Acacia Communications  (NASDAQ:ACIA)

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Q4 2018 Earnings Conference Call
Feb. 21, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to Acacia Communications Fourth Quarter and Full-Year 2018 Financial Results Conference Call. At this time time, all participants are in a listen-only mode. A question-and-answer session will follow the presentation. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to Lindsay Savarese. Thank you. Please go ahead.

Lindsay Savarese -- Investor Relations

Thank you, operator, and good afternoon, everyone. Acacia Communications released results for the fourth quarter and year ended December 31, 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 first quarter of 2019 and beyond, projections on the size of our markets and market share, statements about our customers and new products, and our competitors' products, statements regarding the size and timing of demand for our products, including from our China-based customers, 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 US 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 the GAAP measures to these non-GAAP measures, in addition to a description of the non-GAAP measures, can be found on today's earnings press release.

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

Murugesan Shanmugaraj -- Chief Executive Officer

Thank you, Lindsay. Good afternoon, everyone, and thanks for joining us today. I'll start with the business update and then turn the call over to John Gavin, who will provide a more detailed review of our financial performance and outlook. I am pleased to report a strong fourth quarter with significant progress in our efforts to diversify our revenue base and expand our product portfolio. In the fourth quarter, we exceeded the high end of all three of our guidance metrics with total revenue of approximately $107 million and non-GAAP net income of approximately $17 million or $0.41 per diluted share in the fourth quarter, we had five customers who each contributed 10% or greater of our total revenue. These five customers included the switch and router customer that exceeded 10% of our total revenue in the third quarter of 2018 and the direct hyper-scale AC400 customer that has been a 10% plus customer in prior quarters. Also, as anticipated, sales to ZTE in the fourth quarter increased on a quarter-over-quarter basis. Based on our discussions with ZTE, we believe that in the fourth quarter of 2018, they completed the catch-up activities following the lifting of the ban.

Moving to some product highlights, during the fourth quarter, shipments of our CFP2-DCO modules increased significantly on a quarter-over-quarter basis for the second quarter in a row. In addition, we transitioned our AC1200 module to production in the fourth quarter of 2018. Our NEM customers are telling us that they expect network operators to begin deploying systems using our AC1200 in the second quarter of 2019. Furthermore, fourth quarter 2018 shipments of our stand-alone PIC increased compared to the third quarter, and as anticipated, second half 2018 revenue from this product exceeded first half revenue as system using PIC began to ramp. We anticipate that the 2019 revenue contribution from each of our CFP2-DCO, AC1200 and stand-alone PIC products will be higher than in 2018.

Looking back at 2018, it was a challenging year for both Acacia and our industry. Despite difficult market conditions and the ban on our largest customer, we continue to execute well, prioritizing our key development efforts, managing our operating expenses and continue to make progress on our strategic initiatives . We currently have products in our portfolio than ever before. And we believe these products address our customers' needs across a wide range of optical networking applications. We believe that our continued execution in 2018 positions us well to maintain our product and technology leadership in 2019 and beyond. In addition, our focus on operational efficiencies enabled us to close 2018 with a stronger balance sheet than we had at the end of 2017 even with our execution under our 2018 stock buyback program.

Before I move to a market and product update, I would like to take a moment to discuss China. We have had in-depth discussions with our NEM customers and network operators in China. Based on these discussions, we are encouraged by the recent tender activity in anticipation of 5G and other broadband service rollouts, although the timing of such deployments is uncertain. Additionally, router equipment vendors are reporting strong spending in China, which we believe can be a leading indicator for coherent demand; however, significant trade and tariff concerns still remain and may cause delays and challenges in the China market. Balancing the opportunities with the challenges, we are cautiously optimistic about China demand in 2019.

Moving now to markets and products. When people talk about DCI, they often think only about sub 100-kilometer edge DCI applications. While edge DCI is the fastest growing segment of the DCI market, hyper-scale operators are also expanding capacity in metro, long-haul and submarine links. Submarine links are critical for the operation of hyper-scale networks on a global scale and our expensive to build and maintain. For this reason, hyper-scale operators typically want to use the highest performing optics to increase the utilization of their investment. Several recent field demonstrations and trials in both submarine and edge networks, have highlighted that the performance of AC1200 based solutions exceeds that of competitive solutions currently available in the market.

For example, in December, we announced the results of a field demonstration with our AC1200 on the 6600 Maria Transatlantic submarine cable where single carriers 400 gig transmission was achieved for the first time. In another other field trial, one of our NEM customers reported achieving spectral efficiency that was 43% greater than competitive solutions by operating at up to 300 gig over 10,000 km submarine link. Additionally, in an edge DCI tile, one of our NEM customers reported that a hyper-scale network operator in China demonstrated the first flexible rate optical transmission up to 600 gig over their 100 kilometer open line system.

These results demonstrate the performance advantage of AC1200 based systems, which we believe positions our NEM customers well to compete for share at hyper-scale accounts in 2019. We believe our AC1200 module is also well suited to applications in telecom metro core networks, which typically require higher performance due to multiple (inaudible) nodes. In addition to high performance, we believe the software configurable modes of the AC1200 including flexible 3D shaping reduces the total cost of ownership and improves network utilization. We believe the features of our AC1200 module positions our NEM customers well to compete for share with these telecom network operators. We are excited about the opportunities that we see with our multi-haul AC1200 modules based on Pico DSP.

As we said a year ago, our Pico DSP has a dual-core architecture and internal switch fabric that enable the transmission of three 400 gig Ethernet signals using both wavelengths. With its 1.2 terabit capacity, our Pico DSP offers three times the capacity of competitive products operating at 400 gig today and a 50% increase in capacity or single core competitive products operating at 800 gig. Our AC1200 supports the transmission of these three 400 gig Ethernet signals in a form factor that has 40% higher density than our competitors' current 5 by 7 modules. And when in 400 gig mode, our AC1200 more than doubles the transmission reach as compared to competitive products currently being deployed. Our NEM customers are telling us that they are ramping AC1200 based production bills in the first quarter of 2019 in anticipation of second quarter deployments by hyper-scale and telecom network operators. For this reason, we anticipate an increase in shipments of our AC1200 module in the first quarter of 2019 over the fourth quarter of 2018, as we ramp production to meet our customers' expected demand for this product.

I would now like to transition to an update on our CFP2-DCO modules. Acacia established a leadership position in the pluggable coherent market more than five years ago with the introduction of our coherent CFP-DCO. Less than three years later, we introduced our Meru based who CFP2-DCO and today this product remains highly differentiated with its performance, low power consumption and 200 gig capability.

We are currently seeing a broader industry adoption of the CFP2 form factor based on several industry trends that we believe started with our industry's first coherent CFP2-DCO module. First, we believe this form factor will likely become the preferred solution for metro access and aggregation requirements, as well as for metro core solutions that benefit from a pay as you go commercial model.

Next, we see the CFP2-DCO enabling the emerging trend toward IP over DWDM architectures and the use of open line systems, which was not the case with the CFP-DCO. We believe that the Meru based CFP2 modules are well positioned to benefit from this broader industry adoption. In addition, with its ability to support 400 gig transmission in the future, we anticipate that this factor will have an extended life cycle across multiple DSP generations. Our next generation of pluggable DCO modules will be based on the 400ZR interface being standardized by OIF, supporting distances of 80 kilometers and more for edge DCI in the same from factor as 400 gig client optics such as QSFP double-density and OSFP.

Furthermore, we believe that high performance pluggable DCOs leveraging the same 400ZRs semiconductor technologies we help accelerate the industry's transition to the use of DCO modules in metro and regional applications with reaches in the thousands of kilometers. These favorable trends with the use of 400 gig pluggable DCO modules in ZR, metro and regional applications are being driven by hyper-scale and telecom network operators.

These modules require low power DSP technology and highly integrated Photonics, which we believe is well aligned with the Acacia's strengths. In closing, I would like to make a couple of observations. The edge DCI market has driven the replacement of telecoms DWDM transport equipment with a new class of compact DWDM systems with an increased focus on achieving the lowest cost per bit. We believe our NEM customers using AC1200 in these compact DWDM systems are well positioned to compete in hyper-scale and telecom opportunities.

Additionally, hyper-scale network operators are telling us that they plan to begin wider deployment of pluggable interoperable 400ZR modules in their next generation networks. We believe that this aligns well with our 400ZR development schedule where we are targeting samples later in 2019 and the transition to production in mid-2020. We further believe that our product portfolio and roadmap are well aligned with hype-rscale network operator architectures for both current and anticipated next-generation deployments.

Finally, the strength of our product portfolio is powered by the exceptional execution of the entire Acacia team and I would like to take this opportunity to thank the team for their tremendous efforts once again in 2018. In a year, we had to navigate several challenges that in many instances beyond our control, we were able to remain focused on multiple product ramps, new product development and revenue diversification. We believe Acacia is well positioned with its product portfolio and roadmap to capitalize on the opportunities ahead of us in 2019.

With that, I will now turn the call over to John to provide more details around our financial results and outlook.

John F. Gavin -- Chief Financial Officer

Thanks, Ra,j and good afternoon, everyone. I will start by reviewing our financial and operating performance for the fourth quarter of 2018. Then, I will briefly review our full-year 2018 results. And finally, I will provide our outlook for the first quarter of 2019, before opening the call up for questions.

Before I turn to our financial results, I would like to note a change in the way we are discussing product revenue in our periodic reports, starting with our Annual Report on Form 10-K for 2018. Historically, we discussed period-over-period changes in revenue contribution based on the transmission speed of our products. Given that many of our products have multiple transmission speeds, going forward, we will discuss period-over-period changes in revenue contribution based on three product groups; embedded modules, pluggable modules and semiconductors. For more information on which of our products fall into each of these product groups, please see the description of these product groups included in the business section of our Annual Report on Form 10-K that we filed with the SEC this afternoon. With that, I will turn to our financial results.

Total revenue in the fourth quarter of 2018 was $107.1 million, an increase of 23.7% on a year-over-year basis from $86.6 million in the fourth quarter of 2017, primarily driven by revenue from the newer products in our pluggable module product group. Sequentially, revenue in the fourth quarter of 2018 increased by $12.3 million or 13% over the third quarter, primarily driven by increased sales to ZTE and revenue from the newer products in our pluggable module and semiconductor product groups.

Turning to gross margin. Our GAAP gross margin was 49.5% in the fourth quarter of 2018, compared to 46.2% in the fourth quarter of 2017. Our non-GAAP gross margin was 45.5% in the fourth quarter of 2018, compared to 44.5% in the fourth quarter of 2017. The increase in both GAAP and non-GAAP gross margins was due to do reduced impact of our semi-fixed operating costs and manufacturing, given our higher revenue level in the quarter.

In addition, the increase in GAAP gross margin was also driven by a reduction in our remediation activities related to the quality issue that we reported in 2017 and from the consumption of excess inventory intended for ZTE that previously had been considered at risk due to the ZTE ban. GAAP operating expenses in the fourth quarter of 2018 totaled $41.4 million or 38.6% of revenue compared to $35.1 million or 40.5% of revenue in the fourth quarter of 2017.

Non-GAAP operating expenses, with $33.9 million in the fourth quarter of 2018 or 31.6% of revenue compared to $29.4 million or 33.9% of revenue in the fourth quarter of 2017. The increase in GAAP and non-GAAP operating expenses was primarily driven by year-over-year variability in the timing of milestone payments associated with development costs related to our semiconductor programs and by costs associated with additional staffing related to a product and technology roadmap initiatives and sales and customer support staffing.

GAAP operating income was $11.6 million or 10.9% of revenue in the fourth quarter of 2018 compared to GAAP operating income of $4.9 million or 5.7% of revenue in the fourth quarter of 2017. Non-GAAP operating income in the fourth quarter of 2018 was $14.8 million or 13.8% of revenue compared to non-GAAP operating income of $9.2 million or 10.6% of revenue in the fourth quarter of 2017. The increase in both GAAP and non-GAAP operating income was driven by our higher revenue level in the quarter, partially offset by costs associated with additional staffing related to investments in our product and technology roadmap initiatives.

EBITDA was $15 million in the fourth quarter of 2018, compared to $8 million in the fourth quarter of 2017. And adjusted EBITDA was $18.2 million in the fourth quarter of 2018, compared to $12.3 million in the fourth quarter of 2017. Our GAAP effective tax rate was 34% in the fourth quarter of 2018 compared to an effective tax rate of 439.9% in the fourth quarter of 2017. Our non-GAAP effective tax rate benefit was 1.6% in the fourth quarter of 2018 compared to a non-GAAP effective tax rate benefit of 9% in the fourth quarter, 2017. Our GAAP net income was $9.1 million or $0.22 per diluted share in the fourth of 2018, compared to GAAP net loss of $20.4 million or a loss of $0.52 per basic share in the fourth quarter of 2017. Non-GAAP net income was $17.2 million or $0.41 per diluted share in the fourth quarter of 2018, compared to non-GAAP net income of $11.1 million or $0.27 per diluted share in the fourth quarter of 2017.

Now turning to the balance sheet, in the fourth quarter of 2018, we generated $35.4 million of cash from operating activities and ended the fourth quarter with cash, cash equivalents and marketable securities of $399.9 million and no debt.

Turning briefly to our full year results. Total revenue in 2018 was $339.9 million, a decrease of 11.8% year-over-year and $385.2 million in 2017. GAAP net income was $4.9 million or $0.12 per diluted share in 2018 compared to $38.5 million or $0.92 per diluted share in 2017. Non-GAAP net income was $36 million or $0.86 per diluted share in 2018, compared to $73.1 million or $1.75 per diluted share in 2017. We generated a $83.1 million of cash from operating activities in the full year 2018.

In addition, as a result of our operational efficiency efforts during the year and the ability to consume a higher volume of inventory given increased demand for our products in the second half of 2018, we reduced inventory from $62.2 million at the end of 2017 to $25.5 million at the end of 2018.

Turning next to our outlook, as noted in today's earnings press release, in the first quarter of 2019, we expect total revenue to be between $96 million and $104 million. We expect non-GAAP net income to be in the range of $7.6 million to $14.2 million or $0.18 to $0.34 per diluted share based on an anticipated 41.8 million fully diluted weighted average shares outstanding. And we expect non-GAAP gross margin to be in the range of 45% to 47%.

As a reminder, our outlook is forward-looking and actual results may differ materially as a result of factors described in our earnings release and in our filings with the SEC. In addition, our gross margin can fluctuate based on a number of factors including quarterly product mix and changes in manufacturing-related costs.

I would like next to provide some additional commentary on 2019. Based on our current business objectives, we intend to continue making investments that are strategic in nature and currently anticipate our non-GAAP operating expenses for the full year 2019 to increase over 2018 by 19% to 21%.

OpEx investments are strategic in nature and subject to fluctuation on a quarter-over-quarter basis and to changes in the aggregate based on overall business and market conditions. In addition, as discussed on prior calls, most of our products are not subject to the tariffs that are already in effect. And as a result, we do not anticipate that the China tariffs currently in effect will have an impact on our first quarter 2019 guidance. That being said, we are continuing to monitor ongoing tariffs and trade developments, including as related to Huawei to assess any potential impact on our future business and financial results.

Historically, Huawei has not been a significant contributor to our revenue. Even so, developments or regulatory actions against Huawei could have a broader impact on overall market conditions in China. With that I will now turn the call back to Brenda for questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Quinn Bolton with Needham.

Michelle -- Needham -- Analyst

Hi, guys. This is Michelle on for Quinn. Thanks for taking my question. Congrats on the results. Recently we had seen announcements from Vienna and Egenera on their next generation (inaudible) solution expected to ramp in the back of 2019, which I believe you guys made reference to in your prepared remarks. Could you guys maybe give some more color on how you guys are positioned to compete with the solution with the AC1200 platform?

Murugesan Shanmugaraj -- Chief Executive Officer

Yes, Michelle, let me let me crack at that. So, the first thing is that we have a lot of discussion with the hyper-scale and telecom operators to come up with our own roadmap and when we came up with the AC1200, we intentionally came out with the capacity in the performance advantages. So as I said in my discussion here that we are able to transport three -- 400 gig channels or did a single DSP. So this DSP has two cores, basically it's two DSPs than one transporting up to 1.2 terabits (ph) per second, and so we're able to do 300 gig or 400 gig channels over to the two wavelengths. We have more than 50% increase in capacity or the 800 gig capacity. So, from a capacity standpoint, I think we're well positioned there. And from a performance standpoint, we -- as I talked submarine trials, we more than doubled the reach at 400 gig of competitive product. So -- and from a density standpoint, from on form factor, we are 40% higher on the AC1200 than other 5 by 7 modules out there. So I think I would add, we took the bar high on AC1200 to meet their current generation needs. And then when we talked to the hyper-scale, you clearly see a bifurcation happening, that is being driven by the 400 gig infrastructure inside the data center.

And so, we are seeing more wider deployment of pluggable, interoperable 400ZR modules. We believe that 400ZR and the ZR Plus versions will address a significant portion of the market for their next generation networks. So we have a history of delivering industry-leading product that the market needs, and so we -- while we can't comment on what's in the pipeline, we believe that we are delivering the products for current and future generations that they need, and at the right time, whatever requirements they may have, we will be able to meet. So I think we feel very comfortable with our position there that we are closely aligned with the hyper-scale network operators on the alliance roadmap -- at the product portfolio and the roadmap that we have.

Michelle -- Needham -- Analyst

Okay, thanks for the color. And then the next one just on 5G. You guys have been seeing China tender activity in anticipation of 5G and other broadband deployments over the back half of 2018. And I guess, are these China tender of 5G front-haul, back-haul build-out or for additional provincial or national back-haul capacity additions and do you guys expect China front-haul and back-haul demand to be largely for direct set or coherent technologies or both? Thanks.

Murugesan Shanmugaraj -- Chief Executive Officer

Yes. So there's many questions in that question. So, as I indicated, we have had a lot of in-depth discussions with China NEMs and the telecom operators, and we are cautiously optimistic of the tender activity that we see there. These are toward not just 5G but also the -- for providing additional provincial broadband services. And so, it's -- these tender activities are building out their metro and regional range. And so I think the first topic is that these 5G build-outs are going to increase traffic in their metro and regional networks. And, that's all going to be coherent as we talked about, and that is also the leading indicator of that is their strong modem (ph) sales that some of the other modem (ph) suppliers have of buyers have told us about. And, it's -- one thing we have to be careful about is the tender activity and talks are good, but as I also said the timing is not solely clear.

I think this is -- there is a room for optimism here, but we also talked a little bit about the trade tariff issues adding some level of uncertainty and could delay some of these things. So, -- but on balance, yes, we are seeing activity around. A lot of this is -- this year is going to be around coherent, it's going to be back-haul and metro and regional bandwidth, I think the mid- and front haul would be lower or shorter reach that's not something that we participate at this point in time, but again, we're cautiously optimistic about China demand, of which 5G one of the drivers.

Operator

Thank you. And our next question comes from the line of Tejas Venkatesh with UBS.

Tejas Venkatesh -- UBS -- Analyst

Thank you for taking the question. I wonder if you could comment on how many of your 15 systems customers that you have for the CFP2-DCO are actually shipping line cards or systems to their end customers?

Murugesan Shanmugaraj -- Chief Executive Officer

Yes. So I think, you know, it's safe to say that several of them are shipping production units. I think the volume wise, there is a few more that are coming out with products toward -- throughout the 2019. So we don't break down into exactly how many customers, but we are, as we talked about -- we say some significant increase in Q4 over Q3, and we are looking at '19 looking to be a strong yea as more of these systems come together, but it is several of them have systems that are being deployed, some in higher volume than others.

Tejas Venkatesh -- UBS -- Analyst

Thank you for the color. And then as a quick follow-up. I was wondering if you could talk a little bit about the timing of the 400ZR, where you are with the product, and essentially what to expect over the next few quarters?

Murugesan Shanmugaraj -- Chief Executive Officer

Yes, you know, as I mentioned the ZR, we've gotten the test chips back; these are 7 nanometer and they meet the performance and our power requirements that we've been expecting. So we plan to, based on our schedule, deliver samples later this year, go into production mid-2020. So the revenue contribution per se from these samples is going to be small this year; it is really going to be 2020 more ramping in the second half.

Operator

Thank you. And our next questions are from the line of Troy Jensen with Piper Jaffray.

Troy Jensen -- Piper Jaffray -- Analyst

Hi. Congrats on the good results and great guidance.

Murugesan Shanmugaraj -- Chief Executive Officer

Thanks Troy.

Troy Jensen -- Piper Jaffray -- Analyst

Hi, Raj, you just -- you gave us a lot of good information on the AC1200 here, I just kind of want to make sure I heard it all right. But did you say your products shipped in Q4, you expected to ramp production in Q1 and systems will be available in the market in Q2?

Murugesan Shanmugaraj -- Chief Executive Officer

No. We have been shipping systems -- either the product going out since as I said Q4 we're into production and our customer NEMs systems are being quite -- in various stages of trials, qualification, certifications at their end carriers in Q1, getting ready for deployment in Q2. So it is the Q2 deployment of their systems. So we have been shipping product in, again, increasing volume -- we said that, Q4 we had volume but Q1 of 2019, we anticipate to increase the volume over Q4.

Troy Jensen -- Piper Jaffray -- Analyst

Okay, understood. And then the bigger ramp in Q2 when system starts selling. And John maybe just a follow for you, you had mentioned some comments in your prepared remarks about ZTE catch up spending if I kind of quoting right, could you just elaborate on that and maybe just touch on concerns on China inventory and where you think you are right now with inventory levels with your big customers?

John F. Gavin -- Chief Financial Officer

Yes, Troy. So we did see an increase, as Raj had said in his prepared remarks that was expected as ZTE was coming out of the Q3 ramp-up process after the ban, and of course, they were still in a, we'll call it, a catch up mode in Q4 trying to satisfy some of that residual built up business, one say, recovered from from the ban.

So that definitely impacted our Q4 in terms of quarter-over-quarter growth from ZTE, they contributed roughly $10 million more from Q3 over to Q4 in terms of their quarterly revenue contribution specifically because of a full quarter of that catch up based activity. As it relates to inventory, that's a difficult question for us to really get much insight on. We don't have -- we're not exposed to or don't have that kind of VMI level stocking programs that can give you some additional layer of visibility into where inventories maybe but, what Raj has in his remarks was that Q1 is where we've been told by the ZTE that they're now back into more of a normal mode of business as usual in terms of how they see their business.

So we'll be responding to some of the newer tenders, some of the things that are happening within China, there are possibilities that they are, I would say, pipeline inventory in terms of getting ready for some of these potential deployments. But that's about as much visibility as we have at this particular time in terms of inventory position there.

Operator

And our next question from the line of Vijay Bhagavath with Deutsche Bank.

Brian Yun -- Deutsche Bank -- Analyst

Hi, this is Brian Yun on for Vijay. Just a question around China, in general, and in terms of the 5G tender activity. Is there anything that you could call out or any time tables there, is it more of a second half '19 story or can potential delays kind of last through 2019 in your view?

Murugesan Shanmugaraj -- Chief Executive Officer

Yes, Brain. Again, I think it's a little bit of both, right. When you listen to the conversation -- the discussions with our customers and the carriers there, they are looking at, you know, the ring expansion, not necessarily 5G per se, but all the optical capacity expansion in metro and regional networks and the tenders for 2019 -- in the 2019 time frame in the middle to the second half of 2019. But that's the -- that's what this conversations are, but again, I think that's discussion about tender activity really we've seen, there has been -- these things change depending on a few different factors. So we're not exactly sure of the timing of such a deployment, even though the discussions are talking about this year.

And add to that, some of the -- still the China trade tariffs uncertainly is there and that could slow down spending. So I think in balance, it is in this time frame that they talk about, but it's hard to say that until we see the deployments, until we see the purchase order supporting this deployments, it is hard to say when they will happen and that's -- in actual speed.

Brian Yun -- Deutsche Bank -- Analyst

Okay, got you. And then just a question on your upcoming product cycles, but when you think about your CFP2, AC1200 and even the stand-alone PIC, could you maybe kind of rank order potential revenue contribution in 2019 or breakdown which products you think would drive the most meaningful revenues this year?

John F. Gavin -- Chief Financial Officer

Yes, Brian, this is John. So I'll take that one. So we're not going to -- we're not going to guide forward relative to how we would rank order it, but certainly, we can discuss where those products are from a life cycle perspective. As Raj had said during his prepared remarks, the AC1200 is coming out of 2018 where we have transferred that product into production mode, we have transferred that to the bill process to CMs in anticipation of the ramps. Customers are now looking at their Q1 numbers to start to get ready for some of the bills that they need to do in anticipation of their Q2 time frame deployments versus a CFP2-DCO as an example, which has been in the market now for a while and has been on the brand in 2018. So those two module products, if you will, are in a little bit of the different market cycle introduction timeline from ramping perspective.

And then the PIC, as you mentioned, is also in a similar mode, coming out of 2018. The PIC was just starting to come into some of the systems that it was being designed and called into and now some of those customers announced stated to ramp into their volume cycles for the PIC. So that's where we are kind of coming out of 2018. Both the brands for the PIC and the AC1200 are coming into more of their early volumes cycles, if you will, whereas CFP2 has been out for a little while and we'll continue on with some year-over-year ramping, but it's already been volume production for a period of time now.

Operator

(Operator Instructions) Our next question is from the line of Paul Silverstein with Cowen.

Paul Silverstein -- Cowen and Company -- Analyst

Thanks. I'm hoping you'll indulge me, I've got a handful, but they're all very discrete and mostly housekeeping. On the revenue diversification that you've driving, can you tell us what the total contribution of the five customers were collectively -- the 5%,10%, and what's the nature of those customers. I think I heard you say that the hyper-scale and that's been there with AC400 came in again, as well as on the new switch and router customer for second straight quarter, but can you talk about the other three if anything more new or the characterization of those? And then I've got a couple more quick ones.

John F. Gavin -- Chief Financial Officer

Yes, Paul, this is John. So in terms of top five that's -- it was roughly about 45% (ph) of our revenue in the quarter came from the top five customers. I would say that certainly the switch and router customer that we had discussed last quarter was a significant factor again in the quarter, as well as we had discussed a little bit earlier ZTE coming back in the quarter after having ramped up in a partial quarter Q3, and Q4 is really a full quarter for them, and then we have the hyper-scale customer that is our AC400 based customer that was also a 10% customer in the quarter. And then, our others there would be customers that we've had long-standing relationships with, and have been typical 10% or greater customers in the past.

Paul Silverstein -- Cowen and Company -- Analyst

John, I think I must have heard you feel wrong, I thought you said you had 5%, 10% customers, but I thought you also just said they were collectively 45% of revenue. Obviously, I heard one of the other number wrong, as that math won't work (ph).

John F. Gavin -- Chief Financial Officer

Yes. I think it's an audio issue, Paul, it's 85%.

Operator

Thank you. And our next question comes from the line of Meta Marshall with Morgan Stanley.

Meta Marshall -- Morgan Stanley -- Analyst

Great, thanks. I just wanted to ask a couple of questions. First, you are enabling some kind of competitive DCOs in the market and I just wanted to get a sense of when some of those could potentially kind of work to open the DCO market up kind of further by having more competition in the market. And then maybe second, does any volatility that you're seeing from kind of your cloud CapEx customers, not necessarily 10% customer, but just your general talking to them? Thanks.

Murugesan Shanmugaraj -- Chief Executive Officer

Yes, Meta. In terms of the DCO CFP2 enablement, I mean, as we said before, the goal of the enabling our second source is to improve the adoption -- increase the adoption of the DCO CFP2, and I think that is, as I said in my prepared statement that is we see signs of that happening. We see signs of that where it is being used for metro aggregation and access as well as for IP over DWDM use and open line system architectures. So-and it's also been adopted in a few different industry consortium. So, that part is going well. Again, it's early stages of the overall market adoption.

Our partner that we're enabling will be coming to ramp as their Meru-based product by summer is what they are saying. So that's been viewed and increased and overall hopefully add to the adoption of the CFP2 overall. And then, moving to the DCI customers, the market itself, I think as we said before, we are seeing some good adoption of AC1200 and we are seeing some increased shipments in Q1 over Q4. And we see that continuing throughout the year. The customer trials have gone pretty well and we have multiple Tier 1 then selling into this space. And I think, we also saw the 400 gig customer that John talked about the 10% customer.

So I think the reports are what we're seeing is a little bit mix. I think some of them saying it is growing. However, on a quarter-over-quarter basis as you might have mentioned this in the past, we really don't see a lot of correlation between their CapEx spend and what they spend on DCI as DCIM optical transport. So, from our perspective, we are -- I would say, we are not seeing any implied issues of their CapEx and our contribution from this particular segment we expect it driven by our AC1200 primarily continuing to do well in '19.

Meta Marshall -- Morgan Stanley -- Analyst

Got it. Thanks guys.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Rod Hall with Goldman Sachs.

Bala Reddy -- Goldman Sachs -- Analyst

Hi, this is Bala Reddy on for Rod. Congrats on a good quarter and thanks for taking my questions. Could you talk about -- you mentioned how you're seeing traction in India from you in the end customers. Maybe you could you give an update on what's traction of channel you're seeing out there? And I've got a follow-up.

Murugesan Shanmugaraj -- Chief Executive Officer

Yes. So I think we have covered this little bit last time. This is a, what we are seeing more as the metro CFP2-DCO business coming and this was driven by switch and router customer. What we had mentioned is we are seeing emerging IP over DWDM architectures evolving there and so they've had some good success with this. And there are multiple carriers; however, it is a competitive market I think we mentioned last time, and that is also -- it could be lumpy, so -- on a quarter-over-quarter basis. So I think we are doing well with the product itself and the switch and router but if could be lumpy on a quarter-over-quarter basis.

Bala Reddy -- Goldman Sachs -- Analyst

Understood. And could you talk about how should we think about gross margins, especially now that you have multiple products with probably different -- varying cost structure?

John F. Gavin -- Chief Financial Officer

Yes. This is John. I'll take that one. So in terms of gross margin, this quarter coming in at 45.5% on a non-GAAP basis. That really reflects, as I said on the call, the fact that once we are above the certain revenue operating level that really gives us the opportunity to effectively absorb those fixed operating costs in manufacturing, and at point and beyond that where we get to is the mix of new products -- the mix of products between modules and the semiconductor group; I just talked about in terms of how we going are to be looking at revenue contribution breakouts in the future.

So we have a change in the quarterly mix because that can change quarter-over-quarter in terms of the relative percent of semiconductors and/or modules, but in general, if you look at where we are on new product cycles that also was a factor -- the newer products like AC1200, the CFP2-DCO and even the PIC as a semiconductor product in that group. They all help us in terms of our ability to sustain and improve over times where our margin is. So it really comes down to revenue levels mix of products between the semiconductors and the module product groupings and how that changes from quarter to quarter in terms of where we will be, but our performance is definitely has changed since the first half of the year to the second half '18 and a lot of that had to do with really the change in revenue level and our ability to absorb those manufacturing costs a lot better into the gross margin.

Operator

Thank you. And our next question comes from the line of Paul Silverstein with Cowen.

Paul Silverstein -- Cowen and Company -- Analyst

Thank you for sure. I wasn't expecting to come back to me. With respect to visibility guys, I heard you a comment about China, but can you talk about visibility for the larger business how compares today versus 90 days ago versus a year ago?

John F. Gavin -- Chief Financial Officer

Yes. Paul, I'll start -- this is John. I'll start with that and maybe Raj can chime in. I would say, visibility in general as we've talked about on several calls, is within that quarter, we are getting good refinement from the customers in terms of their demands and requirements, even within the quarter they can still be some changes based on their ability to either move product out or change delivery time frames. But, in general, that quarter our visibility becomes a lot better. I would say, as it relates to China at this particular time, it's the same situation there. We have talked a lot with ZTE over the last-- since the last call. And although we are seeing some signs of the new tender activity and we're cautiously optimistic about where that activity might play out over the course of the year, we still have not seen that from a business perspective.

Yes, it's still early. There was the Chinese New Year, we're just coming back from that and so we suspect that will get a little bit clear over the next month or two in terms -- with respect of where overall China will be. DCI, I think, is another market where we've seen some initial reports of maybe DCI spending down. We've seen some reports recently that indicate that some year-over-year spending happening there from a growth rate. We just feel very well positioned with our product set there. We don't tend to see a lot of correlation sometimes between up or down in CapEx in the DCI. It's really when they need to invest in additional capacity or they're making investments in additional DCI connectivity is when they'll spend on the optical side of it, but those -- that trend from where we are seeing from a market position standpoint with our products where we're feeling good about that market positioning.

And then metro, there has been a lot of activity in metro; Raj has talked about some insight and visibility we've had in markets like India. So there is metro activity more on a global basis going on as well.

Operator

Thank you. This concludes our question-and-answer session. I'd like to turn the floor back to Raj for closing comments.

Murugesan Shanmugaraj -- Chief Executive Officer

Thank you, Brenda. Thank you for joining us -- joining our call today. We look forward to updating you on our progress next quarter and seeing many of you at our upcoming investor conferences and our OFC Analyst and Investor sessions.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Duration: 54 minutes

Call participants:

Lindsay Savarese -- Investor Relations

Murugesan Shanmugaraj -- Chief Executive Officer

John F. Gavin -- Chief Financial Officer

Michelle -- Needham -- Analyst

Tejas Venkatesh -- UBS -- Analyst

Troy Jensen -- Piper Jaffray -- Analyst

Brian Yun -- Deutsche Bank -- Analyst

Paul Silverstein -- Cowen and Company -- Analyst

Meta Marshall -- Morgan Stanley -- Analyst

Bala Reddy -- Goldman Sachs -- Analyst

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