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spk03: 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.
spk07: 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.
spk09: 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.
spk03: Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, you will need to press star 1-1. In the consideration of time, we ask that you 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. Tom O'Malley with Barclays CLN is open.
spk00: Good morning, and thanks for taking my questions. My first one is just related to the segments. It looks like with your guidance for September, the data center business is declining slightly for the year, but the telecom business is looking a lot stronger than you initially expected. Could you just walk through the puts and takes of what's going on between those? You mentioned some of the data center lasers ramping, but any more color on what you saw a little bit weaker in data center and what you're seeing a little bit stronger in telecom?
spk09: Sure. Good morning, Tom. You're correct in terms of the trends that you outlined. I'll just also note that on a year-over-year basis, all three of our end markets were up. IND was up 6%, data center was up 5%, and telecom almost 30%. And on a relative basis, we think for the full year, You know, two, possibly three of the markets will be up. We think the strongest market on a full year comparison will be our telecom business. Again, about 29% year-over-year growth. Industrial and defense, mid-single digits, around 5% year-over-year growth. And data center right now is trending to low single-digit or flat performance on a year-over-year basis. Given the variety of the products that we're selling, of course, and the diversity of our revenue, there are a lot of puts and takes. I think one thing to highlight inside the data center is that during the course of this year, we've seen significant movement of our 100G TWDM4 business from U.S.-based customers over to Asia-based customers, and that trend is a favorable trend, and it continues. On the telecom side, I would highlight that Tremendous growth from telecom coming from access markets, including 10G pond, and also a lot of strong growth in metro long haul. So I think those are just a few key items that I would probably highlight as it relates to the three markets.
spk00: That's helpful. And then in your preamble, you talked about your lack of consumer exposure and how the defense business is relatively protected from what you think would be a macro downturn. Could you talk about the broad-based industrial business? When you look at that business, do you think that that should track relative to GDP, or do you think there's areas within the industrial business? I think you've broken it out like 60% defense, 40% industrial in the past. But And that 40%, could you just talk about any areas that, you know, may outperform GDP and how you think that market, how you think that segment may perform in a down market? Thank you.
spk09: Sure. So first, I'm not sure if our growth rate will or will not track GDP. So I can't really address that. But I would point towards some of the products that we're introducing for the industrial and defense markets. This past June at the International Microwave Symposium, we went through a whole range of product demonstrations and product announcements. And I think I'll highlight a few of these because they demonstrate the focus of the company. For example, we launched a new SLI switch product line for test instrumentation. We launched our 0.14 Ganon silicon carbide mimic process. This is the process we've been working on now coming up on two years. That is focused on a wide range of SATCOM and industrial and defense applications. We demonstrated a 7-watt KA band mimic there. We also demonstrated a 10-watt E-band amplifier, again, focusing on satellite communications, ground-to-satellite communications, so just some real interesting technology there. We also announced our new BOV filter line. We demonstrated the switch filter bank at LBAND, really targeting the defense industry and some of the next generation switch filter banks that customers are looking for. So a lot of the focus and a lot of the work that we've been doing has really been targeting telecom at large, a lot of the wireless standards that are out there, as well as high performance defense applications. And so when we think about our future growth coming from the defense industry it will be radar based platforms it will be communication based platforms it will be handheld and mobile radio high power radios it will be jammers and uav so this it's a very diverse application set for our defense business on the industrial side we've been making tremendous progress penetrating the medical market we've been doing some next generation functions, both on the discrete diode-based technology as well as on our analog and mixed signal technologies. Over the past year, we've been focusing some of our analog designers more and more on industrial applications. And so that's been doing quite well. And then the last thing I'll add is on the test and measurement industry. This is an industry that needs to support the higher data rate applications. higher speed applications, whether it's in the compute market or the telecom market. And Macon is doing a tremendous amount of chip development for applications like memory testers or high-speed analog testers or even optical testers. And so the industrial market for us is really a target-rich environment, and there's certainly a lot of diversity there.
spk03: Our next question, coming from the lineup, C.J. Muse with Evercore SI. Your line is open.
spk06: Yeah, good morning. Thank you for taking the question. I guess I wanted to focus first on data center. I think your outlook for September is a little bit worse than what you thought three months ago. And when I look at kind of the growth trajectory over the last three years, it's about running at about a 4% CAGR. So we'd love to hear your thoughts as we move into fiscal 23 and beyond. whether we should start to see a reacceleration and growth there, and if so, what are the key drivers that you're pointing to, as well as do you already see some of that business in your extended backlog?
spk09: Yes. Thanks for the question, TJ. So we have definitely – seen revenue numbers that are below what our previous expectations were for the full year. And even as we've looked at the business, we've seen shifts within our business there. I'll just first, before I talk about the moving parts within the market segment, I'll just highlight two things for investors to remember. We did announce about a year ago that there would be about a $15 million decrease in our data center business due to legacy programs falling off. which included platforms like PowerPC and some of our networking products that were legacy AMCC product lines. When you add back that $15 million to our current run rate, you would have over 10% growth. The second thing I would highlight is that this is the one market of the three from ACOM that has been more challenged with supply constraint issues. Those challenges have been opening up we saw some nice growth in q3 and also we're seeing good performance in q4 so that's improving in terms of looking forward and where we think the growth will come from going you know looking into fiscal 23 certainly our 400g pam 4 business will be strengthening we like the fact that there's more and more work at 800g and so again we will address these markets with multi-channel TIAs and drivers for very high-speed applications. We also see tremendous opportunities with coherent light. And so as our customers are looking to extend the high-speed reach, you know, they do see limitations with PAM-4, so there is sort of a bit of a migration over to an NRZ and a coherent application. And then the last thing I'll add is there's some product lines that are just beginning to blossom within the data center market. That would be our linear drivers, which are going to put a lot of pressure on DSPs for short reach applications, and our lasers. This year, we have been very, very active with design wins, not only for telecom markets, meaning PON and 5G applications, markets, but also the data center. What we were surprised to see this year is many of the module manufacturers, the pluggable module manufacturers, were interested in bringing our lasers into the data center. And then, as we think about the long-term growth and some of the new technologies we'll bring to the data center, I think I announced on the last call that we had actually some early successes with our new EML laser technologies. And this is the price points and the market for EML lasers is very strong. And we're very excited to start to introduce that technology in the back half of 23 and as we enter 24. So I do think there's tremendous opportunities there within the data center. I will highlight we are absolutely staying in our lane and playing to our strengths. We have, you know, we are not interested in developing DSP chips, for example. We're very focused on providing customers analog chips that are high-speed components that help them solve various problems and potentially be an alternative to DSPs. And I'll maybe add one other point. We've also noticed as more and more of our customers are working on co-packaged optics, we're actually finding lots of interesting opportunities on the analog and on the optical side, including our photo detectors, and our laser arrays. We've been demonstrating single-chip eight laser devices, which are getting a lot of interest in the market. And we're also increasing the power levels of our CW laser products. So there's just a lot of interesting things going on. So we are quite bullish on the long-term prospects for the data center.
spk06: Very thoughtful and thorough answer. Thank you. As my follow-up, Just a quick modeling question. How should we be thinking about OPEX beyond the September quarter? And you talked about interest expense ticking higher. How should we model that into September and beyond? Yeah, good morning, CJ.
spk09: This is Jack. So, you know, as we've discussed in the past and as you may have seen here in our June quarter, you know, there was a bit of an uptick in our operating expenses as we continue to invest primarily in R&D. activities across the organization. So, you know, depending on growth from a revenue perspective, as we work our way out into the future, you'll see a bit of an uptick in our sequential operating expenses on a go forward basis. And then from an overall interest point of view, obviously interest rates are on the rise. And what we're seeing here going into the fourth fiscal quarter or September quarter, that will include basically the full quarter impact of the rate adjustment we had seen back a month or so ago. And then obviously we'll have some of the impacts from the rate increase that was announced yesterday. So that will drive some of the interest rates up from an expense point of view. Some of that will be mitigated as we go forward, depending on short-term investment returns.
spk03: Our next question coming from the line of Quinn Bolton with Neham. Your line is open.
spk10: Hey, guys. Congratulations on the nice results. Steve, you mentioned sort of acknowledging the more challenging economic conditions. I'm wondering, are you starting to see any changes um in your customers order patterns are weekly orders becoming more variable on a week-to-week basis are you seeing any push outs or adjustments to delivery schedules any cancellations anything like that yet uh thanks for the question and so uh this is something we've been very focused on and trying to look for let's say early trends of possible future softness uh and
spk09: At the end of the day, we're not seeing that. We're actually seeing continued strong bookings across all of the different end markets. So that's the good news. And as I think we mentioned in the early remarks, this was our seventh consecutive quarter of having a greater than one book to bill. I'll just also note, one thing we have seen improvements on are some of the availability and lead times for our third-party foundries. We're seeing some of the process nodes that we use come down in lead time, and we think that would suggest that there's capacity opening up, and we actually think this is a good thing. It will allow us to bring some of our manufacturing cycle times down. So I would say that's the only noteworthy item. Some of our third-party large silicon fabs are quoting slightly shorter lead times, and we see that as a benefit. But in terms of the day-to-day business and the bookings, I can say that we're not seeing any indications, and we're keenly sensitive to the daily booking trends, and we do keep a close eye on it.
spk10: Perfect. Thank you for that, Collier. Wanted to also know, just ask on the laser opportunity, you've got lasers for PON, lasers for 5G backhaul, and now starting to merge into the data center. Can you give us just of those three opportunities, maybe relative size or rank order, was one significantly larger than the others, or how do you sort of see those three opportunities for lasers ramping over the next couple of years?
spk09: You know, it's an interesting part of our portfolio. And the thing about our lasers, as you highlighted, we are actually focusing on three different markets. And now sort of more as LiDAR is starting to emerge, we are seeing requirements for very high-powered lasers. But, of course, you've got the data center, you've got access, and then you have telecoms. In terms of our portfolio, as you know, we have the Fabry-Perot lasers, which are good for the short distances. We have the DFBs, which are for longer distances, and now we're working on EMLs, which are for the very long distance applications. Macon does not today produce Vixels, and that is a large part of the market. I can tell you from a customer-based point of view, we have approximately 20 to 25 customers that we are engaged on that are qualifying various types of lasers depending on the application. We're seeing qualifications with LR4. We're seeing qualifications in Korea for WDM12 for 5G. We're seeing CWDM6 for 5G, and certainly 5G for BiDi and also 5G. different data rates applications for 5G, actually higher data rates for mid-haul. So my point being is we have a lot of qualifications going on. We have very few customers today that are actually in production. We see many customers beginning to ramp. If I were to pick one market, which is the largest market of the three, I would say the pond market is actually a very interesting market. You know, at 2.5 G-PON, the annual laser consumption was about 80 million lasers at its peak. And we're going through a period today where Macon is one of the largest producers of 2.5 G-PON lasers for the market. And over the next two to three years, there's going to be a shift from 2.5 to 10 G. And this is actually being driven not only by the China market, but also the global expansion of passive optical networks for fiber to the home. And so we plan on being a major participant in that market. I can tell you today our 10 GPON laser revenue is almost zero. We're only in qualification phases. We think that market will turn on sometime in 23. So I haven't sort of directly answered your question about which is the largest. I think there's tremendous opportunities within each of the segments. As some of the markets adopt silicon photonics, or co-packaged optics. They're going to want high-power CW lasers or they're going to want laser arrays. And we are actively engaged with customers in both those applications. And then the last thing I'll add about our laser portfolio is we expect the profitability of this product line to be accretive to our margins. We have an advantage of being on four-inch indium phosphide. Our edge faceted technology allows us to do on-wafer testing. So we believe we have a cost advantage when we go into high-volume markets.
spk03: Our next question, coming from the lineup, Tori Sandberg with Stifel. Your line is open.
spk13: Yes, thank you, and congratulations on the record operating margin. Steve, when you talked about PAM-4, you said you're happy to see 800-gig activity I was just wondering, does that mean some customers will be skipping 400, meaning going straight from 2 to 8? Or is this more of a timing thing where, you know, the market is actually already starting to do some 800 gig designs?
spk09: I think it's very early, Tori, for 800. And we are engaging customers with not only 800 but 1.6. So we're addressing... the highest speeds, and customers are coming to us for analog solutions. And so that's the point I wanted to make there. So I don't believe customers will be skipping 400G. In fact, 400G is becoming or is the majority of our revenue today within the data center, and that's across a wide range of sub-segments. So we actually divide internally our data center revenue into about nine different categories, depending on the distance, the length, and the speed. And when we look at our 400G platforms, whether it's short reach, DR4, FR4, or active copper cables even, in all cases, we see the 400G revenue growing. So we do have a very strong position from our product set point of view to address the markets. So I think that, no, I'm not suggesting that there are customers that are skipping the 400G.
spk13: Very good. Thanks for clarifying that. My follow-up, either for you or for Jack, they come at a striking distance now from no longer being in a net debt position. And I was just wondering, thanks for clarifying that, My follow-up, either for you or for Jack, they come at a striking distance now from no longer being in a net debt position. And I was just wondering, once we get to that level, which will be very soon, will the company's capital management plans change?
spk09: Yes, Tori, this is Jack, and good morning. So, yes, Tori, this is Jack, and good morning. So, yes, as we look at our cash position and our net debt position, as you highlighted and as I had indicated on the prepared remarks, you know, we do view ourselves as still being in a net debt position. You know, we'll have to see how things go as we move forward. We continue to make investments, you know, internally throughout the organization. And we believe our cash balance and where we sit today is a strategic asset that provides us with a number of different options as we go forward. So, Steve, I don't know if you've got any other thoughts. Yeah, I think that's exactly right, Jack. And I'll just add that we do recognize that a growing cash position is a strategic advantage. And as that cash position grows, it will – allow us to have more options as we look forward. And given the fact that we are either in or maybe soon to be in a recession, having a large cash position also allows us to sleep well at night.
spk13: Excellent. Thank you.
spk03: One more for our next question. Now, the next question coming from the line of David Williams with Benchmark Galen is open.
spk05: Good morning, David. Are you there? Please check your mute button.
spk02: Okay. One moment for our next question. And our next question coming from the line of Matt Ramsey with Cowan.
spk03: Your line is open.
spk08: Yeah, hi, guys. This is Ethan Potasnik on for Matt. Congrats on the great results and guide here. I was wondering if you guys could discuss on gross margins. Things are still progressing really incredibly. I was wondering if you could dive into, you know, where do you see levels From here, is the strength sort of being driven by timing or product mix? Wondering if you guys could explore that dynamic.
spk09: Sure, Ethan, and good morning. This is Jack Cober. So as we look at our gross margins, we have been pleased with the progress that we've made over the past couple of years in terms of those improvements. And as we've also discussed, we have a – continuous improvement culture here at MakeCom, so we're constantly striving to make improvements across the organization. There's been a number of different things that we've done in terms of reducing scrap and waste and trying to improve yields across many, if not all, of our different product lines that we have, both internally manufactured products as well as things that we go to the outside folks on. So we keep picking away at this and making those improvements. continually say we'd like to see incremental improvements over time. But we know, you know, things don't always occur in a straight line. And as our gross margins get up to this higher than 62% range, you know, we understand that it can be a little bit more challenging as we go forward. So, you know, as we look out over the longer term, you know, slow and steady sequential improvement is our goal, but it's not always going to be heading in that consistent direction. One of the other things to think about as well in some of the new product introductions that we have. And that's a core element of our strategy is to introduce more products and at higher gross margins that specify to some of our customer needs. So as we feather in some of those new products looking out over the longer term, we hope that will also be additive to our gross margins.
spk08: Understood. And then I was pretty intrigued by – Some of the commentary on the script on the OTDR product line, you know, given some of the recent qualifications as deployments of, you know, PON and 5G optical networks continue. I was wondering, any insight into time to revenue there?
spk09: Yes. So, we just introduced the products recently. We actually had to go through about three different iterations of the photo detector to meet customer requirements. Qualifications, as I highlighted in my script, are starting now. And we should expect a slow ramp, like all of our different product lines, over the course of the next 12 months. And so we would expect, you know, contribution in the near term and ramping up over time. I'll just also note there that there are multiple markets that would use this type of functionality, including Pond, like you mentioned, but also metro long haul. There's also various military applications, whether it's underwater cables or systems that are in active platforms that need to monitor electronics. So it's a fundamental feature that's necessary in a lot of different optical fiber applications. And MACOM wants to be a leader in this area. We have some outstanding packaging technology. We have dialed in the performance of these detectors. They have to be very fast speed. That way you can identify if there's an issue on a fiber that's close to a break or a bend in the cable of the fiber that is near itself. You need to have effectively a fast switching photo detector to identify the distances between these type of events. Also, I'll just highlight a niche market. This is not a Multi hundred million dollar market, you know, we from our point of view we think this hand is somewhere between 20 and 40 million dollars So over the next few years if we can win a reasonable portion of that market I think we'll be doing well and and just as Jack highlighted and it was your question about gross profit margins I think this is a perfect example of going into a niche market with a customized product and becoming a dominant supplier and and the product line will meet MACOM's goals of increasing gross margins over time.
spk03: Our next question coming from the line of Mark Lipicis with Jefferies. Your line is open.
spk01: Hi. Thanks for taking my question. Steve, I had a question on the defense commentary you made. I think you've always talked about it as a growth factor for MACOM. Maybe I'm reading too much, but it seemed like you highlighted it in particular this quarter. So I'm wondering, is there particularly good visibility or improving visibility in that sector now? And maybe as part of that, if you could just step back since you have decades of experience in the defense market. Do events like the Ukraine war, just this storm, do they typically lead to increased demand or visibility for component suppliers like Mekong? Thank you.
spk09: Thank you. So we are very pleased with the performance of our defense business across a lot of different applications. Historically, Macom was known to be a supplier of discrete diodes, and in some instances, mimics, which were mostly for RF and microwave applications. And what we've been doing over the past three years is really branching out and introducing all the different technologies to our defense customers and absolutely getting well received. So We're very excited about it. As I highlighted in my script, we're also bringing a new design capability to allow us not only to provide components, but also modules and multi-chip assemblies or subsystems. I think about six months ago, we highlighted a 45 kilowatt contract, a multimillion dollar contract from the Navy. We expect more of these type of activities over the next few years. winning and getting involved in very large programs. And this is something that NACOM was not doing four or five years ago. The other thing I'll highlight since you talked about sort of general trends is I think it's warranted to bring up the CHIPS Act, which as everybody knows, the Senate passed this week, and it looks like it should be signed into law sort of imminently. And that provides about $53 billion to the semiconductor industry. And CHIP stands for Creating Helpful Initiatives to Produce Sunny Conductors, and that's exactly what we do. And we are really an ideal candidate to win funding. And the funding will flow through, in many cases, DOD agencies or sponsors. And so as we've been for the last few years reestablishing and building new relationships with the major agencies, that will help us as these CHIP dollars start to flow because we're going to be looking to not only build out and improve and expand manufacturing but they're also going to be providing about 13 billion dollars for semiconductor r d and we want to be a major beneficiary of those funds and so we're very focused on defense we have outstanding technology across many different technology areas whether it's rf optical high speed analog or rf power and so We're certainly very excited about the market. We've been able over the past three years to take the market that had been stagnant and running in about $40 million a quarter. And now we're approaching $80 million a quarter. And so that is certainly due to just market share gains and going after new programs. I wouldn't specifically relate any of this to any particular skirmishes like the Ukraine that you mentioned. Certainly the world is not a safer place today, and so as the challenges emerge for the U.S., that generally drives electronics to higher frequencies and higher power and higher data rates, and these trends play to our strengths. So the fact that we are moving ourselves to the edge of performance should drive our DOD business.
spk01: Very helpful. Thank you.
spk02: Thank you. One moment for our next question.
spk03: Now our next question coming from the line of Harlan Surwood, JP Morgan.
spk12: Good morning. Thanks for taking my question. So as a follow-up to that, Steve, so several of your FABs are AS9100D. They're aerospace qualified. I think your Lowell facility has ITAR sort of trusted FAB status by the Department of Defense. You've also got a number of standard products and custom programs for defense initiatives as you outlined in your preparatory remarks. So as you just mentioned, I mean, you guys are clearly an important partner to the U.S. defense and aerospace industry. And as you combine this with the high probability of the passing of the CHIPS Act bill, it does seem very likely that you guys are going to get access to the associated subsidies. So I know that proposals were requested by the Department of Commerce a few months back. So can you guys just give us a sense sort of base case, how much is the team requesting in subsidies? CapEx right now is about 4% to 5% of your revenue, so any subsidies will be a good boost to your free cash flows.
spk09: Yeah, I just think it's probably a bit too early to get to that level of detail or for us to share that level of detail. It is still certainly early in the process, and I think instead I can just highlight that As we think about how we can help and where we would want to drive funding, it would be certainly towards supporting our manufacturing facilities. But it's also equally we're interested in working with different agencies to develop technologies for new programs. And so it's that semiconductor R&D piece, which can come in a lot of different forms. It can come in the form of process development, circuit design or package technologies. And so, you know, we want to make sure that we use this vehicle to help in many ways subsidize our advanced R&D. So I think you're right in your comments about us being AF9100. We have a trusted boundary facility and we have a growing capability in this area. And so it's just too early for us to talk about specifics. until we have a better understanding of how the dollars will flow.
spk12: And maybe a good example of the, you know, access to R&D dollars, I mean, I think a good example of that, right, is your 0.14 micro-organa and silicon mimic process that was transferred from the Air Force Research Lab. You also characterized this technology as one of the key emerging growth drivers for the team. Is the manufacturing process fully qualified? I know it's running in your law facility. Is the manufacturing process fully qualified? And given that this was a technology that was transferred from AFRL, are you guys limited to just doing custom and standard products purely for defense-related initiatives? Are you guys allowed to use this process for non-defense-related standard and custom products and maybe even also offer the process to non-defense-related boundary customers?
spk09: Yes. Uh, a great series of questions. I'll try to answer all of them. Uh, so just to highlight the, uh, 0.1, four Gannon's looking carbide process that we transferred, uh, from the air force, uh, was paid for by makeup. We used make home R and D dollars. There was no government subsidies or funding for that. Um, and that was a commitment we made to the air force because we felt it was strategic in nature. We wanted to build relationships. We wanted to begin a working relationship. And that has been an absolute success. And this is a transfer of technology that's royalty free. We're not paying the Air Force and there's no royalties associated with it. The second thing I'll highlight, we are not constrained by how we use the process. We can sell it into the commercial markets. In fact, that's exactly what the Air Force wants. They want to see the process go to volume production. And it can also be used, of course, for DOD applications. You generally start to get into limitations when you start to do particular circuit designs, which could create limitations on applications. In terms of the qualification status, so the process is not yet qualified. We expect to be qualified by year end or early Q1 of 23. However, what we have qualified is our PDK, which is the design tools necessary to start making chips. And so our designers and our business development staff are off collecting requirements and designing devices because effectively the process is frozen. And so that's the status. We've been doing demonstrations. We've been engaging customers. We've been sharing all our data. And I want to highlight that this technology is really a launching point for future technologies. And as the chip dollars start to flow, we want to use some of those future dollars to go to shorter gate lengths and create, you know, new capabilities within high-frequency GAN. And so it's really just step one in a long-term program. And we know there's U.S. competitors, two major competitors, that are producing hundreds of millions of dollars of revenue within this technology set. And today, we have zero revenue. And so, our goal is to very clearly step into the market, win market share, and drive growth.
spk02: Thank you. One moment for our next question.
spk03: Now, our next question coming from the line of Richard Shannon with Craig Hellamy. Line is open.
spk11: Hi, guys. Thanks for taking my question. I just had one, and it kind of covered a few of the comments you just made here in the last couple of minutes, Steve, here. But I'll take a phrase you used earlier in the call here about staying in your lane. I think in reference to, you know, not going after DSPs, which I think most people would make sense. And you've also talked about a lot of the opportunities that you have in new markets are being kind of niche-y. But it seems like with the potential from the CHIPS Act that this might allow you to go after, you know, a little bit bigger bigger markets here. And you just described, um, I may have missed some of the detail here about, uh, you know, markets where the revenues are well under the hundreds of millions of dollars. So I guess my question to you, Steve, to maybe expand on just your, your last answer here is that, uh, could staying in your lane allow you to, or allow you to go after much bigger markets in the past, especially with the chip tech money. Um, and maybe just expand on the last answer and I'll, I'll leave it at that. Thanks Steve.
spk09: Yeah, I do think that, uh, Well, first of all, we have a long-term strategic plan, as we talked about, and that plan is a self-funded plan. We are not betting our future strategy on winning dollars from the CHIPS Act. For us, this is an accelerator. It will allow us to do things faster, and it will provide financial benefit and cash flow benefits, of course, and it helps solidify long-term relationships with major banks. agencies and customers. And so to the extent that we are successful winning funding, it will be an accelerator. And it, you know, we don't typically talk about our future plans or when we do decide to jump lanes, what lane we'll jump into, that will come later. But there is potential certainly for us to continuously expand our SAM. And that is a key part of our growth strategy today. we estimate our stance would be about $5 billion, and we want to push that to about $8 or $9 billion over the next few years. And by only spending $130 or $140 million a year on R&D, you can only do so much. And so we have a very methodical and measured approach to stepping into markets we know we can be successful in. And again, I'll just highlight that the CHIPS Act would only be an accelerator. but it won't change our fundamental strategy. Okay.
spk11: I appreciate those comments, Steve. That's all for me. Thank you.
spk03: Thank you. And I will now turn the call back over to Mr. Steve Daly for any closing remarks.
spk09: Yes, thank you. In closing, we'd like to thank our employees, our customers, and our suppliers for their continued support. Have a nice day.
spk03: Ladies and gentlemen, that's our conference for today. Thank you for your participation. You may now disconnect.
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