MACOM Technology Solutions Holdings, Inc.

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

Thank you, Lydia. Good morning and welcome to our call to discuss MACOM's financial results for the third 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 can 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 will 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 fiscal Q3 results. When Jack is finished, I will provide revenue and earnings guidance for fiscal Q4, and then we will be happy to take some questions. Revenue for the third quarter was $172.3 million in adjusted EPS with 73 cents per diluted share. Gross and operating margins increased sequentially in the third quarter, and we continue to generate strong cash flow, ending the quarter with $536 million in cash and short-term investments. Our financial performance reflects ongoing business improvements, along with a growing revenue contribution for new products within our portfolio. The book-to-bill ratio for the third quarter was 1.1 to 1, which was the seventh consecutive quarter above 1. Our backlog remains strong, providing us with good near-term visibility. While we are pleased with the bookings, I'll note that it is normal for our book-to-bill ratio to periodically fluctuate below one. Our turns business was approximately 15% of our total revenue during the quarter, which is in line with the last few quarters. Q3 revenue breakdown by end market was as follows. Industrial and defense was 75.5 million, telecom was 62 million, and data center was 34.8 million. IND revenue was up 12.5% sequentially, while telecom and data center were relatively flat following a strong Q2. These results were mostly in line with our expectations. Industrial and defense remains a key area of opportunity for MACOM. We believe this market has the potential for significant revenue growth over the next few years. Within aerospace and defense applications, We expect growth to be driven by radar modernization programs, electronic warfare applications, unmanned aircraft systems, avionics, secure communication networks, and SATCOM applications. All of these areas are priorities within the broader U.S. defense budget and are critical programs within the various branches of the Department of Defense. As a result, we expect opportunities within this market to remain robust for the foreseeable future. Our telecom and market revenue saw a modest sequential decrease in Q3 following a very strong Q2. Telecom is another broad market for MACOM, and it includes broadband access networks, passive optical fiber networks, wireless networks including 5G, metro long haul optical networks, and broadband satellite communication applications. The primary driving force, forces for growth across all of these applications our higher data rates, and more bandwidth supporting increased computing power closer to the end users. NACOM has a very diverse product portfolio to address the telecom markets, including our monolithic microwave integrated circuits, or MIMIC product line, coherent drivers and TIAs, small signal RF products, RF power amplifiers, high-performance analog ICs, and lasers, to name a few product lines. Finally, our data center and market revenue was relatively flat in Q3 following a strong Q2 performance based on continuing demand for our high performance analog solutions. We are pleased to see modest revenue contributions from our new 25G DFB laser portfolio, and our expectation is for continued slow but steady laser revenue growth and market share gains during the remainder of FY22 and throughout FY23. Customer interest in our recently introduced linear equalizers remains high, and we see growth opportunities in active copper cable applications at both 200G and 400G data rates for high-performance computing systems. I would like to highlight we recently updated our five-year strategic plan. This was the third annual update of our strategic plan, and while we've made great progress executing over the past three years, we are pleased to have further refined and honed our compelling strategy with the goal of creating long-term stockholder value. Our bottoms-up strategic plan includes an in-depth review of all elements of our business and establishes strategic goals and growth objectives through 2026. The foundation of our strategic plan revolves around expanding our served addressable markets, or SAM, by extending existing product lines, introducing new product lines, and raising the bar on semiconductor performance in areas where we choose to compete. Our goal is to provide compelling and differentiated solutions that help solve complex technical challenges for our customers while driving highly profitable growth for Macon. An important element of our strategy is to leverage our existing capabilities and technology portfolio to find adjacent opportunities to expand our markets. Some examples of this over the past couple of years have been our 0.14 micron Ghana silicon carbide process, our pure carbide product line, active copper cable ICs, KV caps, and RF power amplifier pallets. We believe thus far these new products have helped us expand our SAM by about $400 million to $500 million. And I'll note our market share in these product gap categories is negligible today. which provides us with a great opportunity for growth. I'll also note a characteristic of our growth strategy is to target market opportunities that support our financial goal of achieving best-in-class profitability. This requires developing many new and oftentimes niche semiconductor product lines to address these requirements. It might be helpful if I highlight a few recent examples which exemplify MACOM's strategy. First, at this year's International Microwave Symposium, which was held in June, we announced the expansion of our power amplifier product portfolio with the introduction of a 7-kilowatt power amplifier operating in the 960 megahertz to 1.2 gigahertz frequency range. This product is based on Macom's pure carbide, silicon carbide technology, and we believe it represents the highest power level RF amplifier in the industry. This extremely high power level was achieved by combining novel high voltage circuits apologies with advanced packaging materials for improved thermal performance. This product is ideal for high power and high voltage aerospace and defense applications, including radar and electronic warfare systems. Our goal is to establish ourselves as a leader in RF power. Second, we are actively expanding our R&D teams in bringing new engineering design capability to MACOM. We recently opened two design centers, one on the east coast of the U.S. and one in Seoul, Korea. These actions of hiring more experts in analog and digital IC design and adding new microwave subsystem engineering capability supports our future product development plans and initiatives. Hiring best-in-class designers to support organic growth is a strategic priority. And third, we recently introduced a new optical time domain reflectometer, or OTDR, photodetector product line to support customers that utilize fiber connectivity in their defense, industrial, telecom systems, or data center networks. An OTDR test instrument is used to measure a fiber optic cable's optical loss and to identify the location of a fiber cable break or performance problems. Portable OTDR test equipment is used during fiber network installation, and OTDR functionality can be embedded in remote fiber test systems to permanently monitor a live telecom network or an operating system for any changes or failures. We believe the field portable OTDR test equipment market is growing due to the worldwide deployment of PON and 5G optical networks. To be clear, the heart of an OTDR is the indium phosphide-based optical photodetector, and our strategy is to be a leading supplier of OTDR photodetector IC-based products. Here, we have utilized our proprietary internal MBE technology and photodetector IC design expertise to achieve industry-leading results. We plan to sell our OTDR products with pigtailed fiber for an easy turnkey solution, or in a ROSA or chip-on-carrier format, depending on the customer requirements and desired form factor. In recent months, we received two qualifications from leading OTDR equipment manufacturers. The three examples I just discussed show how MACOM is addressing small and medium-sized, high-performance applications with solutions that rely on our internal semiconductor process expertise and or our IC and system design and application expertise. We believe more and more customers are viewing Macom as a strategic supplier of high-performance analog, RF, microwaves, and lightweight semiconductor solutions. And we believe this is directly attributable to the strengthening of our product portfolio. Today, we focus our budgets on R&D, product development, and then engaging customers face-to-face with our regional and technical sales staff, design engineers, and technical leadership. I'll note a key element of our strategy is strengthening and expanding our relationships with Tier 1 and Tier 2 OEMs, and we are making good progress in this area. And to a certain degree, our strong bookings for the past seven quarters is in large part due to the outstanding execution and collaboration between our sales, operations, and business development teams and our customers. Today, we see a growing trend of Tier 1 and Tier 2 customers providing us with their latest requirements for gallium arsenide and GaN mimics, filters, diodes, lasers, and analog and mixed signal ICs. These development projects with our customers across all markets validate that our design capability, products, and new technologies are compelling. Before I turn it over to Jack, I would like to highlight we are cognizant of the uncertainties around the broader global macroeconomic environment. and we do not presume to think our business would be immune from a global recession. Our longstanding posture has been to run the business in a way which enables us to remain both profitable and cash flow positive during all parts of the business cycle. As such, given the heightened economic uncertainty, we have and will continue to manage the business, particularly the capital investments and spending budgets, very carefully. I'll highlight, however, that we have very little consumer market exposure and we believe our defense business is typically decoupled from near-term negative economic trends. Additionally, we believe our business is relatively small compared to the semiconductor industry at large, and growth can be supported by market share gains as we expand and ramp our latest products and technologies. At a higher level, we believe the semiconductor industry growth over the long term is supported by secular growth trends, more specifically the drive towards more bandwidth, faster data speeds, higher frequencies, and higher power levels, whether in radar, electronic warfare, broadband access networks, 5G or the data center, play to MECOM's strengths in RF, microwave, and optical. In many cases, addressing these markets requires advanced semiconductor technologies like GAN, bulk acoustic wave or BAW filters, advanced lasers and detectors, high-speed analog ICs, and high-voltage capacitors. In summary, we believe our position within the industry is improving due to our strengthening portfolio. We have many compelling new process technologies underway, a growing team of world-class IC designers, and unique manufacturing and packaging capabilities. I am confident we will continue to push the boundaries of semiconductor engineering and gain market share. Jack will now provide a more detailed review of our financial results. Thank you, Steve, and good morning, everyone. Financial results for our third fiscal quarter ended July 1, 2022, remained strong, and MACOM's team continues to strongly perform in executing toward our business strategy. Revenue for the fiscal third quarter was $172.3 million, up 4.3% quarter over quarter, and exceeded our guidance range based on strength in the industrial and defense markets. On a geographic basis, revenue from U.S. domestic customers represented approximately 45% of our fiscal Q3 results, with continued diversity across our customer base. Adjusted gross profit was $107.2 million, or 62.2% of revenue, up 50 basis points sequentially. Exceeding 62% gross margin represents another major milestone in improving our profitability. Total adjusted operating expense was $53.1 million, consisting of research and development expense of $34 million and selling general and administrative expense of $19.1 million. As anticipated, total operating expenses were sequentially up by $2.1 million from fiscal Q2 as we continue to expand our R&D team and their capabilities. We continue to carefully manage administrative spending as we support growth-related investments across the business. Adjusted operating income in fiscal Q3 was $54.1 million, up from $50.9 million in fiscal Q2. Adjusted operating margin increased 60 basis points sequentially, crossing the 31% threshold to 31.4% for fiscal Q3. Depreciation expense for fiscal Q3 was $5.9 million, and adjusted EBITDA was $60 million. Trailing 12-month adjusted EBITDA was approximately $224 million as compared to $214 million in our prior fiscal quarter. Adjusted net interest expense for fiscal Q3 was $433,000, down approximately $500,000 from fiscal Q2. primarily driven by higher short-term investment balances and the associated interest income. With increases in interest rates, we anticipate higher net interest expense during our next fiscal quarter ending in September. Our adjusted income tax rate in fiscal Q3 was 3% and resulted in an expense of $1.6 million. Our net cash tax payments were approximately $1.1 million for the third quarter, up $600,000 from fiscal Q2, primarily based on our increases in profitability. We expect our adjusted income tax rate to remain at 3% going forward. Fiscal Q3 adjusted net income was $52.1 million compared to $48.4 million in fiscal Q2. Adjusted earnings per fully diluted share was 73 cents. utilizing a share count of 71.1 million shares, compared to 68 cents of adjusted earnings per share in fiscal Q2. Now, moving on to operational balance sheet and cash flow items. Our Q3 accounts receivable balance was $106.6 million, up from 100.6 million in fiscal Q2, reflecting our 7.1 million increase in revenue over the prior period. As a result, day sales outstanding as of the end of June were 56 days. During the past three quarters, our quarterly revenue has increased by $17 million, which is the primary driver for the fiscal 2022 year-to-date increase in our accounts receivable balance of $22 million. Inventories were $110.2 million at quarter end, up from 93.4 million sequentially. Inventory turns were 2.4 times, down sequentially in Q3 from 2.7 times in the prior quarter. During fiscal year 2022, we have made strategic investments in various inventory items such as manufacturing consumables, substrates, precious metals, as well as critical wafer stocks and finished goods. This strategic increase in inventory is expected to support our growing backlog, which we feel will provide additional stability in the current supply environment. Fiscal Q3 cash flow from operations was approximately $40.4 million, down $2.1 million sequentially, primarily from increases in working capital. Capital expenditures totaled $6.6 million for Fiscal Q3, with additional investments in fab capabilities and R&D equipment. We expect our fiscal year 22 capital expenditures to now be in the range of 25 to 30 million due to the timing of receipt of certain CapEx items. Next, moving on to balance sheet items. Cash, cash equivalents, and short-term investments for the third fiscal quarter were $536.3 million, up 33.3 million sequentially. With our continued cash generation, and 5% increase in trailing 12-month EBITDA, our third quarter gross leverage is 2.7, down from 2.8 in Q2. Our net leverage remains below 1, and our net debt is now $67 million. We recognize that we are still in a net debt position. However, we are pleased that the increases in our cash and short-term investment balances will provide us with new and expanding strategic options for future growth. Finally, I would like to also note that this week we published an updated environmental, social, and governance report, which can be found in the investor relations section of our MACOM website. The report highlights progress we have made in improving our ESG reporting metrics. I will now turn the discussion back over to Steve. Thank you, Jack. MACOM expects revenue in Q4 to be in the range of $175 to $180 million. Adjusted gross margin is expected to be in the range of 61.5 to 63.5%, and adjusted earnings per share is expected to be between 74 and 78 cents based on 71.4 million fully diluted shares. In Q4, when compared to Q3, we expect revenue for industrial and defense and data center to increase by mid-single-digit percentages sequentially and telecom to be relatively flat. 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 financial and take market share in the months and years ahead. I would now like to ask the operator to take any questions.