with the ramp of our top tier customers.
Number two is these are 18 to 24 month lead time development. So in other words, it's not something that we take in and they plug in like a client side and off to market they go within a couple of months these are 18 to 24 they have to develop their product integrate our product than qualify our product and take it to their customers qualify in their customers. So it is a -- it takes time. And that's the other piece of it so while we don’t have new 10% customer, we have two of those in the top five and also as a said in my section. The new customers accounted for 37% sequential growth quarter over quarter and we see that growth continuing which is also what the point I made to offset some of the seasonality. So it will take time at this point but and at the right time obviously we will share with our as soon as customer crosses the 10% threshold but the way to look at it is we have several of this that are not at the 10% level but we are very happy with the progress of our newer customers.
And Doug I'll just add to that as I said in my prepared remarks 25% of our revenue in Q3 was from that new customers stat that's the highest percent contribution of that group to date and we expect that to grow again in Q4 and through the quarters starting in 2017. So we are seeing that start to ramp up and we just had some customers in Q3 from the original customers group that had large quarter for them in Q3.
And then again the part B of your question was about what about the customer who guided and I think I covered a little bit of that earlier one is that customer like VG for example has all the way from mobile to handset, to optical so it's very hard. We don’t see any slow down into 100 G and above optical segment from customer like VG for example. So just because they came they guided some numbers which we can't really comment on. What we can say is that we don’t see any slowdown in that brand. And of course it is being offset as we talk about with the new customers ramping up as well.
Okay that was a really helpful detail and actually the customer that I was referring to kind of, that was with ADVA specifically for the fourth quarter. Two other kind of quick follow-up questions. On the CFP2 DCO I am curious if you can give us a little bit of insight into kind of the economics on a per module basis of CFP2 versus the CFP. And what I'm getting at is there some degree of deflation as we move to this smaller form factor modules. And then second question is just around the competitive dynamics I'd love to get your insight into kind of the clarify announcement which is while smaller based on a revenue basis one of the larger merchant DSP competitor that you have in the market?
Yes, let me address the second one first and then I'll I want you to clarify the first question. So in terms of clarify-imply of course we have a lot of respect for our product in time as well as for clarify. But the point is still the same competition as before. It's not like there is a new competitor it is the clarify that we competed with before.
And we are really not a merchant DSP supplier like Clarify and our now main business is to integrate these low power ASICs and silicon photonics to provide easy to use interconnects to our customers. And the other piece of is we have competed with the other DSP providers and we believe we are confident we'll maintain our performance and power advantage over the competition at large I don t want to specifically talk about any one competitor.
And as we have kept up the cadence of a DSP per year, it is taken several years to come to defining a DSP to get it to the level of power and performance. So I think overall, we currently don’t anticipate this is going to impact our business in the near term. And the other piece on the positive side which is also looked at as well as this reinforces that the coherence product continues to be the preferred choice for DCI majority of the DCI customers and applications. Despite some of the web tour auto player players evaluating non coherent solutions, so I think this just attests to the fact that the space that we are playing in and that a space that we have low power high performance is the pace that the DCI and the Metro [indiscernible] supplier. Now with that let me ask you to clarify when you say the economic between the DCO CFP2 and the ACO CFP2 what specifically were you looking for.
I'll take a crack at that.
Yes I was just wondering on kind of a per module basis the revenue comparison of what the CFP 2 versus the CFP DCO would be I mean I guess is a kind of deflationary substituted product or is it additive in your view?
Yes I know it's we don’t believe that it is substitution at all. Because I think they address different markets I think we have customers who want both the ACO using our DSP as well as I think it also opens it up to other in house DSPs the ACO can work with and the DCO is different where people want a highly integrated very compact level of density in their platform. So it is additive it's not deflationary it's not taking away one from the other. I don't know if o addressed the question.
Our next question comes from the line of Tal Liani of Bank of America. Please proceed with your question.
Hi guys, I have three questions. Last quarter you said that you don’t expect this year to have customers for the ACO customers that are not your DSP or the ACO. I am sure it's the same case but I am wondering has there been any progress with customers large OEMs optical OEMs or anything that puts you closer to the target? Second question is about China, what is the risk and I'm asking it more in a theoretical level what is the risk that your large customer in China finds different alternatives for the solution for coherent, do you see any new competition or anything any development in the market where it provides an alternative to your solution in Chinese market? And on the other hand what is the opportunity that you see with other customers in China, other big OEMs that are currently not using your products and volume, have you been closer to some of these customers with your new products and does it put you in a better position to gain market share with them?
So good questions Tal, let me take them one by one, in terms of ACO, as I responded to Doug earlier, we have sampled to both Acacia ASIC as well as in-house ASIC vendors and so; in terms of are we closer? Yes, we believe we're but again these are ramping up next year, it'd be more material revenue in 2017 but we've made good progress in sampling to both customers who use our own ASIC and who use in-house ASIC. In terms of the risk and diversification in China, I think the way to look at it is it takes many years to get to the level of integration of the low power and the performance that we have for example our the new 16-nanometer ASIC that we came out with that fits in a CFP2-DCO; at a 100 gig it's half the power of the previous version so, of the previous product that ASIC that fits in our CFP-DCO module. So, these take years of innovation and years of signal processing expertise and optical expertise to develop.
So, while we cannot say that we can underestimate anybody, these are not easy things to do because it's not just our customer in China but a lot of other customers cannot do that because as I said before we believe our 16-nanometer ASIC is the only ASIC that'll fit in the DCO-CFP2 module based on the power profile. So, that is the level of innovation we're driving. And that's going to be hard to -- so as we keep executing and distancing ourselves, it's going to be more-and-more difficult. And then not to mention the -- it's not also going to be possible without our own silicon photonic highly integrated small form factor PIC, so to the extent we are executing and we come up with these products on this level we believe it's going to be very difficult for our customer to move to somebody else's solution just because we've set that a cadence of innovation there.
And your third question was on diversification within China, yes. We have I think in my script maybe I mentioned that we've diversified with both switch router vendors as well as additional customers in China. As everybody knows they're two other major customers that we've started working with both of them and ramping both of them and so we made good progress diversifying in China as well. And again as we get to the scale we can we'll share the names once they reach the 10% range, okay.
Our next question comes from the line of Alex Henderson of Needham & Company. Please proceed with your question.
I just have couple of clarifications here. If I sell DCO to a customer and sell them an ACO and the DSP that goes with it the revenues are pretty much identical between the two so there would not be no customer reduction in revenue or it by using your ACO under that scenario correct?
Yes, that's correct, Alex. That is correct if they use the ACO they have their DSP and DCO means that they'd use our DSP.
Second thing, we spend a bunch of time talking with the boys over at ADVA and while their guidance is down 17% sequentially it's consistent with them also saying that their expectation for coherent was for sequential growth in the fourth quarter. Is that consistent with what's you are expectations are?
Yes, that is consistent in terms of what we are seeing as well as on the overall 100G [coherence] space. So again, I think there is some seasonality issues related but you are right Alex that and that was the point I was trying to make with our lead customers as well as that we don’t see any slowdown weakness in the long-term 100G coherence demand.
Yes, and I was saying as ADVA's saying publicly that they expect coherent growth sequentially I assume that's consistent with what you've heard from them is that correct?
We can't really comment on individual customer specific product but the overall 100G growth we see there with all our customers so.
Right, okay. The second question is little bit more detailed on the, the trajectory of OpEx clearly your OpEx has to spike up quite a bit in the fourth quarter I assume but that's not in G&A that's probably timing of R&D probably component development costs for products. Should we expect that to roll back down a little bit in the first half of next year and particularly the first quarter I'm just trying to understand the mechanics of that viable in the numbers that are on that R&D line looks like it's a pretty big increase in fourth quarter does it come back off?
Yes, this is John. So we have a couple of things there that are driving some of the OpEx numbers one is we are adding people so there is a personal cost components of that in our R&D and across the company for that matter where scaling the R&D and SG&A groups for the growth that we expect. Second, thing is yes we are seeing some of the beginnings of the next generations DSP technology node investment that start to come into Q4 but that's mostly are going to be a first half effect in terms of increase OpEx from an R&D perspective again driven by the next node of R&D technology and the other fact is that we've got a lot of new products that are ramping so we talked about the ACO is in ramp mode we just announce CFP2-DCO that's also going to be beginning as prototype and qualification across expenses that would come into Q4 but as we said over a number of times that our quarter to quarter OpEx will fluctuate and it is based on the timing of when our new products due come in any qualification and the silicon development cost based on particular milestones and we are starting to come into a period where we are coming up to some of those new milestones on the newer DSP and PIC technologies.
Our next question comes from the line of Tim Savageaux of Northland Security. Please proceed with your question.
Hi. Good afternoon and congrats on a great quarter. And continued triple digit growth. I want to go back at the kind of guidance discussion assuming that it might be more difficult to kind of replicate what is a very strong quarter with that impact I would kind of assume that your business outside of that key customers growing 15% or 20% sequentially in Q4. Or something along those lines in line what you're talking about from a new customer contribution stand point.
In if to the extent you're not able to be granular to about the new customers in particular I was hoping you might be able to provide a little more color from perhaps some market segments standpoint, geographic standpoint, couple of areas I think you could be seeing some strength is China, ZTE. ZTE itself or directly with the cloud guides or perhaps in the U.S. metros space probably as well. To the extent that you might be able to withstand some volatility in your customer base and still guide sequential growth in the quarter. What's allowing you to do that from a market segment standpoint?
This is John I'll take a first run at that. So If you look at where our new customer growth is it's
really in a couple of spaces, one is as Raj had alluded to earlier even in his prepared remarks he talked about the fact that we are getting an executing on our diversification strategy in customers in China and in that case, we are seeing growth there from a Q3, Q4 perspective.
Also we also reference that over the original 8 customers that new 17 customers set and their kind of split amongst China in terms of non ZTE China customers they are split amongst folks who are focused on the DCI market and also folks that are coming from more of a traditional switch router background. And all of those cases, we had seen in Q3, and expect in Q4 that those particular customers are now starting to come into the ramp that we've expected them to come into relative to the time it takes and Raj had alluded to this earlier in that 24 odd month cycle to really get from initial selection into high volume ramping.
It takes a while in this customers are now getting to that point where their starting to begin those production ramp. So, that's what we are seeing in terms of that overall growth driver outside of the core customer base which as you noted also grew well in that Q3 time frame. So it's really coming from that group across those generic segments of the optical market.
Great and I'll conclude with one quick follow-up coming off of the kind of previous question around the competitive environment post the recent insight acquisition of Clarify. I wonder to any extent does that complicate your supply chain at all. Given their role as I think they're pretty important supplier to you guys but it's not be on the comments on any changes in that relationship is a result of this deal?
I think we have a lot of respect for [indiscernible] and they are our supplier to us. I think you can look at this a little bit of co-operate in some and again we look further for the best product in the market what we can use and as long as it continue to do that. I think we should be continue to have the relationship with them so there will be areas we compete in and there'd be areas we co-operate them. So I think it's no different than some of the other supply systems. Lot of others have in the business as well.
There are no further question and audio portion of the conference. I will now like to turn the conference back over to Raj the President and CEO for closing remarks.
Thanks Tim. I would like to wrap up by thinking our employees first of all for all the hard work they did during the quarter across all parts of the company as it was another exciting quarter for Acacia. I would also like to thank our customers and investors for making Q3 another successful quarter. We look forward to the many opportunities did that we have ahead of us to finish out the year and get ready for another exciting year in 2017. We look forward to updating you on our progress next quarter. Thank you.
This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful rest of your day.
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