Acacia Communications' (ACIA) CEO Raj Shanmugaraj on Q4 2016 Results - Earnings Call Transcript

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Acacia Communications (NASDAQ:ACIA)

Q4 2016 Earnings Conference Call

February 23, 2017 17:00 ET

Executives

Lindsey Fabre - Investor Relations

Raj Shanmugaraj - President and Chief Executive Officer

John Gavin - Chief Financial Officer

Analysts

Vijay Bharadwaj - Deutsche Bank

Quinn Bolton - Needham & Company

Alex Henderson - Needham & Company

Tim Savageaux - Northland Capital Markets

Paul Silverstein - Cowen & Company

Dan Bartus - Bank of America/Merrill Lynch

Dmitry Netis - William Blair

Doug Clark - Goldman Sachs

Meta Marshall - Morgan Stanley

Operator

Greetings and welcome to the Acacia Communications’ Fourth Quarter and Full Year 2016 Financial Results Conference Call. At this time, all participants are 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. Lindsey Fabre [ph]. Thank you Ms. Fabre. You may begin.

Lindsey Fabre

Thank you, Tim and good afternoon everyone. Acacia Communications released results for the fourth quarter and year ended December 31, 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 a 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 and John Gavin, our Chief Financial Officer.

Before I turn the call over to Raj, I would like to note that during today’s discussion, there are references to our prospects and expectations for the first quarter 2017 and beyond. Projections on the size of our market and market share, statements about our customers and new products and other forward-looking statements which are based on the business environment as we currently see it and as such 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 forward-looking statements 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 GAAP. We believe these non-GAAP measures enhance the understanding of our performance. Reconciliations of these GAAP to non-GAAP measures in addition to a description of the non-GAAP measures can be found in today’s press release.

And with that, I would like to turn the call over to Raj.

Raj Shanmugaraj

Thank you, Lindsey. Good afternoon, everyone and thanks for joining us on the call today. I will begin with some financial highlights, following which I will provide an update on the macro aspects of our business, the markets we serve and some recent accomplishments and then will turn the call over to John Gavin, who will provide a more detailed review of our financial performance and outlook.

Our fourth quarter was another record quarter for Acacia and capped off a very successful 2016. For the full year, revenue increased 100% from $239 million in 2015 to $478 million in 2016 and fourth quarter revenue increased 108% from $69 million in 2015 to $142 million in 2016. We are pleased that our fourth quarter results exceeded our guidance for revenue and non-GAAP diluted EPS. Our fourth quarter results were driven by continued strong global demand for our 100G and flex-400G products from the data center inch connect, or DCI, China and metro markets and the ramp of our newer customers. Over the course of 2016, we continued to see demand increase for our products in the DCI market both from our original group of 8 customers and from our newer customers. We expect that this demand will continue to grow in 2017.

The top 5 cloud and content providers, the group we refer to as hyper-scale providers, continue to make significant investments in building new data centers and are expanding their existing capacity. We believe this investment is driving demand for our 100G and flex 400G products. And during the fourth quarter, we saw strong DCI demand from our newer customers. Acacia addresses this demand by providing innovative products that offer the performance, low power and low cost required to scale these growing networks. We are very pleased to report that one hyper-scale provider, who is a direct customer deploying our AC400 product, represented more than 10% of our revenues in the fourth quarter for the first time. In addition, we were recently awarded share with our CFP2-ACO product at another hyper-scale provider. We believe that these recent wins position our products to be deployed in 4 of the 5 hyper-scale providers’ networks in 2017 either selling through our NEM partners or selling directly to the hyper-scale provider.

Turning to China, broadband investments in this market are being driven by the China broadband initiative. We see continued demand for our products in this market as network build-outs have transitioned from long-haul backbone to provincial backbone and provincial metro networks. In the metro markets outside of China, growth is being driven by U.S. and European carriers who are focused on upgrading their metro networks.

Moving to our new customer growth and revenue diversification efforts, we have made great progress in ramping sales to our newer customers in 2016. Revenue from our newer customers expanded every quarter in 2016 from 14% of revenue in the first quarter to 35% in the fourth quarter. In the fourth quarter revenue from these newer customers rose 44% sequentially and 118% year-over-year. Moreover, for the first time in Acacia’s history, we had four customers that each represented more than 10% of our revenues for the quarter including one of the hyper-scale providers that I mentioned earlier. As was the case in the last two quarters, two of our newer top tier customers, they are among the top five contributors to revenue in the fourth quarter.

Sales of our CFP-DCO module had been a significant contributor to our growth in 2015 and 2016 with shipments of over 42,000 modules to-date. According to like counting CFP-DCO modules represented more than 50% of all coherent modules shipments in 2016. Our silicon technology bodes industry leading speed, density and power efficiency and by leveraging Moore’s Law, we have been able to drive down the cost per 100 gig and improve economics which has helped to extend our addressable market.

Now, I would like to provide an update on the strong customer interest we are seeing in our new products. In the fourth quarter we demonstrated our continued technology leadership position in pluggables with the introduction of the industry’s first 200 gig CFP2-DCO module. We have sampled our CFP2-DCO modules to several customers who are currently developing or modifying systems that utilize our CFP2-DCO products. We believe our CFP2-DCO remains on track to ramp production in the second half of 2017. I would like to reiterate that the CFP2-DCO is an industry first product offered only by Acacia and is enabled by two silicon based chips, namely our highly integrated and low power silicon PIC and our unique low power 16-nanometer DSP ASIC.

In 2016, with the introduction of our CFP2-ACO module, we extended our product set to address the needs of customers who prefer to integrate the DSP on to the airline cards. We are pleased that our CFP2-ACO is being utilized by five customers including few of newer customers, one of whom is a hyper-scale provider. Acacia CFP2-ACO module demonstrates our ability to develop highly differentiated products using our silicon based optics technology just like we have demonstrated with that DSP technology. In the fourth quarter, we completed the process of transitioning our CFP2-ACO module to our low-cost contract manufacturer in the Far East. And we are well positioned to commence volume production by the end of the first quarter of 2017. We believe these accomplishments demonstrate our ongoing efforts at broadening our revenue base with our newer customers.

Turning to our outlook for 2017, we believe that key growth markets for Acacia will continue to be in the DCI, China and metro markets. 2017 is also the year in which we believe we will continue to grow business with our newer customers and further diversify our revenue base building on the excellent progress we made in 2016. During the first quarter of 2017, we are seeing a lower than anticipated order rate from one of our larger customers with exposure to their DCI market. This customer has recently indicated that demand from their cloud and content provider customers is hard to predict given the smaller teams of those providers and their changing priorities. This customer’s lower order rate is a major factor in how we formulated our first quarter guidance. However, some of the seasonality that we anticipated in the fourth quarter of 2016 was offset by stronger than anticipated demand from hyper-scale providers and in 2017 we anticipate capital expenditures in the DCI market from the hyper-scale providers to grow in line with industry analysts projection. And specifically, we believe our CFP-DCO, CFP2-ACO and flex-400G products are well positioned to benefit from anticipated growth in this market in 2017.

As for the China markets, based on the drivers I previously mentioned, we believe that our CFP-DCO and flex-400G products are well positioned to benefit from the anticipated growth in these markets. We believe our industry for CFP2-DCO will provide an additional growth opportunity in the China market. In the metro markets in the U.S. and Europe, we believe that our CFP-DCO, CFP2-ACO and flex-400G products are well positioned to benefit from anticipated growth in these markets in 2017. We believe our industry first CFP2-DCO product will provide us with additional growth opportunities in these markets in 2017 as well.

In the long haul market, carriers and hyper-scale providers continue to invest in building out their terrestrial and subsea networks. We believe there our flex-400G and CFP2-ACO products are well positioned to benefit from anticipated growth in this market in 2017. Beyond 2017, we see several opportunities to expand our addressable market. The coherent TAM is continuing to grow based on the drivers we have discussed, specifically China, metro and DCI. Since introducing our first products in 2011, Acacia has demonstrated a rapid pace of innovation and we are not done yet. We plan to continue to make significant R&D investments to further advance the integration of a complete coherent interconnect into an ASIC like package in order to simply the manufacturing process and further reduce system costs. At the same time, we have continued to expand the functionality, intelligence and configurability of our software in an effort to reduce the total cost of ownership to our customers and help them achieve full system optimization.

We expect our further R&D investment efforts to provide us incremental opportunities to expand the TAM for Acacia as high data rates are creating challenges for traditional optic solutions at shorter reaches. We are already starting to see increased interest for our coherent solutions in new shorter reach applications including within DCI, cable networks and 5G mobile application. The Optical Internetworking Forum with support from hyper-scale providers is standardizing coherent interfaces for 400G DCI connections shorter than 120 kilometers. We are playing a significant role in this OIF standardization work and are currently developing ultra compact pluggable 400G single wavelength coherent interface for this DCI application. Additionally, high IEEE considering coherent as an alternative for 400G Ethernet interfaces with research greater than 10 kilometers. These high volumes shorter reach interfaces will need to be low in power and cost effective which requires disruptive innovative products which we have demonstrated we can deliver.

In summary, we are pleased with our strong financial performance and business performance in 2016. We were able to double our revenue and grow our non-GAAP net income nearly 4x on a year-over-over basis. As the 100G, 200G and 400G markets continue to grow in 2017, we believe that the cost and performance benefits of our products help our customers to gain a competitive edge in these markets. We are optimistic about 2017 and believe it will be another healthy growth year for Acacia and one in which we will continue to diversify our revenue base. Due to unique skills in developing differentiated DSP and PIC technology and our ability to transform these essential semiconductor components into high performance modules, we believe we can drive coherent technology into additional applications thereby expanding our TAM. We believe that our business model and market strategy is strong and positions us for further growth. We are very excited about the market opportunities ahead of us and are confident in our ability to maintain our position as a technology leader and continue to execute on our growth objectives.

With that, I will turn the call over to John for a more detailed review of our financial performance and our outlook for the first quarter.

John Gavin

Thanks Raj and good afternoon everyone. I will start by reviewing our financial and operating performance for the fourth quarter and full year 2016 and then provide our outlook for the first quarter of 2017 before opening up the call to questions. We are pleased that our fourth quarter results exceeded our guidance for revenue and non-GAAP diluted earnings per share and came in at the top of our guidance for range non-GAAP net income. Total revenue of $142.4 million in the fourth quarter of 2016 rose 107.8% from revenue of $68.5 million in the fourth quarter of 2015. Total revenue of $478.4 million for the full year 2016 rose 100.1% from revenue of $239.1 million for the full year 2015. This quarterly and annual growth in revenues was driven by continued strong global demand from metro and DCI network build-outs. In the fourth quarter, we saw increased demand for flex-400G DCI focused products and we ramped our production capacity to better serve that demand. In the fourth quarter, we also saw continued strength in the 100G CFP-DCO market as metro and DCI projects continued to drive demand for our products.

During the quarter, revenue from newer customers outside our original 8 2011 customers grew 117.5% year-over-year compared to 103% year-over-year for our original group of 8 customers. Revenue from our newer customers expanded every quarter in 2016 and most recently increased to 35% of our total revenue in the fourth quarter of 2016, up from 25% in third quarter 2016. And we expect to continue to see revenue from our newer customers increased over time as they continue their volume ramps in 2017. For the first time in our history we had four customers that each represented more than 10% of our revenues in the quarter. This includes one of our newer customers, one of the hyper-scale providers that Raj mentioned earlier, which began purchasing our products in volume in the fourth quarter in connection with their DCI build-out.

In the fourth quarter, revenue from product sales to delivery location in the Americas contributed 16% of total revenue, EMEA contributed 30% of total revenue and APAC contributed 54% of total revenue. GAAP gross margins increased to 48% in the fourth quarter from 45.9% in the prior year period. Non-GAAP gross margins, which exclude the impact of stock-based compensation expense, rose to 48.3% in the fourth quarter of 2016 from 46% in the fourth quarter of 2015. Our GAAP gross margins were 46.2% in the full year 2016 compared to 39.2% in the full year 2015. Non-GAAP gross margins were 46.5% in the full year 2016 compared to 39.2% in the full year 2015. This year-over-year increase for both our quarterly and annual gross margins is primarily due to the continued shift in revenue mix to products that contain a vertically integrated silicon tech technology.

Our GAAP and non-GAAP gross margins also benefited from the ramp of our manufacturing in lower cost regions, which was substantially completed for our high volume production products during the fourth quarter. As a reminder, our gross margin can fluctuate based on our quarterly product mix, the introduction of new products, new product ramp up expenses, manufacturing yields and the impact of pricing change. GAAP operating expenses in the fourth quarter totaled $27 million or 18.9% of revenue compared to $17.4 million or 25.4% of revenue in the prior year period.

Non-GAAP operating expenses, which exclude the impact of stock-based compensation expense, were $22.8 million in the fourth quarter or 16% of revenue compared to $17.1 million or 25% of revenue in the fourth quarter of 2015. GAAP operating expenses for the full year 2016 totaled $103.4 million or 21.6% of revenue compared to $51.8 million or 21.7% of revenue for the full year 2015. Non-GAAP operating expenses were $84.3 million for the full year 2016 was 17.6% of revenue compared to $51 million or 21.3% of revenue for the full year 2015.

GAAP R&D expenses totaled $19.5 million or 13.7% of revenue in the fourth quarter of 2016 compared to $12.3 million or 18% of revenue in the fourth quarter of 2015. Non-GAAP R&D expenses totaled $16.5 million or 11.6% of revenue in the fourth quarter of 2016 compared to $12.1 million or 17.7% of revenue in the fourth quarter of 2015. GAAP R&D expenses totaled $75.7 million or 15.8% of revenue for the full year 2016 compared to the $38.6 million or 16.2% of revenue for the full year 2015. Non-GAAP R&D expenses totaled $63.3 million or 13.2% of revenue for the full year 2016 compared to the $38.1 million or 15.9% of revenue for the full year 2015. The increase in GAAP to non-GAAP R&D expenses was primarily related to additional personnel costs as we continue to ramp employee headcount to support new product development and increases in silicon chip development and prototype costs.

GAAP SG&A expenses were $7.4 million or 5.2% of revenue for the fourth quarter of 2016 compared to $5.1 million or 7.4% of revenue in the fourth quarter of 2015. Non-GAAP SG&A expenses were $6.2 million or 4.4% of revenue in the fourth quarter of 2016 compared to $5 million or 7.3% of revenue in the fourth quarter of 2015. GAAP SG&A expenses were $27 million or 5.8% of revenue for the full year of 2016 compared to $13.1 million or 5.5% of revenue for the full year 2015. Non-GAAP SG&A expenses were $20.9 million or 4.4% of revenue for the full year 2016 compared to $12.9 million or 5.4% of revenue for the full year 2015. The increase in GAAP and non-GAAP SG&A expenses was primarily related to additional personnel costs in connection with our scaling efforts to-date and cost associated with our facilities expansion. We plan to continue to invest in our R&D and SG&A organizations as we continued to scale our business to support the many growth opportunities ahead of us and to maintain the pace in a number of new products we bring to the market.

Fourth quarter GAAP operating income increased to $41.3 million or 29% of revenue, up from $14.1 million or 20.6% of revenue in the prior year period. Non-GAAP operating income in the fourth quarter was $46 million or 32.3% of revenue, up from $14.4 million or 21% of revenue in the fourth quarter of 2015. GAAP operating income was $117.6 million for the full year 2016 compared to $41.9 million for the full year 2015, 180.4% increase over the prior year period. Non-GAAP operating income was $138.3 million for the full year 2016 compared to $42.8 million for the full year 2015, a 223.5% increase year-to-year. Our non-GAAP operating income excludes $4.6 million and $20.7 million of stock-based compensation expense for the fourth quarter and full year 2016 respectively.

EBITDA in the fourth quarter of 2016 was $44 million, up from $15.2 million in the fourth quarter of 2015. Adjusted EBITDA in the fourth quarter of 2016 was $48.6 million, up from $15.8 million in the fourth quarter of 2015. EBITDA was $123.3 million for the full year 2016 compared to $44.5 million for the full year 2015 and our adjusted EBITDA was $147.4 million for the full year 2016 compared to $47.5 million for the full year 2015. The increase in EBITDA and adjusted EBITDA was driven by expanded gross profit on the year-to-year incremental revenue and the operating leverage in our business model.

Our GAAP effective tax rate for the fourth quarter of 2016 was a negative 55% compared to a negative 64.2% in the fourth quarter of 2015. For 2016 and 2015 our annual GAAP effective tax rate was negative 14.8% and negative 1.8% respectively. The decrease in our quarterly and annual GAAP expected tax rates were primarily driven by benefits derived from our corporate structure and in the fourth quarter by the recognition of excess tax benefits from taxable compensation on share-based awards recognized in 2016 which per GAAP is not reflected in the annual rate process used in prior period. Our non-GAAP effective tax rate for the fourth quarter of 2016 was 15.7% compared to 17.3% in the fourth quarter of 2015. For 2016 and 2015 our non-GAAP annual effective tax rate was 11.1% and 24.5% respectively. The decrease in our quarterly and annual non-GAAP effective tax rates were primarily driven by benefits derived from our corporate structure.

GAAP net income in the fourth quarter increased to $64.5 million or 45.3% of revenue, up from $22.6 million or 33% of revenue in the prior year period. Non-GAAP net income in the quarter rose to $39 million or 27.4% of revenue from $11.9 million or 17.4% of revenue in the fourth quarter of 2015. GAAP net income increased to $131.6 million or 27.5% of revenue in the full year 2016, up from $40.5 million or 17% of revenue for the full year 2015. The increase in our GAAP and non-GAAP net income was primarily driven by our 108.7% quarterly and 100.1% annually year-over-year revenue growth and increased operating leverage as well as by the GAAP and non-GAAP effective tax rate changes mentioned above. Based on our fully diluted weighted average share count of 41.7 million shares this translates to GAAP diluted earnings of $1.55 per share and non-GAAP diluted earnings of $0.94 per share in the fourth quarter.

Now turning to the balance sheet, we ended the fourth quarter with cash, cash equivalents and marketable securities of $310.4 million and no debt. We generated $36.8 million of cash from operating activities in the fourth quarter. Total cash balance significantly improved from $27.6 million at the end of 2015 to $310.4 million at the end of 2016 with proceeds to us from initial public offering and follow-on offering which were both completed in 2016 and cash generated from operations being the most significant contributing factors.

With that, I would like to turn to our outlook for the first quarter of 2017. As Raj discussed earlier in his remarks during the first quarter of 2017, we have seen a lower than anticipated order rate from one of our larger customers with exposure to the DCI market. This customer’s lower order rate is a major factor and how we formulated our first quarter guidance. We continue to see 2017 as a growth year for Acacia based on three growth drivers, mainly DCI, metro and the ongoing China broadband infrastructure program. In the first quarter of 2017, in addition to ramping production of our CFP2-ACO, we are also beginning the ramp of our CFP2-DCO which began sampling in the fourth quarter and due to the positive early interest and demand for that product and the capacity ramp up time of these complex modules, we will not be able to meet all customer demand in the first quarter of 2017.

As noted in our earnings press release in the first quarter of 2017, we expect total revenue to be between $108 million and $114 million representing year-over-year growth of 28% to 35%. We expect non-GAAP net income to be in the range of $27 million to $30 million representing year-over-year growth of 85% to 106% and non-GAAP diluted earnings in the range of $0.63 to $0.70 per share based on anticipated 42.3 million diluted shares outstanding compared to non-GAAP diluted earnings of $0.44 per share in the first quarter of 2016 based on 33.3 million diluted share outstanding.

As Raj mentioned during his remarks, we believe our business model and market strategy is strong and positions for our future growth, we do not anticipate any changes to the long-term financial goals that we discussed in our third quarter 2016 earnings call.

I will now turn the call back to Tim to open up the call for questions after which Raj will wrap up with some summary remarks. Tim?

Question-and-Answer Session

Operator

Thank you. At this time, we will be conducting the question-and-answer session. [Operator Instructions] Our first question comes from the line of Vijay Bharadwaj of Deutsche Bank. Please proceed with your question.

Vijay Bharadwaj

Yes. Hi. Thanks. Hi Raj and John.

Raj Shanmugaraj

Hi Vijay.

John Gavin

Hi Vijay.

Vijay Bharadwaj

Yes. Hi, so I think my question is on a few things, one is, do you see any share loss or potential share loss to any of your peers that will be part one of the question. And then part two of the question is obviously the company is ramping multiple product cycles in DCI, metro, fiber to the home and on and on, so which of these use cases to product cycles that you have the highest conviction on through rest of the year? Thanks.

Raj Shanmugaraj

So Vijay, let me start, I think as we have said our – the major factor that we have impacting here is the lower order rate from a larger customer of ours who has a DCI exposure. And that indicated the demand from their cloud and content providers is harder to predict and they change priorities often. So it’s pretty much, that’s the major contributing factor. As we have said earlier, we believe 2017 is the healthy growth year for us. We participated in the highest growth market here and we expect to grow share in our coherent market. So we are not losing share to any of our peers. This is purely an issue of demand being a little slower in the first quarter. And our products still continue to make our customers competitive and so we don’t anticipate being – anticipate that the growth share in this growing coherent market. And in terms of which market has the highest growth, I think we have the cycles we are in is the pluggable CFP-DCO as well as the AC400 are today the flagship products for us being used in different applications in DCI, in metro and China. And we continue to see growth in the pluggables as we go into both the DCO CFP2 as well as we talked about five additional customers in the ACO CFP2. So we see the pluggables being very strong. And in terms of the AC400 as well that continues to be very well received in the DCI as well as in the metro and China markets.

Vijay Bharadwaj

Perfect. A quick follow-on for John if I may. John, any kind of changes to your planning assumptions on OpEx in particular for the rest of the year given kind of below expectation first quarter guidance? Thanks.

John Gavin

Yes. Vijay, I think in terms of OpEx for the year what we are seeing right now is that in Q1, again we are not guiding beyond Q1, but for Q1 we are going to see a small increase from where we are ending from Q4 from an OpEx perspective. And then as we have said before in previous calls, we are definitely going to be making some incremental expenses starting in Q2 relative to the silicon development costs. So we are moving our designs into the 16-nanometer node, that as you know is more expensive than coming out of 28-nanometer which is where we have been with some of our volume products. And so some of those projects will step us up a little bit in terms of where we are. But if you look at in terms of total OpEx expense for the year, in total not including both SG&A and R&D, we are seeing kind of a growth rate in total of roughly 38% or so in terms of overall OpEx just to help you there a little bit.

Vijay Bharadwaj

Okay. Thanks, again.

John Gavin

Okay.

Operator

Our next question comes from the line of Quinn Bolton of Needham & Company. Please proceed with your question.

Quinn Bolton

Hi, Raj and John. Congratulations on the strong finish to 2016. Just wanted to come back to the guide, obviously it sounds like one of your larger DCI customer is experiencing some order volatility and so I am just wondering if you had any sense, is that more on kind of metro service provider networks or is it from some of the larger hyper-scale. And then second question, I know you didn’t – the vast majority – the weaker than expected first quarter guide was due to that DCI customer, wondering if you could comment on what you are seeing in China. There have been some very recent concerns about potential inventory build in China and obviously is a big player in that segment. We love your comments on that geography. Thanks.

Raj Shanmugaraj

Yes. So, on the first part of the question, when we talk about hyper-scale, we talk about the top 5, but there are several below the top 5 as well. And so I think the indications we get are they have some level, it’s not from the metro, it’s not from any of the other segments, but from the cloud content providers, including the top, it’s not just the top 5, but they sell to a few others as well. So, it’s more related to the cloud content providers not the metro or any of the other segments. And the second question was China, so again, I think you would have seen today the extension from the news that the sanctions were extended – the sanctions were lifted for another month. The information we get from China is very strong that both from the ZTE has already announced, they are working with penalties at the U.S. government and we believe that the extension just helps them sort out the penalties and work towards closing this issue. But in terms of inventory, we don’t see any inventory build up there. I think we see product demand quite strong and we have indications when we shipped to them is not staying there very long. So, we believe 2017 will be strong China growth for us.

Quinn Bolton

Great. And then just one follow-up on the ACO, you mentioned the 5 customers are ramping and I believe you said that they were all existing customers. By existing customers, did you mean that those were customers using your DSP or some of those 5 customers actually using merchant or other DSPs?

Raj Shanmugaraj

So, I think we said 5 customers, of which 2 are existing 3 newer customers and one of them is a hyper-scale provider. And so we do have – as in terms of just the customers, we have a mix both using ours and not using ours, our DSP.

Quinn Bolton

Great. Okay, thank you.

Operator

Our next question comes from the line of Alex Henderson, an analyst. Please proceed with your question.

Alex Henderson

Yes, I don’t mean to double team. I didn’t know whether I was going to be able to get on to this, so, following Quinn here. Anyway, just a quick question, so as you are looking at this chunk of business that is a little bit lighter than expected in the quarter from one large customer related to DCI, is that a relation – a spend that you think is just lumped out and is going to lump back in, in a bigger way down the line? And that’s just a temporary timing issue or would you recommend people pretty much stay where they are on a full year basis or would you expect that, that’s business that’s lost and we should now be trimming our estimates to relate to the lower start of the year and therefore assume a lower trajectory? I don’t want to pin you into actually giving guidance, but hopefully if you can give us some guidance on how you feel that particular piece will play out?

Raj Shanmugaraj

Yes. As you said, we cannot give guidance, guidance per se on revenue. I think we have, John has said our financial model is still good. But Alex, from what we are seeing, that hyper-scale forecast from that we hear from the customers and the analysts is going to be a growth year for them as well. So, we don’t see any – for the year, it looks pretty strong. China looks like it’s pretty strong. So, overall, from our perspective, we are looking at – we are optimistic about 2017 and we believe this will be a healthy growth year, but beyond that, I don’t know if we can guide you anymore.

Alex Henderson

Yes. And just in qualifying this, this is more of a European kind of end-market phenomenon as opposed to the scaled-out U.S. DCI players?

Raj Shanmugaraj

So, I don’t know if we can answer that. It is one of our larger customers and so that’s where they are seeing it’s more in the cloud content providers rather than in the metro.

Alex Henderson

Okay, thanks.

Operator

Our next question comes from the line of Tim Savageaux of Northland Capital Markets. Please proceed with your question.

Tim Savageaux

Hi, there. Good afternoon. Well, let me try to approach this another way and this is sort of relative to what John described as the OpEx growth rate, Raj would you consider that 38% growth rate to be healthy?

John Gavin

I will take the first cutout and then maybe let Raj respond as well. So in terms of we have been consistent I think in saying that what’s important for Acacia is to continue to invest in our technology and roadmap. And as we said earlier, we see the market growth for both DCI, metro from geographically from China still being strong from a expected 2017 perceptive. So for us these are investments that are in line with our original plan. We will obviously be prudent about how we go forward and spend to our plans going forward. But as we have said several times, it’s important to us to continue on investing in the roadmap and the technology that we develop. So I think that kind of represented in where the OpEx growth rate is, most of that obviously Tim, would be in the R&D side not on the SG&A side in terms of investment.

Tim Savageaux

Right. So I guess the assumption would be that OpEx at least to start this year would be growing at least slightly faster than revenue and that’s fair enough?

John Gavin

Yes. Tim just to follow-up on that, I said that Q1 was going to be fairly much in line with where we exited Q4 from maybe a little bit higher. And then as timing of certain projects kicks-in, in Q2 and beyond that’s when we would start to see some movement there, but not in the first quarter.

Tim Savageaux

Understood. And that’s actually a good segue to my follow-up question which has to do with the trajectory of gross margins, which would appear to be solidly, if not significantly higher implied in your guidance especially given your OpEx commentary, I wonder if you have any commentary on mix shifts or changes, movements towards additional ASIC only sales or maybe the impact probably premature for this, but maybe the impact of any of the new product ramps as you look into Q2 and throughout the year in terms of continuing to drive kind of an upward gross margin trajectory as your kind of bottom line shortfall doesn’t really seem it’s great as the top line I assume gross margin could be a swing factor there?

Raj Shanmugaraj

Yes. Tim, I think from a gross margin perceptive, as you saw in Q4 we had another strong growth margin quarter. We don’t see margin going out for the year, coming down more than 1% or 2% in a range of up a 1% or 2%, so in that range of 47% to 48% is kind of where we would expect to be to your point above products ramping that is a good point in terms of both the ACO and DCO CFP2, those have later, mid to later part of the year volume ramps to those. Those are newer product as you know. And we will be looking at that throughout the course of the year, but typically on newer products that’s when we are on the higher ends with some of the margin scale. So that will come into play for the second half of the year and we don’t see any margin weakness in the first half of the year at this point.

Tim Savageaux

Great, I will hop back in the queue. Thank you.

Operator

Our next question comes from the line of Paul Silverstein of Cowen & Company. Please proceed with your question.

Paul Silverstein

Guys, if you have already answered any of these questions, my apologies to both you and the other folks on the call. But I have got some real quick one word, two word answer type questions. First off, with respect to the first quarter shortfall, I just want to make sure is all of the shortfall due to only one customer or was there any weakness from other customers?

Raj Shanmugaraj

Yes. So Paul, as I said I think that’s a major factor is from the single customer. We have had some typical seasonality from the telecom side, but that is typical. So, the major fact is from the single customer.

Paul Silverstein

Okay. John, any of that on – anything new in terms of price degradation?

John Gavin

No Paul, really we have – as we have discussed before, we have kind of moved pricing with customers to more of a quarterly process. And from that standpoint, we are really seeing no major issues there from say Q4 to Q1 and don’t expect to see anything at this point for the rest of the year. So, that’s been pretty stable.

Paul Silverstein

And can you just remind us the rate that most folks have been citing on the lower end of the 10% to 15%, is that what you are saying?

Raj Shanmugaraj

Yes, that’s consistent with what we are seeing too, Paul.

Paul Silverstein

And finally just a clarification, I apologize if it was there for your comments, but in terms of the CFP2-ACO and DCO ramps, did I hear you say that the ACO you expect to ramp any meaningful volume at the end of the quarter, with the CFP2-DCO ramping a meaningful volume in the second half? Was that the comment or these both ramping at the same time?

Raj Shanmugaraj

Yes. No, so Paul, the ACO has currently been transferred and starting to ramp with our CM base there already in Q1 and then we are supporting some of the initial quantities from our own internal manufacturers here and then in the process probably more towards the Q2 timeframe in moving the DCO into CM higher volume transfer. Most of those are second half ramp.

Paul Silverstein

Okay, I will pass it on. Thank you.

Operator

[Operator Instructions] Our next question comes from the line of Tal Liani of Bank of America/Merrill Lynch. Please proceed with your question.

Dan Bartus

Yes, hey, guys. This is Dan Bartus on for Tal. Thanks for taking my questions. I got two quick ones for you. First is on your key Chinese customer, it looks like revenues there were down meaningfully quarter-over-quarter in 4Q, almost 40%. So, can you just help us understand is there any kind of lull in China deployments? Is this digesting inventory or are there any potentially competitive issues there? And then second is also related on China, just wanting to update on how you guys are feeling about your potential share gains with customers outside of this key customer there as well? Thanks.

John Gavin

Yes, Dan, this is John. How are you doing? I will take the first part of that. So, I am not sure what data you are looking at, but throughout the year 2016, ZTE is the 10% reported customer. So, it’s pretty fairly obvious to see what they are doing. They were very consistent through all four quarters of 2016. I think as Raj had said earlier as we start to look into ‘17 and Q1 specifically, we don’t see any concerns there or any issues from a growth rate from a China perspective in ZTE as well. So, we have not seen that, maybe you are looking at the China metric is it, that can be difficult. If you are looking at just China in the filing, because there are – don’t forget that in our way of recording that, it is the ship to address location, so there can be a lot of CM activity where customers end up transitioning a moving products in this in or out of CMs. And so the quarter-to-quarter China number isn’t exactly a proxy for what any one customer is doing. So, ZTE did not drop off quarter-to-quarter, it’s been very consistent all year with them.

Raj Shanmugaraj

Yes. Dan, on the other piece, again as I said before, the China broadband initiative is we are definitely getting a lot clearer in terms of the demand. It appears very strong. And as you know, we have been working with the – for 2 years with the other two leading providers in China and we made very good progress. So, I think – while they are not in the 10% category, we made very good progress at both of them. So, our diversification in China is going extremely well.

Dan Bartus

Okay, thanks. And maybe a quick follow-up, first of all, I have to check that it looks like the ZTE was 32% on the year and they started the year at around 46%, so I thought it implied a sequential drop there, but a follow-up on that. And then just lastly, I wanted to confirm it sounds like you have some Web 2.0 customers for the CFP2-ACO products. I am just wondering high level, what’s the value proposition of them using your ACO product there? Thanks.

Raj Shanmugaraj

Yes. I mean, it’s – our ACO product, we didn’t say some, we just had one hyper-scale guidance providers given our share. And truly I think there are some providers whether service providers or content providers, they want to be able to use the DSP onboard and just buy the optics. And so from that perspective, we started out a little late, but we have caught up, made good ground on the ACO business. And as I said before we have five customers that are utilizing our product. And we have some technical advantages as well. Our product is silicon photonic base and it’s definitely got some power and we are hearing that we have performance benefits as well. So that’s – and the reason they won’t have pluggable is to have multiple sources, so that puts us in a pretty good position to participate in that market.

Dan Bartus

Okay, great. Thanks.

John Gavin

And Dan just a quick follow back, I think you are looking at percentages I think in terms of any percent of revenue in any one quarter. I think if you look at that revenue, it’s been very consistent.

Operator

Our next question comes from the line of Dmitry Netis of William Blair. Please proceed with your question.

Dmitry Netis

Okay. Thank you, guys. I want to approach some of the questions that’s been asked, maybe slightly differently and try to kind of nail down this issue, but what I am trying to get to the bottom off is given the $20 million shortfall here in Q1, that is a sizable customer and knowing who your top five your DCI customer is, it’s pretty easy to kind of understand for us who that customer might be and if this is the customer we think it is who reported this morning actually, what we are trying to – what I am trying to reconcile is that the guide that they put out for Q1 was actually relatively strong, they mentioned some inventory builds and basically just improving visibility there with the ICPs and cloud providers, so again is this just the timing issue we are seeing here and you would expect sort of snapback coming into Q2 or maybe second half of the year given what that customer has said earlier this morning, it just does not make a kind of sense other than just the timing issue here, so we are trying – help us to reconcile that comment?

Raj Shanmugaraj

Yes. I think again, we are not going to get into specifics of customer. I think you have to make sure that you get the information from them. But the customer has other business outside of the cloud and content provider, so that’s number one, that don’t – that are not using our product. And the other piece of it is that as the projections are that the hyper-scale guys and the cloud content providers is going to be a growth year in terms of CapEx for 2017. So I think from our perspective we are optimistic that it is going to be a DCI is going to be a good growth year for us as well. But I think quarter-over-quarter predictions are what are they said is more difficult to predict, because of changing priorities and short supply of personnel. So I think at the high level that 2017 numbers look pretty good. We can only see whether it is a Q1 issue or something else.

Dmitry Netis

Okay. And then if I could follow-up on and again I don’t want to ask you for an annual guidance, but – and I don’t think you will give us that, but in prior meetings calls you had mentioned what the market growth expectation was and I think that 30% growth rate was mentioned on several occasions in several investor conferences, then now with $20 million shortfall in Q1 maybe we are sort of winding up below that number, but it’s still a healthy call it 20% plus growth that the models at least here are projecting, you are on the other hand coming in here saying you expect growth granted of a very strong 2016 where you grew over 100%, but I mean there is a difference between 20% and just slightly above flat growth if you will, so we are just trying to calibrate, we are in the single-digits here for the year or we are in sort of 20% still rate where you think the markets growing, so can you sort of explain maybe your thinking relative to the market growth and where you think you will end up?

Raj Shanmugaraj

Yes. So Dmitry, as you know we cannot give our guidance for the year. I mean, I think that’s the issue. All we can say is we are participating in a strong growth market and we continue to grow port share. So, in other words, our share in the coherent ports, we continue to expect to gain share. But beyond that, there is mix shift. There is other stuff that plays into it. So, really we can’t give anymore guidance on what that number is going to be. It is – we do believe that this is going to be a growth year – healthy growth year for us.

Dmitry Netis

Okay, I had to try maybe one last one real quick on the customer – new customer growth rates quarter-over-quarter, John, you said it was 44%, do you mind tell us what the original customers grow at?

Raj Shanmugaraj

Yes, the original was 108% was their growth rate on an annual basis.

Dmitry Netis

What was it on the sequential Q3 to Q4?

Raj Shanmugaraj

Hold on, we will get that for you.

Dmitry Netis

Okay.

Raj Shanmugaraj

9%.

Dmitry Netis

Alright. Very good. Thank you very much, guys.

Raj Shanmugaraj

Okay.

Operator

Our next question comes from the line of Doug Clark of Goldman Sachs. Please proceed with your question.

Doug Clark

Great and thanks for getting my question in here. So, I do want to do kind of a little bit of match to help reconcile and address some of the issues on the first quarter guide kind of piggybacking off that last one. I mean, your large customer outside of ZTE is $30 million and the sequential guide down is $30 million. So, either that customer is going to zero or there is something else that’s coming down sequentially. Can you address which of those it is and if it’s something else, what else is declining sequentially?

Raj Shanmugaraj

Yes. So, Doug, as I said before, I think the major contributing factor is the large customer going down and we have had some typical seasonality on the telecom side. So, it’s not going to zero. I think as we said before, the DCI market is robust. It’s just the order rate has been little slower and that’s what’s causing this shortfall.

Doug Clark

Maybe you can help clarify what is in your mind typical seasonality for the telecom side, just because I mean looking back at your first quarters, I actually don’t see a sequential decline in any of the first quarters?

John Gavin

Yes, Doug, this is John. I think when we have talked to a lot of the customers in that space, that’s what we are hearing from them is that their typical pattern, their business mix is actually lower Q1 in terms of the start of the year. So, that’s what we are seeing from a telecom perspective.

Doug Clark

Okay. And then my final question was and I think you kind of mentioned in there that you can’t meet demand in first quarter, is that for a specific product line kind of the newer products or is that across the board?

John Gavin

Yes, Doug, now that was for the – that was specifically the CFP2-DCO. That product has been sampling. We sampled that starting in Q4. And we have seen a sharp increase in what customers want for additional samples in trialing for that product and at this point we are capacity constrained throughout Q1 to meet that.

Doug Clark

Okay, got it. That makes sense. And then final one is either in fourth quarter or the first quarter guide, is there any mix shift towards DSPs kind of the implicit margin assumptions in the first quarter given the lower revenues and kind of just economies of scale would suggest that there might be some favorable mix shift. So, I am wondering if there is any shift towards DSPs?

Raj Shanmugaraj

No, that’s a good follow-up question. I think we may have missed that in one of the earlier questions, but we are still seeing roughly an 80:20 mix in terms of module versus DSP mix.

Doug Clark

Alright, perfect. Thanks, guys.

Raj Shanmugaraj

Yes. Thanks, Doug.

Operator

[Operator Instructions] Our next question is from the line of Meta Marshall of Morgan Stanley. Please proceed with your question.

Meta Marshall

Just one question for me. I guess, I wanted to ask a number of the systems vendors have new DSPs coming out in the market during the year and just whether you thought some of the DCI slowdown realizing you don’t have full visibility through a customer, but is evaluation of those alternatives or if you still kind of competitively think that your solution is best? Thanks.

Raj Shanmugaraj

Yes. We continue to believe we have leading technology. We – this is not because of as I said before of a market share loss by any means. We see it is as order take slowdown. And of course there are DSPs coming in, but we continue to believe we have leadership position in the DSP technology that we have. So today, this is not what we believe is the reason for doing it. And we do also think that coherent, I mean part of the question is coherent, we believe is the technology of choice for anything greater than 40 kilometers. I think there is other technologies coming in. We don’t believe that and again as I have said in my narrative as you get into higher speeds, it gets even more and coherent is being – the cost is coming doing even further. So from our perspective, this is not a competitive or a share issue.

Meta Marshall

Got it. Thank you.

Operator

Our next question comes from the line of Tim Savageaux of Northland Capital Markets. Please proceed with your question.

Tim Savageaux

Hi, just a quick follow-up, given the outlook for Q1, do you think you will be able to grow this new customer kind of metric sequentially understanding that most of the weakness at least, my guess is coming from the traditional eight and to the extent that you saw growth rate not in front of me, new customer growth in ‘16 where would – and I guess where would you expect that to continue to ramp throughout the year from that Q1 base or I guess if you could talk about new customer growth expectation?

John Gavin

Yes. Tim, we are not going to guide into kind of a full year what new customer growth rate will be, but we definitely as I have said in my remarks we have seen this metric go from roughly 14% in Q1 of 2016. We actually finished Q4 at 35% and that was up from 25% as the metric from Q3. So we have been on that mission to diversify into the customer base and get those new customers ramped up as we have said a lot, it is a long process to get them from initial design in adoption to the first kind of quarters of higher volume that can be an 18 months to 24 months process. But many of those customers are moving through that time horizon if you will. And as we have had disclosed in Raj’s remarks already, we have actually seen that first new customer pop into a greater than 10% customer in Q4. So we expect to keep building on that momentum. And we think from a year-over-year perspective it will be higher for sure. How it plays out quarter-over-quarter could vary, but from a year perspective, we do expect that new customer base to continue to grow.

Tim Savageaux

And just a follow-up quickly on that, did you provide a number for the full year, I think you kind of given us three quarters here, I can take a guess than before, so we can get a sense of the absolute number for new customers in ‘16, can you provide a growth rate for ‘16 or ‘15 as well?

John Gavin

Full growth rate from 2016 from ‘15…

Tim Savageaux

New customers?

John Gavin

Yes. That was 117.5% for the new customer group they grew 117.5%.

Tim Savageaux

For the year, because I know that’s pretty close to what you said for the fourth quarter, I want to make sure that’s not a coincidence?

John Gavin

I am sorry that was fourth quarter over fourth quarter, sorry Tim. We will look that up, hold on a second. That group grew about 98% year-over-year.

Tim Savageaux

Thanks very much. I am sorry one more quick one and then I assume the third 10% customer was one of the top 8, sorry traditional 8?

John Gavin

Yes, that’s correct. They have been top 8 in our quarters before.

Tim Savageaux

Thanks very much.

John Gavin

Sure.

Operator

This concludes the Q&A session at this time. I would now like to turn the conference back over to Raj Shanmugaraj for closing remarks.

Raj Shanmugaraj

Thanks Tim. I would like to wrap up by thanking our employees across all parts of the company and around the world for all their hard work during the fourth quarter and throughout this busy and exciting year for Acacia. I would also like to thank our customers and partners for making 2016 another successful year. We look forward to another great year in 2017 and to updating you on our progress next quarter. Thank you.

Operator

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 night.

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