Acacia Communications, Inc. (ACIA) CEO Murugesan Shanmugaraj on Q2 2018 Results - Earnings Call Transcript
Acacia Communications, Inc. (NASDAQ:ACIA) Q2 2018 Earnings Conference Call August 2, 2018 5:00 PM ET
Monica Gould - Investor Relations
Murugesan Shanmugaraj - President and Chief Executive Officer
John Gavin - Chief Financial Officer
Raghunathan Kamesh - Goldman Sachs & Co. LLC
Quinn Bolton - Needham & Company
James Kisner - Loop Capital Markets
Meta Marshall - Morgan Stanley
Thejeswi Venkatesh - UBS
Brian Yun - Deutsche Bank
Paul Silverstein - Cowen & Company
Timothy Savageaux - Northland Capital Markets
Dmitry Netis - William Blair
Mark Kelleher - D. A. Davidson
Michael Genovese - MKM Partners
Alex Henderson - Needham & Company
Fahad Najam - Cowen & Company
Greetings and welcome to the Acacia Communications Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It's now pleasure to introduce your host, Monica Gould, Investor Relations. Please go ahead.
Thank you, Kevin, and good afternoon, everyone. Acacia Communications released results for the second quarter ended June 30, 2018 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'd like to note that during today's discussion, there are references to our prospects and expectations for the third quarter and second half of 2018 and beyond, projections on the size of our markets and market share, statements about our customers and new products, statements regarding the size and timing of demand for our products, particularly in the China and DCI markets and from ZTE.
Statements regarding the listing of ZTE ban and it's expected or anticipated impact on our business, on our third quarter revenue guidance and on our other short and long-term financial goals. Statements regarding the impacted industry consolidation 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 earnings 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. Reconciliation of the GAAP measures to these Non-GAAP measures, in addition to a description of the Non-GAAP measures, can be found in today's earnings 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. I'll provide a business update, after which I'll turn the call over to John Gavin, who will provide a more detailed review of our financial performance and outlook. In the second quarter of 2018, total revenue of approximately $65 million was at the high end of our guidance range and non-GAAP net loss of approximately $3 million or $0.08 per basic share were in line with our guidance range.
First, some highlights on our second quarter. As we anticipated, our second quarter results and product mix were negatively impacted by the ZTE ban that went into effect April 15, 2018. Despite ZTE ban related challenges, we made good progress on our revenue diversification and new product initiatives.
During the second quarter, three customers each contributed greater than 10% of our total revenue, including a China-based NEM from our newer customer group. Revenue from our newer customer group represented 47% of our total revenue and three of our top five customers were from this group. We are pleased that the second quarter revenue from this group increased quarter-over-quarter both on an absolute dollar and on a percentage of revenue basis.
We are continuing to see improving demand for our products in our key markets, namely DCI, Metro and China. We are seeing opportunities for growth in the second half of 2018 or the first half largely driven by revenue from non-ZTE customers. Indicative of these growth opportunities, at the midpoint of our third quarter revenue guidance, we are anticipating approximately 25% quarter-over-quarter revenue growth, excluding ZTE from both quarters.
We believe this non-ZTE customer growth demonstrates a success we are having with our revenue diversification initiatives. We also believe that we will continue to see the benefits of these efforts through the second half of 2018 and beyond. In addition, we believe the lifting ZTE ban may further improve our second half growth opportunities. We are also pleased that sales of our newer products made an increased contribution to our total revenue in the second quarter.
Sales of our CFP2-DCO and ACO modules represented approximately 20% of our total revenue with the majority of this revenue coming from our DCO modules. Revenue from our CFP2-DCO is continuing to increase as more systems are being introduced by our NEM customers. Additionally, we continued shipping AC1200 samples during the second quarter, which are being qualified by multiple customers.
Before I turn to a general market update, I would like to discuss ZTE in a bit more detail. As most of you are aware, the recently lifted ZTE ban was in effect for nearly three months. We are currently engaging with ZTE to assess their future demand for our products. We have slowly started shipments to ZTE during the third quarter and anticipate shipments will ramp for the remainder of the quarter as ZTE continues to ramp production.
ZTE as communicated to us that they anticipate continue to ramp capacity over the next few quarters. Although, we believe it is too early to know when our shipments to ZTE will become more ordinary course. For these reasons, we are cautiously optimistic that ZTE's revenue contribution may continue to improve over the next few quarters.
Next I would like to provide a general market update. We are continuing to prioritize our product development efforts in the DCI market, which we believe represents the largest growth opportunity for coherent interconnect despite quarter-over-quarter variability in this market.
Our NEM customers tell us that they are seeing a high level of engagement with their hyper-scale customers using our products, including our AC1200 product family. Additionally, several hyper-scale end customers are looking forward to our 400ZR module, which is currently under development and based on the specification being standardized by OIF. Due to the strength of our product portfolio, we believe our NEM customers including our switch and router customers are well positioned in this market.
Our NEM customers also continue to tell us that the metro markets in Europe, North America, and Asia outside of China are growing. Given recent RFQ activity in India, India is also showing signs of strength and we believe our compact pluggable coherent modules are well suited for their networks. As you have likely heard, Infinera recently announced its intent to acquire Coriant.
We have longstanding business relationships with both of these companies. We are well penetrated in many Coriant platforms and do not believe that this announcement will have an adverse impact on our business in the short or medium term, although it is too early to predict any longer term impact. We look forward to continuing our engagement with these companies, on existing projects and potential new opportunities in the future.
Moving to the China market, prior to the ZTE ban, we were seeing signs of improving conditions both at ZTE and at other China NEMs. Following the ZTE ban, there was a slowdown with new tender offers and awards, while deployments based on previously awarded tenders continued.
Now that the ZTE ban has been lifted and assuming no further adverse regulatory or legislative impacts to China NEMs, we believe that new tender activity could pick up in the second half of 2018, given the continued demand for video, cloud and high bandwidth edge services in that market.
During our last earnings call, we stated that our Tier 1 switch and router customers had started ramping with our newer products. In the second quarter, we saw significant quarter-over-quarter increase in revenue from this group driven primarily by sales of CFP2-DCO and sampling of our AC1200 modules. We are pleased with the progress that we are making with this customer group and anticipate one of these customers may become a 10% plus customer in the next few quarters.
Next I would like to provide an update on our product development efforts. I'm very pleased with our progress on the ramp and qualification of our AC1200 module. We are continuing to ship AC1200 samples to customers, supporting data rates up to and including 600 gig per channel.
We expect our AC1200 sample shipments to continue to ramp in the second half of 2018, including to several Tier 1 customers and also expect to be in production with our Pico DSP using first-pass silicon by the end of 2018. For a DSP as complex as Pico, we believe getting to production with first-pass 80 silicon demonstrates our industry leading DSP capabilities.
Moving to our CFP2-DCO, we anticipate the strong ramp up this product to continuing the second half of 2018 as additional systems based on our CFP2-DCO on to market. We believe this product has established a high barrier to entry due to its performance, size and low power.
To help expand our addressable market, we announce our collaboration with Oclaro to enable fully interoperable CFP2-DCO modules based on our low-power Meru DSP. It has been four years since we last launched the first commercially available CFP-DCO and demand for this product family remain strong.
We anticipate that strong demand for this product will continue into the second half of 2018 despite the availability of competitive offerings. We also recently introduced a ZR version and the lower power version of our CFP-DCO module, based on our Meru DSP. We believe these new variants of our CFP-DCO further differentiate this product family and extend our technology leadership.
Lastly, we continue to make good progress on customer qualification and testing of our standalone PIC. We believe that PIC sales will continue to help expand the size of our addressable market. As customers begin to ramp to volume shipments, we believe we should see significant increases in both unit volume and revenue for this product in the second half of 2018 or the first half.
Before I turn the call over to John, I would like to highlight some key takeaways. During the second quarter, we stayed focused on execution, particularly on new product development, revenue diversification and operational efficiency initiatives.
On the product development front, we believe there are AC1200 module with supports two channels at 600 gig is the highest density coherent module currently being sampled in our industry. We believe there are pluggable CFP2-DCO remains the only commercially available coherent CFP2-DCO in the market. The pluggable coherent 400 ZR is even more challenging than our CFP2-DCO into its power and size requirements.
We believe occasions one of the few companies with the skills and expertise necessary to deliver this class of highly complex models. Our revenue diversification efforts are paying off. We added a new 10% plus customer from our newer customer group in the second quarter and we believe we will be adding a switch and router customer as another 10% plus customer within the next few quarters. We believe our differentiated solutions, supporting applications from subsea to be edge position as well to benefit from growth in the overall coherent market.
Additionally, we believe that the trend of coherent technologies moving to DCI and other edge applications will help further diversify our customer and revenue base expand our TAM and position as well for the long-term.
With that, I will now turn the call over to John to provide more details around the financial results and outlook.
Thanks, Raj, and good afternoon, everyone. I will start by reviewing our financial and operating performance for the second quarter of 2018, and then I will provide an update on ZTE in our outlook for the third quarter. I will also provide additional perspectives on the second half of 2018 before opening up the call for questions.
As Raj mentioned, our second quarter 2018 revenue, was at the high end of our guidance range and our non-GAAP net loss and non-GAAP loss per basic share were in line with our expectations. Total revenue in the second quarter of 2018 was $65 million, which included $4 million in revenue from ZTE for products shipped prior to the ban. Our second quarter revenue decrease 17.6% on a year-over-year basis from $78.9 million in the second quarter of 2017 due in large part to the lack of ZTE revenue in the second quarter following the imposition of the ban.
During the second quarter revenue from newer customers outside of our original eight customers increased 44% on a year-over-year basis removing ZTE's revenue from our second quarter in 2017 and 2018. A percent of quarterly revenue contributed by our newer customer group increase from 37% in the second quarter of 2017 to 50% in the second quarter of 2018. In the second quarter of 2018 we had three customers that each contributed more than 10% of our revenue and as a result of the ban ZTE was not one of them.
Turning to gross margin. Our GAAP gross margin was 38.8% in the second quarter of 2018 compared to 32% in the second quarter of 2017. GAAP gross margin in the second quarter of 2018 was impacted by higher semi-fixed operation costs absorbed on a lower quarterly revenue base. Our GAAP gross margin in the second quarter of 2017 was adversely impacted by expenses related to a previously disclosed quality issue which did not significantly impact our gross margins in the second quarter of 2018.
Our non-GAAP gross margin which excludes $0.6 million of stock-based compensation expense and a $0.9 million net benefit from subsequent period reserve adjustments attributable to our 2017 quality issue and from adjustments to the ZTE reserve recorded in the first quarter of 2018 was 38.3% in the second quarter of 2018 compared to 42.7% in the second quarter of 2017. The decline in our non-GAAP gross margin was driven by lower revenue in the second quarter of 2018 compared to 2017 which affected our ability to absorb higher semi-fixed operating and inventory related costs.
Additionally, our non-GAAP gross margin in the second quarter of 2018 was impacted by our higher than anticipated shift in our product mix towards modules. Operating expenses in the second quarter of 2018 totaled $37.3 million or 57.4% of revenue compared to $32.1 million or 40.6% of revenue in the second quarter of 2017.
Non-GAAP operating expenses which excludes $7 million of stock-based compensation expense and $0.8 million of certain litigation related costs were $29.5 million in the second quarter of 2018 or 45.4% of revenue compared to $26.5 million or 33.5% of revenue in the second quarter of 2017.
The increase in GAAP and non-GAAP operating expenses was driven by continued investments in our product and technology roadmap. GAAP R&A expenses totaled $24.3 million or 34.7% of revenue in the second quarter of 2018 compared to 22.7% or 28.8% of revenue in the second quarter of 2017.
Non-GAAP R&D expenses, which exclude $4.5 million in stock-based compensation expense, totaled $19.9 million or 30.6% of revenue in the second quarter of 2018 compared to $19 million or 24% of revenue in the second quarter of 2017. The increase in GAAP and non-GAAP R&D expenses was also primarily related to the continued investment in our product and technology roadmap.
GAAP SG&A expenses were $13 million or 20% of revenue in the second quarter of 2018 compared to $9.4 million or 11.9% of revenue in the second quarter of 2017. Non-GAAP SG&A expenses which exclude $2.5 million of stock-based compensation expense and $0.8 million of certain litigation related costs were $9.7 million or 14.9% of revenue in the second quarter of 2018 compared to $7.5 million or 9.6% of revenue in the second quarter of 2017. The increase in GAAP and non-GAAP SG&A expenses was primarily driven by a year-over-year increase in expenses associated with sales and customer support staffing and related support resources.
GAAP operating loss was $12.1 million or negative 18.6% of revenue in the second quarter of 2018, up from GAAP operating loss of $6.7 million or negative 8.5% of revenue in the second quarter of 2017. Non-GAAP operating loss in the second quarter of 2018 was $4.6 million or negative 7.1% of revenue compared to non-GAAP operating income of $7.3 million or 9.2% of revenue in the second quarter 2017.
Our non-GAAP operating loss in the second quarter of 2018 excludes $7.6 million of stock-based compensation expense, $0.9 million net benefit related to subsequent period reserve adjustments for the 2017 quality issue and ZTE inventory recorded in the first quarter of 2018 and $0.8 million of certain litigation related costs. Both our GAAP and non-GAAP operating margin impacted by the lower gross profit driven by lower revenue in the second quarter of 2018 and increased operating expenses in support of our product and technology roadmap.
EBITDA in the second quarter of 2018 was negative $8.9 million compared to negative $3.7 million in the second quarter of 2017. Adjusted EBITDA was negative $1.4 million in the second quarter of 2018 compared to positive $10.2 million in the second quarter of 2017.
Our GAAP effective tax rate benefit up 70% in the second quarter of 2018 compares to a tax rate benefit of 179.8% in the second quarter of 2017. Our non-GAAP effective tax rate benefit of 3.8% in the second quarter of 2018 compares to tax rate benefit of 33.7% in the second quarter of 2017. The reduction in benefits as a result of applying an annualized effective tax rate of negative 2.2% in the second quarter of 2018 compared to a positive 1% in the second quarter of 2017.
Our GAAP net loss was $3.2 million, or a loss of $0.08 per basic share compared to GAAP net income of $4.7 million or $0.11 per diluted share in the second quarter of 2017. Our non-GAAP net loss was $3.2 million or a net loss of $0.08 per basic share compared to non-GAAP net income of $10.8 million or $0.26 per diluted share in the second quarter of 2017.
Now turning to the balance sheet. Despite a challenging quarter, we generated $8.8 million of cash from operating activities and ended the second quarter with cash, cash equivalents, and marketable securities of $374.8 million and no debt. In addition, through our ongoing focus on operational efficiencies, we are able to reduce accounts receivable and inventory balances in the second quarter.
Before turning to our outlook for the third quarter of 2018, I would like to briefly discuss ZTE. The July 13 lifting of the ZTE ban allowed Acacia and other U.S. suppliers to reengage with ZTE. We are cautiously optimistic that our business with ZTE will become more ordinary course over the next few quarters. We continue to closely monitor this around regulatory and legislative activity, relevant to our business with ZTE and in China, because of the extraordinary circumstances surrounding ZTE, we are providing more specific ZTE related revenue guidance on a one-time basis for the third quarter.
With that, as noted in today's earnings press release in the third quarter of 2018, we expect total revenue to be between $86 million and $94 million. At the $90 million midpoint of our revenue guidance range anticipate $14 million to be attributable to ZTE.
We expect non-GAAP net income to be in the range of $4.1 million to $9.3 million and non-GAAP earnings to be in the range of $0.10 per diluted share to $0.22 per diluted share based on anticipated $42.2 million fully diluted weighted average shares outstanding.
Regarding the ongoing tariff discussions, we do not anticipate that the tariffs already in effect will impact our third quarter guidance and we are continuing to monitor tariff news to assess any potential impact on our future business and financial results.
I will now provide some additional perspectives in the second half of 2018. With respect to non-GAAP gross margin, anticipating that our non-GAAP gross margin will increase as our sales volume increases and product mix shifts more toward newer products. As such, we currently estimate our non-GAAP gross margins to be in the range of 40% to 43% of revenue in the third quarter of 2018 and the range of 42% to 44% for the full-year.
As a reminder, our gross margin to fluctuate based on our quality product mix, introduction of new products, new product ramp up expenses, manufacturing yields and variances, warranty and excess and obsolete, inventory charges, impact of pricing changes, as well as cost associated with the scale of our production operations and associated overhead costs relative to revenue levels. In addition, in the near-term, our gross margin would be fluctuate as a result of activities associated with their ramp and production capacity due to our re-engagement with ZTE.
For non-GAAP total operating expenses, we continue to believe two thousand and 2017 to 2018 year-over-year growth to be in the range 10% to 12% down from our 18% to 20% estimated earlier in the year.
We are still evaluating whether in to what extent the recent Ninth Circuit opinion, an Altera [de-commissioner] will having our tax obligations and effective tax rate for the third quarter and beyond.
With that, I will now turn the call back to Kevin for questions.
Thank you. [Operator Instructions] Our first question today is coming from Rod Hall from Goldman Sachs. Your line is now live.
Hi, this is RK on behalf of Rod. Thanks for taking my question. I first wanted to talk about gross margin. For the quarter, you're reported numbers lower than 40% to 42% you guided. And I know you talked about a higher module mix in the quarter impacting margin? So could you talk about why that happened and whether that expected to continue?
Yes. Hi RK, this is John. Your question on gross margin, so yes in Q2, we quoted a 38.3% non-GAAP gross margin that was lower than we had expected back when we had done our original forecast and that's really a result of couple of things, one is we are going to lower operating levels from the revenue perspective that does give us some challenges in our ability to absorb some of the fixed cost natures of the support, operations we have been producing products and technical nature of our products.
And then secondly, more to the factor of why the difference from expectations, we really did see a customer mix shift within the quarter to more modules than we anticipated. So typically we have a blend of around 80, 20 in terms of where our module versus component mix is that in the quarter, shifted from our customers more towards the module request side of it more buys into modules and as such on the lower revenue base doesn't influence our gross margin.
In terms of what we expect - we do expect to see some recovery, again with the higher midpoint of $90 million in Q3 as we've released in our guide to Q3. We will see a lot more ability to absorb these costs. These costs will go up so our absorption rate will be higher. And then we're starting to see the effect of higher margin newer products come into the mix and therefore both of those will be affecting our Q3 potential estimates for gross margin.
Okay. Thank you. So could you also talk about why you think that the acquisition of Coriant would not cause any material impact in the near-term?
Yes. Let me take a crack at that as we said we have long standing relationships with both of these companies. And the other balance penetrated within the Coriant platforms. So when we look forward to engaging both of these companies on existing projects and new opportunities and this present us an opportunity to grow our business with the combined company. So based on our penetration there we believe that this doesn't have any short or medium term impact of those two soon to access longer term impact.
Thank you. Our next question is coming from Quinn Bolton from Needham & Company. Your line is now live.
Hi, guys. Nice job on the results and the guidance. I just wanted to come back to the gross margins understand that the lower revenue in the absorption effect and the mix shift back to modules kind of both being headwinds for gross margin. But you did see I think see if CFP2-ACOs and DCOs represented 20% of revs were they were only 10% last quarter. So your mix shifting I would think within that module mix the higher margin new products and so is there something else going on or you just not getting are the volume still loan up on the CFP2-ACOs and DCOs that they're not yet contributing to the stronger margins here in the near-term.
Hi, Quinn. That's true that the CFP2-DCO is still in those initial volumes ramping perspective. So I think it will have the effect that you're describing more in Q3 thus we think the estimate for margins will recover in Q3 and also from an expectation standpoint again within the quarter what we started with from an estimate of company modules versus chips in the mix there where we had customer moving that mix honest within the quarter.
So as a win more into a module heavy mix for the quarter thus that impacts the Q2 numbers. But as you point out not only the CFP-2-DCO that our ability to keep ramping on the AC1200 those two things will kick in to wait into gross margin or heavier in Q3 then it was able to do in Q2.
Thank you. Our next question is coming from James Kisner from Loop Capital Markets. Your line is now live.
Thank you very much. So Raj one question on just ZTE and you said that $14 million or so it's kind of a slow start and I know you're not going to guide if ZTE but I just kind of wonder like you if there's any idea you're kind of with the based line kind of normal course of business consumption is your competitors of yours as basically kind of hazard a guess on their kind of baseline China revenue given quarter. But I mean this is already varied between 30's to 60's and just any idea what kind of normal consumption looks like knowing there's always going to be variability and given quarters there any perspective if you give their?
Yes, James, so this is the early stages of reengagement with them as you can help and part of it is they are fulfilling there current tender awards that they have so they prevent they already had it so they started of doing it. However, since it is early stage the hard working through with trying to understand that demand power our product mix and the tanking and requirements and so we started shipping slowly at this point to them and we believe we are going to be ramping through the quarter.
Now what they have told us is they are going to be ramping capacity over the next few quarter, but as I said in my prepared statement, we believe it's too early to know when you shipment become more ordinary. So we are cautiously optimistic, we are not guiding beyond Q3 at this point, but we are optimistic that these revenues continued to grow to improve over the next few quarters.
Thank you. Our next question is coming from Meta Marshall from Morgan Stanley. Your line is now live.
Great. Thanks. And you may have addressed at the very end, I just missed if it was tax rate or OpEx that you are referring to. But if you could just kind of talk about how you're thinking of OpEx progression throughout the year, you kind of had a more 20%, kind of 18% to 20% target kind of before ZTE you would slowed some of that spending, just how you think of that ramp with the ZTE business coming back?
And then second question maybe the new - not maybe new, the new, but one of the newer China NEMs are new 10% customer, are they buying DCO or are they buying kind of separate components, if you could just give us a little taste of what type of business are there applying?
Sure, Meta. This is John. We will split the question between Raj and I'll take the OpEx question first, which is last quarter in light of the ZTE ban, we did go back and do a full scale readdress of our cost structure and you are correct. Our original trajectory was on 18% to 20% total non-GAAP OpEx year-over-year growth rate. We visited that and pull that down to a 10% to 12% growth rate and that was in light of corrections we made because of the ZTE ban.
We have looked at the cost structure now that the ZTE is back of the ban and we still believe that we can land within that 10% to 12% range for the year and maybe some smaller resource issues we have to address in supporting ZTE, but again, in light of some of the things that we've put and play back in the April timeframe. We still believe in that 10% to 12% year-over-year growth rate would still apply even with ZTE back of the ban. And I'll turn to Raj for the second part.
Yes. Meta on the non-ZTE China NEM, as we have stated before in earnings calls, we have engagements with the other two as well in China and so we've been working with the other China NEMs. So in this particular instance for this 10% customer, we have a broad-based of products, so it includes as you said modules CFP2-DCO, CFP-DCO, AC400 as well as chipsets. And so it does have a few generations of products that they've been working on and they're beginning to ramp some of these products.
Thank you. Our next question is coming from Thejeswi Venkatesh from UBS. Your line is now live.
Thank you. I really wanted to focus on the product cycles. Could you talk about how the AC1200 is tracking versus prior expectations? When do you expect meaningful revenue contribution?
Yes. Tejas let me address that. The AC1200 is being designed by multiple Tier 1 NEMs. As we said, we are sampling with multiple Tier 1 who are targeting the largest hyper-scale guys. And so where we are in the cycle is that we started shipping samples since the end of second quarter and we will be continuing to go through ramping the second half of 2018 with more meaningful contribution coming from in 2019. And the thing I want to point out is that we are, as I said shipping multiple data rates and including 600-gigs. So we are shipping with [indiscernible] and so we're not aware of any delay that this is causing. I think it lines up with some of the schedules that we talked with our customer volume.
Thank you. Our next question today is coming from Vijay Bhagavath from Deutsche Bank. Your line is now live.
Hey. This is Brian Yun on for Vijay. Can you give us a little bit more color on the recent CFP2 partnership with Oclaro. So how should we think about the TAM expansion opportunity and also the incremental revenue opportunity there? Thanks.
So the announcement we made was primarily to extend the TAM for DCO-CFP2. And a part of it is being a pluggable product. There was benefits and trying to have a fully interoperable CFP2-DCO based on our Meru DSP. So in terms of this collaboration we announced in second quarter, I think it's going to take some time to introduce, but we are seeing some benefits of the adoption or at least kinds of the adoption already in some markets. But in terms of revenue expansion, I think we're going to look at it as a couple of different ways. One is that, we believe that this would expand total available market for CFP2-DCOs overall.
And so I think that pie gets a larger and so we would both benefit from it and then of course, we would be selling the Meru DSP that we would get benefit of the [indiscernible] revenue from this. And then of course this is enabling an ecosystem that fully interoperable DCO-CFP2. That would help the penetration adoption of the overall product in the market.
Thank you. Our next question is coming from Paul Silverstein from Cowen & Company. Your line is now live.
Hey, guys. Can you hear me?
So I'll apologize if you're interest this early in the call [indiscernible] multiple calls here. First off, on the comparable landscape, INFA has been making a lot of noise with others - 200-gig being hands down the best product in the market, lower power consumption is neutral everybody else.
Can you trust that in comparable landscape in general next - again, if you said it, my apologies, but 10% customers, how many were they. And just to be clear on the OpEx commentary Raj and John, you don't expect that to push back, cutting back on OpEx including R&D, you're not expecting that to push out in the timeline perspective any of the coming launches in terms of new technology new platforms?
Yes, Paul, let me take the first part of it as you said, and then John will address the OpEx piece. So of course we have a lot of [indiscernible]. We understand there M200 is in some NEM customers, and our perspective is having another merchant DSP vendor should help the trend more towards the merchant model as this becomes available.
But the one thing you motioned that we are not seeing - we are not seeing any CFP2 products based on M200, although it be there, we're hearing that there might be some other designs as I said before. The Meru DSP, our own DSP power and performance remains differentiator. And as I said in my discussion, we believe we are the only commercially available CFP2-DCO in the market for the past 18 months.
So it has been a little while. We don't see competition in terms of the CFP2 this year at this point. And we also don't believe that the landscape has changed. I think they do well in the customers they have been in and we are quite happy with our competitive position.
And Paul, this is John. On the OpEx question, so initially back in April [indiscernible] ZTE, we did make a point to prioritize and preserve our schedule and project spending for the product roadmap. So we're still - nothing has changed. We are still within that timeline including spending with the net 10% to 12% year-over-year range. So nothing changed there.
We may have some minor incremental spending given that we are back supporting some resource base with ZTE, but it fits within that envelop with the 10% to 12% we originally discussed back in Q1s calls.
Thank you. Our next question is coming from Tim Savageaux from Northland Capital Markets. Your line is now live.
Hi, there. Can you hear me?
Okay. Sorry about that. I just want to make sure I heard you right John, which is the guidance for gross margins 42% to 44%that was for the year?
Okay, great. Well not to focus too much on Q2 margins, but instead on Q4, well that would seem to apply a return into high-40s from a gross margin perspective. I guess the assumption I'm making there is some moderate improvement in ZTE. But I guess my question is about the extraordinary increase in revenues ex-ZTE that you're guiding for? For Q3 maybe a little color around that, is that other traditional aid or mostly new switch, router guides, cloud OEMs and direct and if you characterize that and then that would seem to be above trend, but how sustainable or maybe double-digit increases in kind of the ex-ZTE revenues in the second half?
Yes. Tim, we're not going to speculate or guide on how we're going to sustain some of the growth rates, but we can tell you that as it relates to the Q3 guide from a revenue perspective, we really are seeing some of the more larger original NEMs have a recovery from where they were in Q2 is an example. We have talked about the growth in the newer switch and router base of customers being a factor and they are particularly ramping on some of the newer products and getting those products into their customers from a market introduction perspective. As you mentioned, obviously ZTE will be a factor. Although, we don't know at this point.
The factor on that, we will have to figure that over the next quarter or two. And then we are seeing some increases in some activities in India right now where a lot of our NEM customers are positioning in there for some of the bids that are going on within the India market right now. So it's really I'd say combination of factors. It's the - some of the strength of the newer products and they are ramping towards the second half of the year out of the first half of the year some of the diversification of some of the newer customers coming on board now with their platforms and moving into volume and some recovery from some of the original aid conversion and some are larger of those original aid customers.
Thank you. Our next question is coming from Dmitry Netis from William Blair. Your line is now live.
Okay, great. Thank you guys very much. So I have two questions. One is back to the OpEx discussion. As you sustain that 10% to 12% type growth rate this year versus what you originally had, could you give us a little bit of color what's getting pushed out as far as R&D? What getting scrubbed to the reasonable level of detail that we could ascertain your R&D progress? I mean what is getting sacrificed as a result?
Well I just want to say, Dmitry just to cover the OpEx question, so I think when we look at the situation back in April, we did look up and down the expenses that we had. We definitely looked at growth rates from a people perspective and made some adjustments there from the new hire perspective. We looked at getting more efficiency out of some of the external silicon payments and some of the silicon runs that we were doing, and that's allowed us to readdress some of the 2018 growth rate.
To be clear, we're going to have increases next year because we're spending into the 7-nanometer cycle on the external silicon cost and those are timed so to speak within the 2019 time frame. They have some impact in 2018, but there are larger factor in the OpEx for 2019, so we don't have any scheduling issues, we adjusted top to bottom reassessment on really everything from CapEx expenditures to the ramp of hiring and rationalize that against the roadmap and product deliverables and we were able to address that within the 10% to 12% range.
Very good. So now on the major programs such as 400-gig, 7-nanometer chips aren't getting can't as a results. So that's good news.
None of the products strategy items has changed nor their expected timings move either in that process.
Now my second question is on the open line system. There's a lot of noise. There's a lot of hype that goes out there and it goes from the west scale down to Tier 1, as you know AT&T stopping their open line systems and a lot of traditional transport vendors are talking about it.
I would think that's a positive trend that comes to you sort of pluggable nature of your design and product and sort of the module approach that you have. How you're approaching this open line system trend vis-à-vis the west scale and maybe even perhaps the Tier 1, specifically here in North America seems to be a big opportunity kind of looming here. I want to make sure you're participating in it as well?
Yes, Dmitry, we talked about this as well before a couple of different themes. One is when we talk about in the DCI space, as a level of desegregation where they're buying open line system separately. They do their own software and then they buy transceivers, so that is happening, and so we definitely are participating and engaging. At the end of the day we do engage with all our end customers as well and understand their requirements, so that we are able to deliver product that they're able to use.
And in terms of the [indiscernible] that is definitely beneficial to us now. It is a little tricky as you can imagine where we have engagements with several Tier 1 NEMs. So we almost - always work with NEMs and if they're engaging hyper scale regarding an opportunity, we don't - we working with them to get to that opportunity. If there is other open line system opportunity, then we engage with - on these line system opportunities, but we do work with NEMs or engaged with the largest of DSI and Tier 1 batch.
Thank you. Our next question is coming from Mark Kelleher from D. A. Davidson. Your line is now live.
Great, thanks for taking the question. Want to go back to ZTE one more time. If I look at the $4 million in the quarter for the first two weeks of the quarter, if we were to multiply that out at that pace, it would indicate significantly strong recovery of March and December quarters from ZTE. Is there something - going on with ZTE specifically that they were bringing in product ahead of ban that would make that an invalid point or was there and is there a general recovery going on in China that that $4 million was kind of pointing to?
Yes. Hi, Mark. This is John. So no I don't think there's anything to retrieve there from $4 million rate for a two week period of time. If you look at the timing of it, sometimes customers don't want inventory to hit their books, sometimes at the end of quarter. We can see it's not unusual to see shipments go out in a larger basis the first one, two, even three weeks of the beginning part of the quarter.
I wouldn't be anything into that in terms of any kind of a run rate or a strategy that they may have been pursuing in office and so I think that was just the kind of the ordinary course of business. How their requested ship date had worked out, and then the ban as you know took effect on April 15. So that was roughly two weeks of shipments, which isn't unusual for a customer that's been historical size of ZTE to have flows into two to three period of that size.
Thank you. Our next question is coming from Michael Genovese from MKM Partners. Your line is now live.
Great, thanks. It sounds like the new 10% customer maybe a company that makes its own DSP. So could you just talk theoretically like why a customer that has a big budget from the 10-K DSPs would all of the sudden become a 10% customer, and be buying your modules.
Yes, I think vis-à-vis did not say that Mike in terms of who it is. I think there are couple other players there. So - and you're not going to names at this point. As we said, we are working with all the China NEMs and so we do sell modules and chip sets to them. So that's what we can share and have stated.
Thank you. Our next question is coming from Alex Henderson from Needham & Company. Your line is now live.
Speaking in under the wire. Thank you.
I've got a multipart question maybe could help put some context into where we're going and hello. So I was wondering if you could look at the mix of business between cloud and traditional service providers in terms of where your product is selling through too. And then comment against that with respect to any competitive actions by either NEL or Nokia in terms of their chipset development and how that will folded into the AC1200 as we ramp it into 2019. So kind of take those three pieces and kind of melt into a stream of logic for us that we can use to look out in the next year with?
Yes, Alex, let me take a crack at this and John can pipe in. So in terms of just - we have a couple of different ways. We reached 12-guys, one is we have some drift engagements, but we also have throughout NEM partners. And so that's the first step, so we don't always know exactly what we get through with our NEM partners. So it's hard to gauge exactly what our total cloud exposure is and it is various also I guess we're not able to tell where these shipments go, where the NEM shipments go to career or to a cloud.
So in terms of what is happening there is more - as migration going to 400-gig on the switch side. You're seeing that there is upgrade that are being planned within a lot of the cloud size and that one category of expansion that's happening in the cloud size the other one of course is the DCI edge market that is also key for the expansion for the DCI edge, but coherent place into that.
And so all regions talked about is our products that we are positioned. I think we are happy with our competitive position. The AC1200 for example what is place well in both DCI edge as well as the 400-gig DCI applications. And so we view that as are entering into two NEMs as well, and then of course we have 400 ZR products that comes after that that would be a pluggable smaller form factor of product. And so other these are tied to 400-gig upgrades happening or being planned within the DCI hyper-scale guys.
I think one thing I would add to Raj's point is that as we develop these new products like AC1200 and CFP2 as well as the overlay to some of the switch and router traditional customers coming on board for us. That gives us a larger exposure in more opportunities with projects to work with in the DCI segments. So that increases our ability to have platform opportunities there with more products and more customers able to ship into that market.
And Alex the other point I want to mention is the AC1200, I just wanted to remind you, we have two channels of 600-gig each and so if you look at per unit volume, it is as we believe is there [indiscernible] product available that sampling out there. So and when you look at DCI application as we go the forward 400-gig switch migration, they want the lowest cost per bid and having two channels of 600-G gives them the highest capacity. And so that is definitely competitive develop position in that these application.
Thank you. Our final question today is coming from Fahad Najam from Cowen & Company. Your line is now live.
Hey, guys. If were squeezing me in. Just one quick question on in terms of the timing for the ramp in AC1200, you noted you're shipping samples in the second half of the year. But it terms of do you see any prospective risk for adoption for 400ZR many or ramping the AC1200. Do you see any offsets there or is that go to a different market and should we think about that is further diversification of your revenue i.e. in some of the product markets?
Yes, these are different products and different segments, although it could be used. One is pluggable. The AC1200 is not a pluggable product. It is - as I said before it's two time 600-gig platforms in there and that's much more of a NEM product where they can integrate that into their NEM transport or into their switch router platforms and so the way that is going to be deliver to hyper-scale is typically to NEM customers and as appose to the pluggables are going to be is the generation beyond that the best smaller form factor in this 400-gig and I think that's going to be further behind the AC1200.
So we see 19 as we said before 19 as a meaningful, the full production year for the AC1200. And we believe that the samples of the 400ZR start happening towards the end of the next year in 2020s realistically the timeframe for the ramp of the 400ZR. So there is definitely different application, different timing for these two products.
Thank you. We reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further closing comments.
Thanks, Kevin. Thank you all for joining our call today. I would like to wrap up by thanking our employees around the world or all their hard work during a challenging second quarter. Our talented employees are responsible for delivering on occasion innovative product roadmap with generating excitement among some other largest service and hyper-scale providers around the world. We look forward to updating you on our progress next quarter.
Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.
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