MACOM Technology Solutions Holdings, Inc.

Welcome to MACOM's second fiscal quarter 2022 conference call. This call is being recorded today, Thursday, April 28, 2022. At this time, all participants are on a listen-only mode. I will now turn the call to Mr. Steve Ferranti, MACOM's Vice President of Strategic Initiatives and Investment Relations. Mr. Ferranti, please go ahead.

Thank you, Lydia. Good morning. Good morning. and welcome to our call to discuss MACOM's financial results for the second fiscal quarter of 2022. 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 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 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 8K, which was filed with the SEC today. With that, I'll turn it over to call 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 fiscal 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 the second quarter was $165.1 million in adjusted EPS with 68 cents per diluted share. We continue to improve the quality of our earnings as both gross and operating margins increased sequentially. We also generated strong cash flow, ending the quarter with over $500 million in cash in short-term investments, which is a record level. Our financial performance reflects the numerous improvements that we have made across many aspects of the business. Overall demand for our products continues to increase. Our book-to-bill ratio for the quarter was 1.2 to 1, representing the sixth consecutive quarter above 1. Our backlog is, again, at record levels, which is helpful as we plan the remainder of fiscal 2022. We believe that the strong Q2 bookings reflects market share gains, market traction from our new products, as well as long lead orders, which are being placed well ahead of the required ship dates. Our turns business was up slightly to approximately 19% of our total revenue during the quarter. The business metrics for our new products shows favorable performance. In aggregate, as a percentage of total revenue, products less than three years old are contributing more to revenue today than in the past and with gross margins that are higher than our current corporate average. These trends are in line with our strategy to build a diversified and highly profitable product portfolio. Our team continues to work effectively to accelerate product and technology developments. To meet our future goals, we are investing in new HR programs and benefits for our existing employees, as well as expanding our workforce with additional design, operations, and sales staff. I am pleased with how our team has been performing, and with the amazing new talent we are attracting to the company across all functions of our organization. Revenue breakdown by end market for Q2 was as follows. Industrial and defense was 67.1 million. Telecom was 62.9 million. And data center was 35.1 million. Data center and telecom revenues achieved strong double-digit sequential growth which was offset by a decline in IND revenues due to timing of shipments. Additionally, we expect our top line growth in the second half to be slightly higher than in the first half of our fiscal year. Now moving to our three end markets. The industrial and defense markets have been a focus area for MACOM because we believe these markets have the potential for significant revenue growth over the next few years. Customers in these markets typically produce products with long life cycles, which can create an annuity-like revenue stream for MACOM. In part, our strategy is focused around strengthening and expanding our high-performance product portfolio to better address the highest frequency, highest power, and highest data rate opportunities across these markets. IND customers are performance-driven, and they look to adopt new technologies. we will engage this market with our proprietary semiconductor technologies, our IC design capability, and our growing subsystem design capabilities. Our continued focus on this market is uncovering numerous large opportunities in which our technology is a perfect match for the customer's needs. We see opportunities with our new 0.14 micron Ghana silicon carbide MIMIC process, our pure carbide high power amplifiers, our analog and mixed signal ICs, and our specialty optical and RF subsystem products. Our new products are creating a growing pipeline of meaningful opportunities involving a variety of ground, airborne, and ship-based programs, including radar, electronic warfare, avionics, and microwave communication applications. And I am pleased that we are now engaged with some of our largest customers in to insert optical connectivity technology in their applications. I'll note, we maintain a long-term perspective in this market because most defense programs take a long time to transition to production. However, the programs have long life cycles, and we are able to stack up multiple programs with high dollar content, which makes the financial returns compelling. I am pleased to announce that in Q2, we were awarded a multimillion dollar two year development contract to produce a 45 kilowatt transmitter utilizing our gallium nitride amplifier and phased array antenna technology. This government contract with the Navy validates that our GAN amplifier and phased array technologies are best in class. Congratulations to the CAPTURE team for this award. Our telecom and market revenue increased sequentially in Q2, following a strong Q1. We continue to experience broad strength in demand across various telecom applications, including 5G, metro long haul, broadband access, and broadcast video. As a reminder, telecom is a very broad and diverse end market for MACOM, spanning numerous communication protocols, network architectures, and topologies. Today, we are only delivering a fraction of the overall opportunity for this market. Our primary long-term growth drivers across these market opportunities will be new product introductions. As an example, we recently announced availability of our 128 gigabaud transimpedance amplifiers and modulator drivers for coherent networking applications. These new products improve upon MACOM's already strong competitive position in these markets by supporting long-haul, metropolitan, and data center interconnect, or DCI, applications. This new product family includes high bandwidth, low noise, and low power consumption dual channel and quad channel TIAs and quad channel drivers that are designed to enable coherent transmit and receive systems that operate from 800 gigabits to 1.6 terabits per second. Additionally, Over the last several quarters, we have been gaining traction with 5G OEMs and O-RAN equipment manufacturers for our RF portfolio of front-end modules, high-power switches, and amplifiers. A number of our customers have recently moved programs to low-rate initial production using our power amplifier products. Here, we are providing 100-watt, 220-watt, and 450-watt peak power GaN on silicon carbide amplifiers for small cell and macro base stations for both U.S. and international deployments. The base station power amplifier market is large and comprised of numerous opportunities spanning different customers, frequencies, and power levels. We are just beginning to penetrate this market. Demand for our LightWave products for telecom and access application also continues to grow, especially for our 25G DFB lasers. We have multiple 5G front-haul customers in low-rate production with our lasers, primarily for CWDM6 modulation schemes. Our expectation is that production volumes will increase over the next 6 to 12 months. Finally, our data center and market revenue was up in Q2 based on incremental demand from our high-performance analog solutions, which include CDRs, TIAs, and driver products. In March, we attended the 2022 Optical Fiber Conference, or OFC, in San Diego, where we had more than 10 product demonstrations to showcase our latest products. For example, one of the demos included a single chip laser array with eight CW lasers, each operating at different wavelengths. The laser array utilized MACOM's etched facet technology and is ideal for co-packaged optics. This laser array was developed to work alongside one of our customers' chipsets to enable connectivity at speeds as high as 2 terabits, making it ideal for AI or high-speed chip-to-chip connectivity. MACOM is currently engaged with several customers to enable data center interconnect requirements at 800G and 1.6 terabits with our next-generation linear driver and TIAs. In some instances, we will support a linear interface architecture, also known as direct drive, to optimize performance of the entire signal path from host switch ASIC to the optical interface. One of the first expected deployments will be for applications addressing deep learning and AI for high-performance computing utilizing low-latency InfiniBand networks. And last, Macom is pleased with the customer interest level in our recently introduced linear equalizers, and we see growth opportunities in active copper table applications at both 200G and 400G data rates for high-performance computing platforms. The foundation of our growth strategy revolves around introducing new product lines, new technologies, and raising the bar on semiconductor performance in areas where we choose to compete. We often use trade shows as a venue for product announcements and for our teams to drive deadlines associated with these events. IMS, or International Microwave Symposium, which supports the RF and microwave industry, is less than two months away. During this event, we plan to unveil some of our latest products, technologies, and product lines. At this year's event, we plan to demonstrate our highest power level amplifier, a GaN power amplifier which delivers 4.5 kilowatts of RF power, almost 1.7 times higher than our 2.6 kilowatt device we introduced last year. Our first 8 watt and 10 watt 5G massive MIMO GaN on sick power amplifier modules, or PAMPs, which include driver stage, CMOS power management ICs, and a Doherty output stage. We'll introduce the first GaN MIMIC products from our internal AFRL 0.14 micron GAN on silicon carbide process, specifically a 10 watt KA band mimic chip. We will also introduce our first wave guide package products, specifically an E band power amplifier module, which combines 16 of our 80 gigahertz mimics using a novel wave guide combiner. And last, while we've been utilizing SOI technology in our 5G RF modules for some time, we are launching our first SLI standard product, a DC to 67 gigahertz switch, for test and measurement and IND customers. Perhaps most notably at IMS, we plan to demonstrate our first BAW, or bulk acoustic wave, product. BAW technology is a passive silicon crystal filter technology used in most handset and wireless applications to filter unwanted signals. We are not targeting commercial wireless applications or consumer electronic markets, but rather high performance industrial and defense electronics. In addition, our team plans to implement novel semiconductor processing techniques to push the frequency performance of BAU technology. Today's BAU technology is limited to about six gigahertz, and we plan to push our technology through 15 gigahertz. IND customers have a growing need to filter out high frequency signals in their microwave systems. Our goal is to enable solutions with filters based on our proprietary semiconductor processing techniques. At IMS, our chip-scale packaged BOP product will be showcased in two applications, a two-channel switch filter bank and alongside a MACOM comb generator to select the desired frequency. It is difficult to estimate the size of this market, but we conservatively estimate the opportunity exceeds 100 million, and we believe customers will be willing to pay a premium for our technology. Before Jack reviews our financials, I would like to highlight that in March, we celebrated our 10th anniversary as a public company. Today, Macon is recognized as a trusted partner, and I congratulate our entire team for their hard work and significant contributions to both our customers and the industries we serve. To mark the anniversary, our marketing team updated and launched a new website with a modern look and feel which better organizes information and improves product navigation so our customers can quickly find the information they need. In summary, we have many compelling new processes underway, world-class IC designers, and unique manufacturing and packaging capabilities. I am confident we can continue to push the boundaries of semiconductor engineering. Jack will now provide a more detailed review of our financial results. Thank you, Steve, and good morning to everyone.

We continue to build on our sound financial performance during our second fiscal quarter ended on April 1st, 2022.

Revenue for the second quarter was $165.1 million, up 3.5% quarter over quarter. On a geographic basis, revenue from our domestic U.S. customers was approximately 45% of our fiscal Q2 results, representing geographic diversity across our customer base. From a supply standpoint, the environment continues to be challenging for our operations, planning, and logistics teams. The recent resurgence of COVID-19 in Asia has resulted in additional lockdowns in various cities, which has an impact on some of our outside assembly and test suppliers. Also, shortages of certain key components and production capacity limitations within our supplier base is impacting our ability to ship product. We expect these conditions to improve modestly in the second half of the fiscal year. MACOM's operations team has done an excellent job managing through this difficult environment, enabling us to meet our near-term revenue goals. Adjusted gross profit was $101.9 million, or 61.7% of revenue, up 30 basis points sequentially. Q2 adjusted gross margin came in toward the upper end of our guidance range, based primarily on continuing operational improvements. We are pleased with our growing gross margins and expect further improvements over time, albeit at slower rates. Total adjusted operating expense was $51 million, consisting of R&D expense of $31.8 million and SG&A expense of $19.2 million. Total operating expenses were sequentially up $2 million from fiscal Q1 2022. driven by an increase in R&D and staffing-related costs. While we anticipate modest increases in OPEX over time as we grow our R&D capabilities, invest in new technology developments, and expand our product portfolio, we do expect to maintain fiscal discipline over all of our discretionary spending. Adjusted operating income in fiscal Q2 was $50.9 million, up from $49.1 million in fiscal Q1, Adjusted operating margin was 30.8% for fiscal Q2, sequentially up from 30.7% Q1. Depreciation expense for Q2 was $5.8 million, and adjusted EBITDA was $56.7 million. Trailing 12-month adjusted EBITDA was $213.9 million as compared to $205.1 million in our prior fiscal quarter ending in December 2021. Adjusted net interest expense in fiscal Q2 was $1 million, down approximately $200,000 from fiscal Q1, primarily driven by higher short-term investment balances and the associated interest income. Our adjusted income tax rate for fiscal Q2 was 3% and resulted in an expense of approximately $1.5 million. Our net cash tax payments were approximately $500,000 for the second quarter, up $300,000 from fiscal Q1. We expect our adjusted income tax rate to remain at 3% going forward. Fiscal Q2 adjusted net income was $48.4 million compared to $45.4 million in fiscal Q1. Adjusted earnings per fully diluted share was 68 cents. utilizing a share count of 71.1 million shares, compared to 64 cents of adjusted earnings per share in fiscal Q1. Now, moving on to operational balance sheet or cash flow items. Our Q2 accounts receivable balance was $100.6 million, up from $97.4 million in fiscal Q1. As a result, day sales outstanding were 55 days. Our accounts receivable balance reflects an increase over prior periods primarily due to higher revenue and the timing of shipments during the quarter. Inventories were $93.4 million at quarter end, up by $4.8 million sequentially, and inventory turns were 2.7 times, down sequentially in Q2 from 2.8 times in the prior quarter. These higher inventory levels are to support future revenue growth. Fiscal Q2 cash flow from operations was approximately $42.5 million, up $8.4 million from our prior fiscal quarter. Capital expenditures totaled $7.1 million for fiscal Q2 as we further invested in our FABs, facilities, and R&D equipment. We continue to expect our strategic capital investments for fiscal year 2022 to be in the range of $30 to $35 million. Free cash flow was $35.4 million for the second fiscal quarter, up $6.4 million sequentially, mostly due to higher adjusted net income. Now, moving on to other balance sheet items. Cash, cash equivalents, and short-term investments for the second fiscal quarter were $503 million, up $25.3 million sequentially, and $235 million, or 88% from the previous year's second fiscal quarter. We view our cash and short-term investment balances as a strategic asset that will help support future growth initiatives as we go forward. With further improvements in trailing 12-month EBITDA, our second quarter gross leverage is currently 2.8 times, down from 2.9 in Q1. Further, our net debt is now around $100 million, and net leverage is currently below 1. Prior to our annual stockholder meeting in March and throughout the year, we conducted extensive investor outreach, focused on better understanding the concerns and perspectives of our stockholders, including diversity, governance, and other topics related to ESG. We discussed our ongoing company-wide review of ESG-related matters and initiatives with the goal of enhancing or creating additional policies, programs, and practices over time. Finally, I would also like to highlight that last week Moody's upgraded our corporate credit rating from B2 to B1. We view this as continued recognition of our improving operational and financial achievements during the past year, as well as our ongoing and consistent efforts to improve the business. These improvements across the business would not have been possible without the teamwork and dedication of the entire MACOM organization, and I'd like to thank our team for their efforts. I will now turn the discussion back over to Steve. Thank you, Jack. MACOM expects revenue in Q3 to be in the range of $168 to $172 million. Adjusted growth margin is expected to be in the range of 61 to 63 percent. And adjusted earnings per share is expected to be between 68 and 72 cents based on 71.3 million fully diluted shares. In Q3, when compared to Q2, we expect industrial and defense revenue to increase by approximately 5% to 10%, and telecom and data center revenues to be relatively flat. As I highlighted earlier, we expect our second half FY22 growth to outpace our first half FY22 growth. In summary, we stand in front of a multibillion-dollar SAM with a unique and growing technology portfolio. Our strategy is to further diversify our products, customers, and end markets. We maintain a long-term perspective on executing our strategy, and we will work to manage our business to be profitable throughout all business cycles. We are confident we can continue to improve our financials and take market share in the months and years ahead. I would now like to ask the operator to take any questions.

Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, you will need to press the start and the one key on your touch-tone telephone. In the consideration of time, we ask you to please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. Now, first question coming from the lineup, Quinn Bolton with Nieham & Company. Your line is open.

Hey, guys. Congratulations on the nice, steady, consistent results. I wanted just to ask, you know, with the business mix shifting around a little bit, what are your expectations for year-on-year growth by segment in fiscal 22? It sort of feels like the telecom business may be stronger than what you might have thought a quarter or two ago, and, you know, wondering if you still think data center is is tracking to be up slightly fiscal year 22 versus fiscal year 21. Thanks.

Hi, Quinn. Good morning. Thank you for the question. So your comments are accurate in terms of our outlook for the full year. We are seeing very strong growth from telecom, and we expect that to continue through Q3 and Q4. And we do also expect both IND and the data center to deliver year-over-year growth. And we do believe we are on track to deliver a minimum of 10% growth for the full year. You know, we're seeing broad strength across all of our markets. Our book-to-bill across all market segments this past quarter was, again, close to 1.2 individually, let's say. So very strong, broad performance across all of the segments. And we are on track per our original planning as we looked into the year for at least 10% growth.

Great. Then my follow-up question just on the data center business. Sounds like it came in a little bit better than expected in the March quarter, but I think you had talked about last quarter having pretty solid backlog and your biggest challenge was sort of supply constraints. Wondering if you could just sort of talk about the supply constraints and do you think you'll be able to hit that very strong customer demand as you look into the September quarter on the data center side?

So all indications are we will. And as we sort of roll the math for the back half of the year, we see our data center business segment in Q4 being close to $40 million. And a lot of that is coming from improvements in supply chain but with that said we do see some positive trends within that segment including as I highlighted on my comments a very strong interest in our linear equalizers for copper cables for both 200 and 400 G we see that all of our Pam for product segments or subsections of the data center are up we see all of our 400 G business growing And we're starting to get more involved with high-performance computing at the higher data rates that I talked about. So there's a lot of positive trends there within the data center that will certainly help our long-term growth prospects.

And our next question, coming from the line of Harsh Kumar with Piper Sandler, your line is open.

Yeah, hey, guys, congratulations on my part as well, solid execution in these kind of very turbulent times. I just, Steve, you seem to be very excited about the telecom business, and you cited a bunch of opportunities there, but I was curious maybe if I would ask you to stack rank your top one or two opportunities that you're most excited about within telecom where you think near the midterm the most amount of growth will come from.

Yeah, so I think that's a difficult question to answer because we have so many moving parts within telecom. If I just look at the performance in Q2, the strength and the growth came from primarily 5G, both on the RF product side as well as the optical side. So that would include products like front-end modules and then analog ICs for front haul. And also we're starting to get traction with our light wave components, both on the laser side side and the photo detector side inside of some of the front-haul platforms. So that's certainly supporting the growth, and these are product lines that we've talked about during the course of the year. So we're very pleased that things are coming together as we had expected. We're also seeing growth from what we call access markets, which includes 10G PON. We have a very strong position with some of our analog chips within that market. We are also starting to support that market with photo detectors, which is a content gain for that market for this year. And later on this year and going into next year, we plan on adding lasers to that market, which will really turn that market on for Macom. And as you know, historically, when Macom was supplying lasers to the two-and-a-half GPON market, there were quarters where we were doing $10 million to $20 million of revenue per quarter just for that market segment alone. And then the last thing I would add is Metro long-haul business is also very strong right now. Not only our legacy 32 gigabaud business, but also the new content for 64 gigabaud. And as I highlighted in my scripts, we're introducing our 128 gigabaud products as well. So we really have a nice position there. And so, you know, the common denominator for all of these markets is really infrastructure. We are getting good traction from, within the infrastructure markets within telecom. And, you know, certainly quite pleased about that.

Thanks, Steve. Thank you for that, Carlo. Very helpful. And then this is a good segue into my next question. You guys are on the work, actually started launching lasers in selected markets. I think telecom is one which you highlighted already. I was curious of the 40 million number that you cited for the fourth quarter for the data center business. Does it have lasers in it? And then secondly, can you help us think about understanding what the scope of your entry into lasers is and perhaps Sam or Tam opportunity, but this, this entry into the variety of markets associated with lasers. Thank you. Sure.

Yeah. So, um, Yes, there is contribution of laser revenue within the data center segment, and it really is in two areas. It's land WDM, which is currently in production, and we expect growth in the back half of the year with that platform, and that's for the data center. And then the other is CWDM4 winning market share, and that we expect to also happen within the next six months. So that sort of answers your question about is there laser revenue within the data center. So the answer to that is yes. But more broadly, you know, we're looking at telecom and specifically 5G. And we've been working for the last year and a half on gaining market share and getting customers to qualify our product. We are seeing traction for CWDM6 and also buy-die platforms. bi-directional optical links. And, you know, we're very interested in this market because we believe MACOM has a competitive advantage because we're on 4-inch indium phosphide. We do all of the testing of the laser and the lasing of the laser at wafer level, which is a differentiator, because our competitors cleave the wafers and test after that. So we just have a far superior cost structure. And so when we launch these lasers, they will be accretive to our gross margins. This is a very profitable part of our business. And certainly it's helpful for, you know, our goal to increase gross margins. And then the last thing I'll add is our laser business is really a portfolio. So today we sell Fabry-Perot's and DFB's, which are generally laser. good for 2 to 15 kilometer lengths. We sell CW lasers for folks that are using silicon photonics. We are launching higher and higher power CW lasers as well. And we also have aspirations to extend into other types of laser classes, including EMLs, which is for the longer reach applications. And we're very attracted to EMLs because these have very strong price points And we also believe that there is a shortage of capacity in the EML segment. And so over the long term, you're going to see more laser families coming out into more markets. Of course, there's other industrial markets that consume lasers. And, you know, we're continuing to do a better and better job there. And I'll highlight, by the way, we recently just exceeded a 10,000-hour deadline qualification milestone for our DFP platform. And this platform is the foundation of our EML business, or future business, which would target the data center.

Our next question, coming from the line of Tori Sandberg with Stifel, your line is open.

Yes, good morning. This is Jeremy calling for Tori, and let me add my congratulations on the execution here. Just to follow up on the laser comments, can you give us maybe a quick update in terms of the competitive dynamics? Have there been any changes in terms of supply chain or recent geopolitical impacts on the competitive landscape here?

Yeah. Well, first of all, the laser segment is a very competitive segment. And so we have U.S. companies we compete with. We have Asian-based companies that we compete with. We have Chinese companies that we compete with as well. So it's very competitive. And I would say, no, there's really no shift. We have seen some smaller companies discontinue some of their product offerings, you know, The laser is really a cornerstone technology for optical links, and customers are very careful about bringing vendors on for high-volume applications because if the laser stops lasing the link, that's it for the link. So we have been making sure that when we step into this market, we lead with quality and reliability and that we want customers to know that we're setting some of the highest marks in terms of not only functionality but reliability. But to answer your question directly, I would say no, there's no real change in the dynamics. It's very competitive. And when we enter this market, we enter the market having analog solutions for the customers. That includes drivers that drive the lasers as well as TIAs that are used on the receive side. So we have nice content within a lot of these optical transmitters and receivers. And then the last thing I'll highlight is we still are the only company in the industry that's running this type of product on four-inch indium phosphide.

Got it. Thank you. And maybe switching to the IND side, can you tell us about any shift in terms of, you know, demand that you're seeing there, just again in the current environment? and maybe what are some of the key applications going forward? Thank you.

Sure. Well, I would say there's really no changes in the environment. Our customers continue to seek out advanced technologies for their platforms. But maybe I'll take a moment to just say a few more words about our strategy within this segment. You know, we want to, as I highlighted, provide customers with the highest power, highest frequency, and highest data rate solutions. And so earlier this week, we announced a fairly large contract, a multimillion-dollar two-year development contract with the Navy to produce a 45-kilowatt effectively transmitter using our GAN technology. And so we think this is an important milestone for MACOM as we build out our capabilities to do multi-chip assemblies, and very high power components. And so we just think that's a great example of the capability of MACOM's engineering. It speaks to our thermal engineering, our power control to run the devices, and, of course, our ability to produce phased array antenna systems. So it's a nice project for us. It's a multi-year project. It will lead to more programs like this. and the team is just doing a phenomenal job there.

And our next question, coming from the lineup, Tom O'Malley with Barclays. Your line is open.

Good morning. Thanks for taking my question. I just wanted to ask specifically on the I&D side. You mentioned some push-out due to customer timing, and you're obviously guiding that business up strongest of your three segments. Is that related to the I side or the D side? Traditionally, you don't really have these big, chunky revenue bunches except in the Defense Department, so I would assume it's there, but any color on the moving pieces between March being weaker and then June being a bit stronger here?

Sure. Maybe I'll say a few words, Tom, and then Jack can also add. So certainly we are, as you highlighted, you know, had a down IND, and that really had to do with operations rebalancing and reprioritizing shipments within the quarter based on customer priorities. And as we highlighted, as Jack highlighted in the script, we had a higher turns business. We saw incremental demand for the data center coming in. And so essentially what we did is we had a mid-quarter remixing of priorities based on customer priorities, let's say. And so that's really why IND came down the way it did. There's nothing structural, no issues, no execution issues or anything like that. It was simply a matter of resetting priorities during the middle of the quarter and Jack, I don't know whether you want to add to that or just the general trends on IND. Yeah, and just to add to that, Tom, as Steve had mentioned, the book-to-bill across the business has been strong, specifically within IND. And we move some things around like we typically do during the course of the quarter.

So we expect that strength that we're seeing going into Q3. you know, to remain as we go forward. So nothing really specific to highlight.

Things tend to move around throughout the business, and that's where we ended up here for the quarter and with our outlook going into Q3.

Gotcha.

Gotcha. And then as a follow-up, I think there's a lot of concern out there, obviously, with the China shutdowns, particularly with the module makers. Could you just fill us in with any details you have or what you're seeing in terms of your supply chain there? Is there any financial impact that you're recognizing in the results that you just gave us? Are you seeing that improve or get a bit worse? Any color there would be really helpful as well.

Sure. So just a few words about our business in China. So we have We have about four different offices in different cities. Most of those offices are sales or application labs. And so in areas like Shanghai that have been shut down, we have a lot of the staff working from home. In Shenzhen, we do some planning and logistics, and it's been fully operational even sort of on and off over the past two years where we've had periods where folks need to work from home. We do not have any suppliers in China. We have, so we're not impacted if certain regions shut down. You know, it's really a focus on the customers and the sales and applications. And so we've been able to push through it. We've not been impacted. Certainly, you know, at some level there's a bit of a headwind there if parts of the country shut down. But from our point of view, our customers have been very active. Our sales and applications teams have been very active. It would have been fortunate to not be impacted the way some companies have with the cities shutting down.

Now, our next question coming from Delaina. Vivek Arya with Bank of America. Your line is open.

Thanks for taking my question. Steve, I have one more on the IND segment. If I take kind of a longer-term historical view, It seems like IND, you know, tends to have a strong year followed by a softer year, so there seems to be that cyclicality in the business. And I'm curious, what is the right way to think about the growth opportunity for IND? Can this grow in line above or below, you know, kind of the 10% to 15% kind of growth rate that you think for the company as a whole?

I do, and I think – I'm not sure your comments about, you know, an on-year and an off-year are, I don't know. I don't, not sure that's accurate, but from our point of view, I can tell you that Maycom's ING business, if you look back over the past five, six years, was very weak due to lack of attention. And that changed in 2019 where we began to focus on the market. And so what you see us doing is cross-selling our existing portfolio and adding products and technologies that are attracted to that market and driving our sales force into the market to win contracts like we talked about, the Navy contract, and we want to do more of that. This is a very, very large market, and we've moved over the last three years our revenue from being range-bound really in the $30 to low $40 million per quarter up to the high $40s to the $50s, and now we're You know, we're in the 70s, so we believe this trend will continue because we're throwing a lot of weight at this market, whether it's on the optical side, whether it's on the RF and microwave side, or now even supporting customers with what I would consider small, high-end subsystems for very niche applications. So over the long term, as we've talked about, our goal is to reach a billion dollars by our fiscal 25th. It will be led by our telecom business first because it's so diverse, followed by our defense business or industrial and defense business. And then last, it would be our data center business, primarily because the solution set available for that market is limited compared to the other two. So that's our general sense. It's a huge market, one of our largest opportunities. And by the way, as I highlighted in my commentary earlier, we just launched our BACH technology for this market, the industrial and defense market. And if you were asked the question, well, why did you do that? Our answer would be we sell some of the industry's best ALGAS high-power pin switches to the market. Sitting right next to these components are filters of all different technologies. And customers want to move away from ceramic filters or IPDs or even cavity filters and or tunable mimic filters, and they want to move towards something smaller with higher performance. And so to do that, there needs to be innovation. And so we've put ourselves on the track, essentially, to produce and innovate with a very high-frequency BAU technology, which would be the first for the industry. And so that's why we've taken our first step into the market, and we think that will, again, open up a whole new window of growth opportunities for And so, you know, that's just one example. The other example, of course, which we've talked about for the past two years, is really our 0.14 GAN on silicon carbide process, which will absolutely target phased array radar programs, SATCOM programs, and all sorts of microwave applications for IND. So we're putting a lot of our focus on this market. These customers have very sticky programs. So once we get in the programs, you know, we believe that the revenue streams can last for multiple years, which, of course, is a very different dynamic than what you might see in the data center where you have programs turn on and turn off, you know, rapidly. And so, you know, we're very attracted to the business attributes of the industrial and defense market. And by the way, one last comment on the industrial side. We've recently had some nice wins inside of medical applications where we're now moving from single component to multi-chip assemblies to medical applications. As everybody knows, we automotive certified our fab about six months ago. In this past quarter, we won an automotive platform for a telematics program, which will go into production within the next six months. So a lot of interesting developments. activities within our IND space, and we do believe it will continue to be strong.

Very helpful. And for my follow-up, Jack, I was hoping you could just give us a sense for how we should think about balance sheet inventory. I understand everyone is holding more inventory than usual because of all the well-known reasons. What is your target in terms of days of inventory and How does that impact your FAB utilization and gross margins, if there is an impact?

Yeah, and as we've discussed over the past few years, inventory has been an area of focus for us. And I think if you go back a few years, we brought our inventory levels down to what we thought were healthy levels. Over the past couple of quarters, there's been a bit of a build in our inventory for strategic purposes, and I think that's played out well for us in terms of supporting future growth and revenue opportunities as they emerge. In terms of a long-term goal, I don't think we've established a longer-term goal. I think we've been around three times. We've come a little bit below that with some of the increases that we've seen in inventory, but, you know, I think right around that three times is where we've been, you know, would be a healthy enough target. And from a turns perspective, with our improving gross margins, that puts pressure on the inventory turns as well. So it's a little bit of an uphill battle that we've been fighting overall when you look at turns with regard to the margin improvement that we've had.

Our next question coming from the line of Harlan Sir with J.P. Morgan.

Good morning. Great job on the quarterly execution and strong margins. You know, on the strong innovation profile, which obviously is going to drive the growth, is going to drive the margin profile kind of mid to longer term, right? You guys have a target to increase the number of new, I believe it's standard product introductions by about 35% this year. Can you guys just give us rough percentages, like where the new products are focused on by end market? I'd just like to know where more of the R&D focus is as you think out over the next few years. And maybe just kind of as a follow-on to that, you guys do have actually a pretty strong pipeline, I believe, of custom product development as well. Are most of these activities focused on your IND business, primarily defense-related customers, or do you have custom product development programs in telecom and data center as well?

Harlan, thank you for the question. It would be very difficult for us to break out R&D for you by end market or by product line, or by section. So that would be a lot of maybe sensitive information. So I would rather not say that. But I will say sort of some general comments. So our high-performance analog business is one of our largest segments. And so you could imagine that that's receiving a fairly large percentage of our R&D dollars. And that market has historically supported or that HPA business, high-performance analog business, has historically focused on the data center. And so part of our strategy is to expand their focus into industrial defense and more analog and mixed signal type components outside of the data center. And so that group, you know, our focus, our goal is to expand that group into other markets. And so I would certainly highlight that. When you contrast that to one of our smaller parts of our business, which would be our lightweight business, that business contains sort of three different technologies, lasers, which we talked about today, the photo detectors, and then silicon photonics. And so we continue to invest significantly in all three of those segments, And so two of the three segments today are generating revenue, the lasers and the photo detectors, and we're continuing to invest in silicon photonics. So I probably wouldn't want to go any further than that, other than to say that our guiding principle on investing in R&D really revolves around our strategic plan, where we've laid out the technologies we want to invest in in the near term, the product lines that we want to expand, as well as filling in gaps within the portfolio. I mean, we recognize we have a small portfolio compared to our peers within our industry. And so as we've talked about today during the prepared remarks, you're starting to see more and more new product lines coming out for existing and adjacent markets. And we believe that is the best way for us to outgrow the industry. But we don't necessarily want to – with any more detail than that. I will say what we're not doing, we're not investing in sort of next-generation DSPs. We will be very careful not to invest in large programs or systems that have very low margins. That is not interesting to us. There's a lot of companies out there that produce optical and RF and microwave equipment, and their financials are... and they generally struggle for profitability. And so we will absolutely pick and choose areas where not only can we provide something differentiated, but also it will meet our financial criteria of being accretive to our profitability.

Thanks for the insight. Very insightful. You guys continue to drive strong gross margin improvements. It's been a combination of mix, manufacturing efficiencies, and optimizations, maybe stronger on the optimizations front. But it actually looks like your incremental margins are kind of now settling into a stable range of somewhere between 70%, 75%, which is where we would expect them to be given the richer mix of your products. And also, I know you guys have talked about mid- to longer-term target of mid-60s gross margins. So we would expect that your incremental margins to be in that 70-75% range, but is this how we should think about the margin trajectory on continued revenue growth, kind of in that sort of low to mid-70s type of incremental margin range?

Great question. And so maybe I'll say a few words and then Jack can also contribute. You know, our operations team, our sales organization, our finance team has done a phenomenal job improving the profitability of the business, including the gross margins, through a combination of the things that you mentioned, pricing, execution, yield enhancement programs, working with our vendors to get better pricing, all of those things and more. And that work continues every day. When that is flushed out, the way we will continue to push up the margins is will be through innovative products. And, you know, today we've highlighted on the call so many examples of product lines or product sets that are truly best in class that will command higher gross margins. And as those elements start to layer on to our business, it will continue to push the margins up. The reason why we do not give a target model is because it's very difficult to predict the timing and the mix of those things And the new products, as everybody knows, take, you know, months if not years to really kick in to move the needle both on the revenue and also on the gross margin line. So we would rather talk about the gross margin and operating margins retrospectively about look what we've done as opposed to trying to forecast one or two years down the road. Other than to say directionally we are continuing to push the margins higher and the data that we collect on our new products, is very supportive of our goals. Do you want to add to that, Jack? Just to pile on a little bit more in terms of some of the internal initiatives that we have been going through and how those continue to contribute to the margin improvements that we've seen, as well as the revenue increases, that additional volume through the top line is helping to drive incremental margins as well. So it's really a combination of factors that have supported us thus far, and we think will continue to support us as we go out into the future. But it does become a bit more challenging as we continue to go forward with the improvements that we've made over the past few years.

Our next question, coming from the line of David Williams with Benchmark, your line is open.

Hey, good morning. Thanks for squeezing me in. Um, just, I guess a couple of high level questions, but, uh, just kind of think about the order book is still, uh, still very strong book to build, but have you seen any changes, I guess, in the behavior of your customers or maybe their longer term planning, just kind of given the volatility that we've seen in the marketplace over the last several weeks?

Uh, the short answer is no. Um, as we entered this month or as we're finishing out this month, um, orders continue to be strong across all the different market segments. So we've not seen any pullback or slowdown from our customers. So nothing to report there.

Fantastic. Thank you. And then a few others have commented on substrate constraints, really on the high-performance products. And just wondering if you're seeing anything similar there or maybe specific areas of constraints that could potentially be troublesome as we head through the second quarter.

Yes, so we have absolutely been afflicted by the substrate issues associated with capacity in the industry, and it's hit two parts of our business. We talked about in the past the data center, some of our high-end products, HPA products, and also what we call connectivity products, which could be, for example, cross-point switches, very high-end switches, So that is yes. So the answer is yes, we have been affected by that. That has been built into our guidance over the past two to three quarters. We talked about on our last call that issue causing a back-end sort of step-up in our data center revenue. And so that is still happening. our current thinking, and that's why we're going to see a significant step up in data center in Q4, which is some of those supply constraints being worked out and, you know, Macomb will have access to the packaging that we need to ship our products. It's something that will slowly get better over time. We've been taking actions to move away from certain technologies and to move our components and our products into other technologies that are suitable. And so all that engineering work has been happening behind the scenes. And as we think about 2023, we think things will slowly get better and it won't be an issue. So it's something that our business units do a great job managing. They're fully engaged. And it's just one of those things that we're managing through.

Olivia, we'll take the next question, please.

Our next question coming from the line of TJ Muse with Evercore. Your line is open.

Yeah, good morning. Thank you for taking the question. I guess a follow-up question on the supply constraint side. Curious what your view was pre-China lockdowns in terms of when you thought things would normalize and how that's been affected due to lockdowns. Just trying to get a better understanding there.

Hey, CJ, it's Jack. Just to clarify, I know in my prepared remarks I had some commentary with regard to supply chain, and I think that's just to highlight that those items still do exist. Obviously, they've been evolving over time, and there have been some more recent items that have come up more specifically in China, and I think Steve had addressed that in his earlier response to one of the questions. But part of the prepared remarks was also for recognition to our operations team in terms of how well they've been able to manage through this over the past number of years, really, when you look back over time. So, you know, no real major impacts to us over the past quarter versus where we were three months ago. You know, we did highlight that we were expecting some modest improvement as we work our way through the back half of the year. But as always and as we've learned, that's, you know, always subject to change. But based on where we're sitting here today, you know, no real major change from where we were a quarter ago.

Okay, that's helpful. And as my follow-up question, I wanted to focus on aerospace and defense side of things. You know, obviously the world's changed in the last, what is it, 62 days, plus or minus? And with NATO now looking to actually hit their targets for defense spending, have your conversations or your internal plans for engagement changed at all? And how should we think about, you know, kind of the duration of design cycles and when you might see a step up in that part of your business.

Sure. So as we talked about earlier, we really began to focus on the I&D end market in 2019. And we've been continuing to invest in products, technologies that we believe would be ideal for the customers within this segment. And so that That is probably more important than the current dynamics that are happening today in the world. And so I would just bring you back to that as being really the main point is that MACOM is improving the technologies for industrial and defense and markets. And our sales and marketing teams have been doing a great job engaging at all different levels these customers. And so you know, that's really the point. I wouldn't want investors to think that because of the activities in the Ukraine that, you know, there's going to be an uptick in our business or a windfall on a particular program. I wouldn't think of it that way. I would instead just recognize that this is an area, you know, one of three markets. It will over time be a very strong market for us continue to be a very strong market for us, but I wouldn't be I wouldn't focus on the current events as as Something that might create You know a financial windfall for the company Well, thanks guys for taking my questions I

Steve, I'd like to dive into the topic of GAN here. I've had some positive commentary the last few calls here. It sounds like the business is really building, particularly on the booking side. You've also talked about a goal of getting to the company of a billion dollars in a few years. I wonder if you can give us a sense of how the backlog is building here and how you think about the size of your GAN business relative to that goal out in a few years. I mean, can GAN be a 10%? of that total, and how would you kind of think of it between your IND and telecom segments?

Sure. So we have really three parts of our GAN strategy, and I'll say just to point that out. So the first part of our GAN, actually four segments of our GAN strategy. The first is high-frequency mimics using 0.14 GAN on silicon carbide. That will address high-frequency IND and SATCOM and microwave radio links using GAN. And those can be multifunction mimics that would be used on the transmit and receive side of microwave systems. The second piece is lower frequency but very, very high power. We call that pure carbide. And a year ago we introduced the industry's highest power device, 2.6 kilowatts, And at IMS in June, we'll be demonstrating a four and a half kilowatt device. And those will be targeting radar systems, jammers, EW, anywhere where you want extremely high power. And we will sell products to customers not only at the chip level, but also packaged or multi-chip assemblies, or what we call pallets, where we take our very high power devices and we put other ancillary circuits around it, drivers, isolators, things like that, combiners. So that's the second piece. The third piece would be for telecom and all things wireless, which is primarily massive MIMO. And we'll be demonstrating at IMS also our power amplifier modules. And the industry within 5G has moved from discrete amplifier lineups, drivers, and already output stages now to more combined power amplifier modules. And we are right in the fight on that. And as I talked about, we are gaining traction in design wins for small base stations and macro base stations. And over the next year, we'll start to get design wins on PAMs, the power amplifier modules. And then all of those three segments that I've talked about are GaN on silicon carbide. And then the fourth item is GaN on silicon carbide. We continue to work on this technology, and we continue to work with ST on this technology, and ST continues to make progress. And so when that technology is ready, we will step into the market where it makes the most sense. And we have seen different bands opening up at different power levels, arguably lower power levels, that may get on silicon actually more attractive as a solution than silicon carbide. there may be instances in the next six to 12 months where GAN on silicon is good enough to beat LDMOS and to beat silicon carbide. So that has yet to play out, but those, you know, at a high level, those are the four lanes that we're in for RF power. And so when you ask the question, can that be 10% of our revenue? Well, this year we should be somewhere in the range of 670 to 680, on the top line, and so can we do $67 million of revenue in Gantt? The answer is absolutely. And, in fact, our power business is one of the fastest-growing parts of our portfolio today, albeit from a small base. But the team is doing a great job. We continue to hire. We just hired the dream team of DPD engineers that really know how to get into the weeds on getting amplifiers to work inside of 5G radios and then when it moves to 6G and when you start to see the new frequencies come up at the higher bands, this group is really going to help us out. So we're big believers in RF power. It's in our DNA and we look to win more market share over the next two years.

Steve, thanks for that great detail. I'll ask a follow-on question. It could be long. I don't intend it to be, but one of your prepared comments, you talked about an emerging subsystem capability in IND. Can you talk to that, the strategic and financial implications of that and when we might see that?

Sure, and I think we do recognize that some customers want to hand the problem to us to solve, especially in areas of high power where you need specialized equipment and people that are experienced dealing with it. And so the Navy contract that we talked about would be really an example of moving in that direction. But we will move very carefully. We did recently open up a small design center in Western Mass, which is Massachusetts, which is primarily focused on building up the building blocks necessary to address this market. And these engineers are expert at building multi-chip assemblies, working with Waveguide for the higher frequencies. And so this is something that will just start to emerge over time. There won't be a big pivotal moment. It will be MACOM starting to address more opportunities in the market where we see that it's a perfect fit for our capabilities. What we don't want to go after is business where you can go out to the market, buy products, chips from five or six different semiconductor companies and then put together a solution. We will build modules based on our proprietary technology and semiconductors, not other people's chips. And so that filter eliminates probably 75% of the opportunities. So we will be very selective when we engage on a small subsystem or a module opportunity.

Our next question coming from the lineup, Ruben Roy with West Park Capital. Your line is open.

Thank you. I had a quick follow-up, Jack, on the gross margin discussion, just kind of thinking about the different segments, the product segments and product mix. As you think about, Steve mentioned, products less than three years old starting to contribute more to revenue and higher margins on these new products that you guys are designing. Can you remind us what the margin differentials are, if any, across the three product groups today? And as you think about Q4 and data center, you know, starting to really pick up, are there going to be any margin impacts from, you know, sort of the mixed change over the next, let's call it, you know, four to six quarters? Thank you.

Yeah, thanks, Ruben. Yeah, from an overall gross margin perspective, by each of the end markets, that's not something that we break out We do look at the gross margins, and there is a bell curve across our entire product portfolio where we've got some that are obviously higher than the corporate averages and some that are lower. The same holds true for the new product introductions that Steve had referenced in his prepared remarks. There's going to be a spectrum of different gross margin profiles that those products have. We are looking to obviously focus on the ones with the stronger gross margins to try and focus on how we can do more of that. We also focus on some of the lower performing products, even the ones that we're introducing to make sure we understand why they have margins that may be below our expectations or may not even have the revenue desires that we had going into the development cycles. But NPI and overall gross margin is an area that we focus on across the organization. And, you know, some of those gross margin implications that we have, you know, come into play in terms of some of the production capabilities that we have within our own internal fab and our internal test and assembly facilities. And then there's other implications as well with some of the product that we have externally fabbed and how that might play out from an overall mixed perspective as it relates to our overall gross margins.

Very helpful, thanks. And just a quick follow-up, Steve, I don't think you mentioned PON in your remarks today. I know you had a 25-gig PON demonstration at OFC, and I'm just wondering if you can give us an update on where we are with 10-gig PON and kind of your perspective on when we're going to get to 25-gig and how that might impact your telco business.

Sure. So 10-gig PON volumes continue to ramp, and we see that with some of our product lines. As we've talked about in the past, our goal is to expand content within the platform. So today we have a very strong driver business. We are picking up market share with the photo detectors. We will be introducing lasers to customers. That's an ongoing activity. And so generally speaking, and then the last is burst mode TIAs, which we still have to do a little work on. So Generally speaking, our pond business for 10G is growing. It's an international market. It's not just China. And we are strengthening our position within the market.

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

Thank you, Olivia. In closing, we would like to thank our employees, customers, and suppliers for their continued support. Have a nice day.

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