Welcome to MACOM's Second Fiscal Quarter 2024 Conference Call. This call is being recorded today, Thursday, May 2, 2024. [Operator Instructions] I will now turn the call to Mr. Steve Ferranti, MACOM's Vice President of Corporate Development and Investor Relations. Mr. Ferranti, please go ahead.

Thank you, Olivia. Good morning, and welcome to our call to discuss MACOM's financial results for the second fiscal quarter of 2024. I would like to remind everyone that our discussion today will contain forward-looking statements, which are subject to certain risks and uncertainties as defined in the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those discussed today. For a more detailed discussion of the risks and uncertainties that could result in those differences, we refer you to MACOM's filings with the SEC. Management's statements during this call will also include discussion of certain adjusted non-GAAP financial information. A reconciliation of GAAP to adjusted non-GAAP results are provided in the company's press release and related Form 8-K, which was filed with the SEC today. With that, I'll turn over the call to Steve Daly, President and CEO of MACOM.

Thank you, and good morning. I will begin today's call with a general company update. After that, Jack Kober, our Chief Financial Officer, will review our Q2 results. When Jack is finished, I will provide revenue and earnings guidance for fiscal Q3 and then we will be happy to take some questions. Revenue for Q2 was $181.2 million, and adjusted EPS was $0.59 per diluted share. We ended the quarter with approximately $476 million in cash and short-term investments on our balance sheet. Our business remains healthy and profitable and we continue to generate strong cash flow while investing in future growth opportunities. We expect our net income and associated cash generation to increase in the second half of our fiscal year compared to the first half. In Q2, our book-to-bill ratio was 1.0:1. In our turns business, where orders booked and shipped within the quarter, was approximately 20% of total revenue. This was a notable quarter for new orders and our team did a great job securing 2 large future programs, which I will discuss in a few moments. Despite the sequential bookings improvement, we still see weakness in our telecom and industrial end markets. Fiscal Q2 revenue by end market was as expected, with industrial and defense at $90.9 million, telecom at $47.2 million and data center at $43.1 million. For the quarter, data center was down 12.9% sequentially. I&D was up 18% sequentially and telecom was up 54.1% sequentially. We maintain a highly diversified customer base consisting of thousands of customers across a broad range of end markets. And our strategy is to further diversify and expand our geographic and industry exposure. We continue to see new growth opportunities across all our end markets. Industrial and Defense is our largest market, and it has been steadily growing…

Thank you, Steve, and good morning, everyone. Revenue for the fiscal second quarter was $181.2 million, up 15.3% sequentially based on growth in our Industrial and Defense and telecom end markets. Our I&D and telecom revenue was supported by the first full quarter of revenue contribution from the acquired RF business. On a geographic basis, revenue from U.S.-based customers represented approximately 44% of our fiscal Q2 results flat sequentially. Adjusted gross profit for fiscal Q2 was in line with our expectations at $103.5 million or 57.1% of revenue compared to 59.2% in fiscal Q1 2024. 2 items impacted the quarter's margins. One, mix associated with the Wolfspeed RF business acquisition; and two, underabsorbed costs primarily at our low wafer fab. As we move forward through continuous improvement actions and grow our revenue, we expect to drive our consolidated gross margins to be closer to 60%. Total adjusted operating expense for our second fiscal quarter was $63.3 million, consisting of research and development expense of $40.1 million and selling, general and administrative expense of $23.2 million. Total operating expenses were up sequentially by $8.7 million, primarily due to the full quarter of expenses associated with acquisitions. Adjusted operating income in fiscal Q2 was $40.2 million, up from $38.6 million in fiscal Q1 2024. Adjusted operating margin was 22.2% compared to 24.5% in fiscal Q1 2024. I'll note, our operations team has been focused on margin and yield enhancement activities associated with current production programs from which we expect to see near-term incremental benefits to our operating margin. Depreciation expense for fiscal Q2 was $7.3 million, up from $6.3 million in fiscal Q1 2024, driven by a full quarter of the acquired RF business. Adjusted EBITDA was $47.4 million, up $2.6 million or approximately 6% sequentially. Trailing 12 months adjusted EBITDA was…

Thank you, Jack. MACOM expects revenue in fiscal Q3 ending June 28, 2024, to be in the range of $187 million to $193 million. Adjusted gross margin is expected to be in the range of 56% to 58%, and adjusted earnings per share is expected to be between $0.63 and $0.69 based on $74 million fully diluted shares. In fiscal Q3, we expect revenue in all markets to be up sequentially. We believe data center will lead with low double-digit growth, followed by telecom with mid-single-digit growth and Industrial and Defense with low single-digit growth. We believe we can achieve modest sequential improvements in revenue and operating profit over the remainder of fiscal 2024. And over the longer term, as revenues in our telecom and Industrial business recover and as our margin enhancement activities continue, we expect gross margins to trend back towards 60% with operating margins above 30%. I would now like to ask the operator to take any questions.

[Operator Instructions] First question coming from the line of Thomas O'Malley with Barclays.

I just wanted to start off with the progress thus far on the RF acquisition. You guys clearly had some milestones laid out for when you would take over that fab. But in the intermediary period of time, you were talking about maybe running some more of your lines. You now have the business under your roof for the first full quarter. Can you talk about what's going on there thus far? And then in terms of what you're able to do in terms of getting that gross margin profile to where you want it to be, what steps your are taking to do that because I would assume that's a large portion of where the headwind on gross margins right now?

Thank you, Tom. So as everybody knows, we closed the acquisition about 4 months ago and I can report that the customer engagements have been outstanding. Our RF team and the Wolfspeed RF team have been meshed together and the team is settling in and working well together. So we're very pleased about the level of collaboration with all the new employees that came over to MACOM. I can also say that the work that's being done in our operations organizations is really truly world-class. That includes working with the team in Morgan Hill with the back end manufacturing capability that came over with the transaction as well as our team in Malaysia. We had a team in Malaysia and Wolfspeed had a team, and we brought those 2 teams together to support a lot of the high-volume demand. So I would say that from an integration point of view, we're doing quite well. As it relates to looking at the gross margins and taking steps to improve the gross margins, I think we have a lot of work to do. I can tell you that our team has laid out a long list of action items outside of the fab to address a lot of the areas that we have full control over. But then when you move into the fab, as I think I mentioned on our last call, we have to operate within a certain framework, which is defined by the fab operating committee, which is comprised of both Wolfspeed and MACOM staff. And this team is really looking at the day-to-day operation of the fab, setting priorities, setting up various projects. MACOM controls the wafer starts and the mix and also the amount of development versus production. And so really, it's early innings, let's say, we're still establishing a good working relationship inside the fab. We have always felt with this transaction that the biggest risk with the transaction is really making improvements, operational improvements related to the fab, and that is certainly a work in progress. But I can report, we're very happy with the results. We have an outstanding working relationship with the Wolfspeed team. And as Jack mentioned in his script, we expect incremental improvements in the gross margins really starting now and going into our fiscal 2025. And then the last thing I'll just highlight is the business itself is hitting all of the key markers that we wanted from a revenue and an operating profit point of view. So we're very pleased with the performance and the financials of the business to date.

Yes. The second one is broader as well and not looking for exact guidance, but just want to hear your thoughts. So you guys have historically said that you expect telecom to be your fastest growing business. And if you look at the fiscal year '24 and how it's tracking, that data center business is going to be a big leader in terms of growth. So when you look at fiscal year '25, do you still think that telecom is going to be the leader in your growth? Or are you seeing some of these opportunities in data center come on, at least in the near term in terms of this year and next year, come on so quickly that, that may be the leader in growth when you look at fiscal year '25.

I think that's a good question. And I don't think we're prepared to comment on the growth rates of the different markets today. As we take a step back and look at our telecom business and our data center business, they're about the same size right now within a few million dollars on a quarterly basis. So we do think over the long term, the telecom will outgrow data center just due to the amount of different opportunities in different market segments. So we think over the long term, that will be the leading market over data center. Now with that said, the data center market is doing really well. We're having a great year this year. We expect, as I talked about in my script, a very strong year next year. The data rates are going higher, and this makes it more complex in terms of fielding solutions due to the sort of the changes going on inside the data center. We find that there is a tremendous amount of opportunities for short-reach, high data rate connectivity. And that's where we play. And then the industry is trying to bring on different ways to solve the same problem. And that's why I spoke about the LPO MSA, which is really the industry coming together and saying, how do we make an optical or a copper link that uses less power. And we are absolutely right in the mix of that. And what we're very happy to see is a growing number of companies joining the MSA leading networking companies, leading module manufacturers and even leading chip companies. And so we think over the long term, that will be a tailwind to our business.

And our next question coming from the line of Harsh Kumar with Piper Sandler.

Congratulations once again, a solid quarter, solid guide. I was going to ask this later on, but since you were talking about LPO, I'll ask this right now, Steve, there was a big debate at the OFC around LPO. Everybody was showing it you, everybody was wanting to get there. But it seems like the luminaries in the networking world had doubts and they expressed it pretty openly. We all know the benefits are there. But I was curious how you see the path of adoption of the RPU in the market, it would be fantastic for you and a handful of other players and really bad for some guys that make DSPs. But I was curious how you see the adoption happening and what the impediments are at this point in time?

Sure. Well, a few things. First, you have to understand that the LPO solution that we're working on is being done in the context of a broader portfolio of products for the market. So whether LPO kicks in or not, isn't going to change our -- the opportunity set, let's say, inside the data center. We don't -- I don't want investors to feel like we're evangelizing LPO. We're not. We see it as an interesting product set that is very similar to the current analog solutions that we sell today in active optical cables and also it's sort of a cousin to our 200 gig electrical solutions for ACC. So with that said, I think it's going to take time. I think what you see in the industry right now is people showing examples of links working and meeting the bit error rate requirements at significantly lower power, lower latency and a lower cost compared to DSPs. So I think it will take time. The first step is to have the industry come together and create [ interop ] specs so that the hardware people know exactly what the switch and the server people want from a specification point of view. And that work is really happening this year. So it's true that there are a lot of companies showing examples of hardware working in a lab environment, that's very different than making 10 million or 20 million links. And so there -- the concept needs to mature and we think that will take time. And a certain part of the work that we're doing at MACOM. So I just want to highlight that it's an activity. We think it's an important activity. It's in line with our analog solutions that are pushing higher and higher data rates but I don't want folks to believe that if LPO doesn't work, then our data center revenues won't grow.

Of course. Steve. And then we're hearing good things in data center. We obviously see what the growth rate of the generative AI spaces and all of those compute power needs to be connected. So I was curious if you could just maybe give us an idea of how you see your data center trending. I know you said telecom grows bigger in the longer term. But perhaps in the near to midterm, maybe you could comment to the extent you're comfortable with, with the prospects of your data center business. Yes, that's it.

Yes. I think in the near term, we're going to do quite well and we're building backlog with lead customers. We're seeing 800 gig, the leaders at 800 gig have a very strong position in the market, and we're part of that supply chain. And we see it now spreading to other ISPs and other folks building the hardware. So the 800 gig business for MACOM right now is very strong. These are basically short reach, 100 gig per lane, mostly pluggables. And so we think that is -- that business will continue to grow. Then we get to layer on basically solutions for 1.6 terabit, and that's where our 200 gig per lane products come in for next generation. And we're starting to build backlog for those solutions. So we think going into 2025, 800-gig solutions will grow. Our position at 1.6 will grow. We think we will have more diversity in our revenue by customer next year, which is a good thing. And then sort of adding to that, we are also seeing some traction with our 400-gig ZR light for sort of the 12 to 15-kilometer reach in and around the data center, and we have good content on some of those platforms. So we think the near term is looking very good. However, as we always say, it's the most volatile part of our portfolio. It turns on quickly, and it turns off quickly. There's a -- it's a fast-paced environment and so it can be volatile. And so we always temper expectations. But given the trajectory, I think this year will be one of MACOM's best years in terms of total revenue in the data center. It should be a record or near record year.

And our next question coming from the line of Quinn Bolton with Needham & Company.

I wanted to follow up on the data center opportunity. One of the big things that seem to come out of OFC is that you're starting to see potentially a pretty large ACC opportunity at 200 gig per lane to connect GPUs together in -- across somewhere between 8 to 16 racks sounds like this opportunity could reach into the 10s, if not exceed $100 million as it ramps. And I wanted to see how MACOM is positioned -- if you guys think that there is a significant opportunity for you as you look into fiscal or calendar '25.

Well, I -- we certainly heard and saw the same things at OFC. So I don't think we would disagree with the fact that there's a big opportunity there. And -- so we'll have to wait and see on that. I guess would be the best thing to say, Quinn. So it is a big opportunity. There's more customers coming online at the higher data rates, which plays to our favor. We have a lot of different products and form factors and solutions for these customers. But you have to understand that there's still a lot of work being done, a lot of testing, a lot of qualification and we think that this year will really be the year where we can secure strong positions for 200-gig ACC. But I would say that, yes, there's an opportunity. I think you're -- we're seeing the same things you are.

Great. And then Steve, you called out a couple of the larger programs in your prepared comments. And you mentioned something about that, that sort of helps accelerate or drive pretty strong growth in fiscal '25, I know you haven't given guidance for '25, but I think -- the Street was already looking for '25 to be probably back in your long-term CAGR of 10% to 15%. I'm kind of wondering, does this push you potentially to the high end or above that range as some of these new programs ramp to volume?

Well, potentially, but it's -- as things are ramping up, we have to remember, things are also ramping down. And there's also uncertainty associated with the market and our customers run rates and whatnot. So I would not want to signal sort of our target for next year. I think there are certainly models out there that people can look at. But from our point of view, what we're seeing this year is good performance in the back half as we're guiding into Q3. All 3 markets are up. Our data center business will be up by double digit, telecom mid-single digit. We are building very strong backlog. As I highlighted, that large contract is significant in the bulk of that revenue will begin at the midyear -- middle of our fiscal year '25. And so potentially, we could have a very good year next year, but we're not really giving more specific guidance than that.

And our next question coming from the line of Karl Ackerman with BNP Paribas.

It sounds like telecom is beginning to recover, I think, [indiscernible].

Karl, this is Jack. We're having trouble hearing you.

Sorry, can you hear me now?

Yes, better.

Okay. Great. So it sounds like the telecom is beginning to recover a bit sooner than what some of your peers have suggested is the near-term performance in June and your outlook for fiscal '25 driven primarily by satellite products that you spoke about? Or is it broader than that?

Right. So I think it's -- I think every company has a different position within the telecom markets. And so I think we're just -- our behavior is very different than maybe what our competitors are doing. And so we have a lot of very specific things happening within the telecom end market that are favorable. We talked about the large SATCOM business that we announced this large award. We -- I mentioned that we are seeing some shifts in some of the production run rates at some of our existing 5G base station customers and some growth opportunities there. I think that's very specific to MACOM. It doesn't necessarily reflect what's going on in 5G. And I also mentioned, of course, that cable is very weak, and we expect it to be weak. So we don't think that's going to be helping things next year. The other sort of bright spot that I might mention is our Metro/Long-haul business is also beginning to improve. We had some great product releases recently, including 130 gigabaud coherent IC, which is just starting mass production and that supports connectivity up to 1.2 terabits per second. So that's going to be a tailwind. I think the legacy Metro Long-haul business is relatively weak, but we also are seeing strengthen some of our 800-gig ZR applications in that space as well. So -- and then the last thing I'll mention is PON is very weak from our -- for a general point of -- or general comment and our thinking is it will remain weak for at least another few quarters. So I wouldn't necessarily say that we are a bellwether of what's going on in telecom. Our markets and our product set is very different than our closest peers.

And our next question coming from the line of Tore Svanberg with Stifel.

Yes. Could you share with us the contribution from the acquisition in the quarter? And the industrial defense being up 18% sequentially, was that all organic? Or did that also include some of the acquisition?

Yes. So maybe I'll say a few words and Jack can also add. So I think we mentioned on our last earnings call that we expected the Wolfspeed business to contribute about $30 million this quarter, Q2. And so that was about the amount they contributed this quarter. It was a little bit higher than that. So very happy about that. And then in terms of the growth that we're seeing this quarter, sort of Q3 to -- Q2 to Q3, half the growth is coming from our data center sequential growth. And then the balance of that is really spread between the telecom and the I&D markets. And -- it's both Wolfspeed business or the RF business and MACOM business or said differently, the MACOM based business is beginning to improve.

Just to add, I think we had discussed the acquired RF business being profitable and generating some bottom line. So we did see that come through as expected for the full quarter here in the March time period.

Very good. And as my follow-up, Steve, you just mentioned you expect data center to potentially reach a record year. If I'm not mistaken, the record was $173 million and you just guided to a $50 million quarterly run rate. So I mean, wouldn't you be above that record for this year, unless I'm misreading some potential volatility in the business for the back half?

Yes. I think I was looking at the last 5 years, Tore. I think the number you're quoting is probably back in 2016 or '17 as sort of the high watermark for the data center. And so I have to caveat my comments to being back to 2019.

Got it. So maybe because of that, how should we think about the volatility of the data center business? Because it grew very strongly for 2 quarters last year then it took a breather this last quarter, now starting to grow again. So is that sort of the cadence going forward sort of like 2 quarters of strong growth over one digestion? Any other types of visibility there would be helpful.

Well, I think you hit the nail on the head. It's a very volatile end market, and we can't control that volatility. So I think investors need to expect continued volatility over time so long as the trend line is showing that overall, the business is growing and becoming more diversified. I think we'll be able to manage that business. So you're certainly right that it can turn on and off. You typically see that when the ISPs release large orders into the supply chain as they're doing a build-out or you see that when they're moving from one data rate to another. Some people are saying that the speed of these transitions is increasing. And so we're trying to keep up with all of that. But yes, you are exactly right. The data center is certainly a volatile end market. We have a very conservative approach to forecasting and managing the business so that we don't get ahead of ourselves in terms of investor expectations.

And our next question coming from the line of Srinivas Pajjuri with Raymond James.

One of the questions on the data center. I think copper connections are becoming more and more important as AI gains traction, especially clusters, AI clusters gain traction. I'm just trying to understand the market size is the way you think about it, Steve, maybe? And your positioning because we keep hearing that this could be hundreds of millions of dollars of opportunity longer term. So I just want to hear your thoughts on how you think about the ACC market, in particular, and how you're positioned to kind of capture and leverage that potential?

Yes. Well, we certainly hear the same things. And what we're trying to do is make sure that we have the best equalizers in the market to capture market share to work with all of the cable manufacturers work directly with the network folks, work with people that are designing next-generation switches, working with people that are struggling to improve signal integrity. And so that is where we sit in terms of a position in the market. You are correct to say that there is a lot of copper deployed in the data centers. More and more, that's becoming electrified to carry higher speed data. And the limitation is certainly distance. It -- you can get it to work very well over short distances. But as you go longer in distances, you need to most likely switch over to an active optical cable or a pluggable solution and use a DSP, especially if it's a long link. So I think there is a spot inside of the data centers for active copper cable. We -- you have to recognize that the history of our data center revenue has always revolved around analog solutions and the active copper cable end product that we're designing is exactly that. It's an analog solution, which makes adjustments in terms of the signal integrity through the copper. It's also early in this cycle, and we think over the next few years, there is certainly great potential. It's probably one of the highest volume products in the data center, especially due to the reconfiguration of the data centers these days. And so yes, we are -- we see the opportunity. We are very sober about what that means to MACOM and how much revenue we'll generate. There's competition. There will be more competition. And so we think we're in a lead position from a technology point of view, and we'll work hard to try to keep that.

Very helpful. And then just one clarification. On the cable weakness that you mentioned, could you maybe help us understand how much exposure you have to cable market? And you seem to think that even next year, that market could remain weak. Just wondering what's giving that level of visibility as why you think, I mean you talked about DOCSIS 4 probably not ready or either the technology issue with more of a market demand issue? Any color would be helpful.

Yes. We have about maybe 5 to 10 different product lines that we sell into cable infrastructure. And so we follow the industry very carefully. During COVID, we saw a huge run-up of production from our cable customers, many of which today are sitting on a tremendous amount of inventory. So we think that all of that inventory needs to bleed down with sort of the current generation. When we look at the market and the financial models of a lot of sort of this industry, it struggles to make money, let's say. And so it's a difficult market, and there's a lot of pressure coming online in terms of alternative solutions, including PON, fiber to the home, satellite solutions and whatnot. So I can tell you today, our cable revenue is close to 0. And so that's the good news. So if anything turns on or comes back, then that will be a tailwind for our revenue. But we think that it's going to be some time. We think that the hardware manufacturers want to continue to sell the DOCSIS 3 product because they have a tremendous amount of inventory, and that could last for a couple of years before people start investing and it's a big -- it's a heavy lift to launch DOCSIS 4 into the market. So we'll have to wait and see. We continue to engage the customers. We have some great differentiated technology. And as we think about the next 3 years, like I mentioned, we are keeping our expectations very low.

And our next question is coming from the line of Peter Peng with JPMorgan.

Wanted to touch on the gross margin and what your expectations are for the -- recall for the Wolfspeed RF business that you were in the low 40% and there's plans to maybe bring that up to the 50% as we exit. So is that still on track? And then just on the overall -- how do we think about gross margins kind of moving forward?

Yes. I'll say just a word on that and then Jack can answer your question. So we look at this as a long-term project to improve their gross margins in a similar way to what we really did as a company over the last few years, moving MACOM's gross margins, which were in the low to mid-50% up to above 60% and we had to do a lot of work internally, operationally, yield enhancement programs, managing costs associated with high-volume production and so our team is very skilled at taking a business that has underperforming gross margins and improving them. And so that is part of what we're going to do. And the last thing I'll say before I turn it over to Jack is we do want to let investors know that this will take time. It's not -- there's no magic bullet here that will all of a sudden move there. The RF Power business up to, let's say, 60% or above. There's multiple pieces inside of that business that will be addressed on a case-by-case basis. Jack, maybe you can add to that.

Yes, just to provide some additional color, we do have numerous margin and yield enhancement programs that are occurring throughout the entire MACOM organization in addition to what we're doing more specifically with the acquired RF business. And then if you take a step back, just overall from a gross margin standpoint, there's a number of things that we have going as well from a new product introduction standpoint, and we've talked about this a bit in the past with our new product introductions, having gross margins higher than the corporate averages for MACOM. So that will be another area that we continue to focus on as we go forward that will support improving margins as we work our way into the future. But it will take time. These things don't happen overnight. There's a lot of hard work that goes into it. But going back to where Steve had mentioned, our goal would be to approach it similar to the way we approach things back in the 2020 through 2023 time period with looking to make incremental improvements across the business over time.

And then for your data center, can you just provide some color on what's the exposure to more of the higher speed line products versus the more legacy? And then as we think about the 1.2, 1.6 products. What kind of -- is there any content gains that you guys are expecting from this?

Yes. So the -- just sort of looking at the recent quarter, I can say the vast majority was servicing 800-gig applications. So more than 50%. The legacy business has been improving, as I mentioned in my comments, that includes 100 gig CWDM4 long-reach type applications. We've seen some strength there. Also Tier 1 has been showing some improvements. So the legacy business is moving in the right direction, nothing or shattering, but certainly, we are seeing positive trends there. In terms of the content for the 1.6, it primarily revolves around laser drivers and transimpedance amplifiers. Those are the 2 functions that we want to sell into this hardware. Also, it's not just on the optical side, it's also on the active copper cable side. Our customers want to move 1.6 over copper, if it's possible. And we're certainly up for the challenge.

Now I will now turn the call back over to Mr. Steve Daly for any closing remarks.

Thank you. In closing, I would like to thank our employees, customers and suppliers for making these results possible. We are excited to be involved with new I&D programs and cutting-edge data center applications for next-generation high-speed infrastructure and to service the growing SATCOM market. We will continue to work as a team to meet our customers' needs and execute our strategic plan. Thank you and have a nice day.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.