MACOM Technology Solutions Holdings, Inc.

Welcome to MACOM's second fiscal quarter 2023 conference call. This call is being recorded today, Thursday, May 4th, 2023. At this time, all participants are on the listen-only mode. I will now send the call to Mr. Steve Ferranti, MACOM's Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.

Thank you, Olivia. Good morning, and welcome to our call to discuss MACOM's financial results for the second fiscal quarter of 2023. 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 discussions 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. And with that, I'll turn over the call to Steve Daly, President and CEO of MACOM.

Thank you, and good morning. I will begin today's call with a general update. After that, Jack Kober, our Chief Financial Officer, will provide a more in-depth review of our results for the second quarter of fiscal 2023. When Jack is finished, I will provide revenue and earnings guidance for our third fiscal quarter, and then we will be happy to take some questions. Revenue for our second quarter of fiscal 2023 was $169.4 million in adjusted EPS with 79 cents per diluted share. Cash flow from operations was approximately $33 million and we ended the quarter with $577 million in cash in short-term investments on our balance sheet. Overall, our team did an excellent job on execution to meet our business and financial targets. Our book-to-bill ratio for Q2 was 0.5, which was well below our expectations, and our turns business, or revenue booked and shipped within the quarter, was approximately 9% of our total revenue. also lower than expected. Despite the weak Q2 bookings, our backlog remains strong as seven of the nine past quarters have had greater than one book-to-bill ratios and our book-to-bill ratio for the full year FY22 was 1.1. Given the extraordinarily weak Q2 bookings, I thought it would be helpful to discuss the current order trends and address a series of important questions. First, Were we surprised with the weak Q2 bookings? As discussed on our last earnings call, we had anticipated that bookings would be weak in Q2. However, our actual bookings were approximately $40 million below our internal forecast. So, while we expected some softness, we did not expect the magnitude of weakness in the number of cancellations that occurred during the quarter. What caused the weak bookings? We believe a combination of excess customer and channel inventory, as well as pockets of short-term and demand weakness. What markets have the most inventory? We believe our data center, networking, and 5G infrastructure customers and the associated sales channels continue to have high levels of inventory. Additionally, some of our cable broadband customers have significant levels of inventory, and they will not be ordering more products for at least a couple of quarters. Most of these customers placed large orders in FY21 or FY22 to lock in capacity and to minimize the risk of supply chain interruption. As supply constraints have been resolved, many of these customers find themselves with excess inventory and therefore are delaying new orders or asking to push out or cancel certain backlog. Are any of our target end markets slowing down? We believe there is end demand slowdown in certain parts of the data center and telecommunication markets. For example, our customers that manufacture optical transceivers for the US-based cloud ISPs are telling us they expect to receive new volume production orders, but only at 60 to 70% of the prior year's levels. We also believe the China pond market demand is currently weak compared to last year. somewhat offset by moderate support for XGS PON for the U.S. and European markets. We do not see any slowdowns in defense opportunities or end demand. Are there any notable MACOM specific issues causing the weak bookings? With the exception of the timing of DoD orders, we believe the weakness is excess inventory and or short-term end demand related. Is MACOM losing market share? We do not believe we have lost market share or have lost any major customers or programs. Most of our design wins are sole source sockets based on our product's performance. Additionally, our design inactivity is strong and the interest in our newest products very high. Given the weakness in Q2 bookings, what is our outlook for Q3 and Q4? We have identified which major programs and associated orders are delayed, reduced in scale, or canceled. We believe it will take time for customer and channel inventory to return to normal levels. Therefore, we expect bookings to remain relatively weak in the next one or two quarters. That said, we do expect booking trends will begin to improve in Q3. Where is end demand strong for MACOM? Defense, medical, avionics, satellite communications, and high-performance compute remain strong. Further, we are confident that our growth potential continues to improve. We have been expanding our SAM and our latest products are compelling. The near-term weakness should not be confused with the long-term secular growth potential in our three core end markets. In summary, the Q2 bookings do not reflect the strength and the depth of MACOM's portfolio and our long-term growth potential. I hope this extra detail on bookings helps investors understand the current market environment. Turning to our end markets for fiscal Q2, industrial and defense revenue was $77.2 million, flat sequentially. Telecom was $53.9 million, down 12.3% sequentially, and data center was $38.3 million, down 7.6% sequentially. I'll note that both IND and data center revenues are up year over year, and telecom is down year over year. Within telecom, North America, China, and Korea have led in 5G deployments thus far. As the number of 5G subscribers increases, additional network densification and capacity expansion will be required to support the associated increase in traffic. Based on these factors, we do believe 5G will remain a growth opportunity over the next few years, and we will continue to invest in penetrating this market. Additionally, within our telecom market, fiber-based broadband access networks continue to increase globally, displacing copper and coax-based networks. Fiber-to-the-home deployments create a very large high-volume market with the total unit shipments of 2.5G and 10G PON approaching 100 million units annually, representing a sizable opportunity for MACOM over the next few years. Satellite-based broadband networks are seeing a resurgence as a viable alternative or supplement to terrestrial-based systems. Low Earth Orbit, or LEO, satellites configured with mesh network architectures are making global broadband coverage a reality. Constellations announced by SpaceX, OneWeb, Amazon, Kuiper, and Telesat will drive demand for thousands of new LEO satellites over the next few years. To support these systems, new ground station infrastructure is being built, along with the associated backhaul fiber networks. All of these RF and microwave platforms play directly to MACOM's strengths. Turning to the data center, we see new trends emerging fueled by growing bandwidth demand. Today, hyperscale operators are in the early stages of 400G and 800G deployments, and 1.6T is following closely behind. The technical challenges for high-speed mixed signal ICs and systems designed associated with these higher speed nodes grows more complex with each successive generation. This has a number of positive implications for our business. Artificial intelligence and machine learning are just beginning to be deployed, which will drive the next wave of growth within the data center. Finally, we see the defense market as a growth opportunity for MACOM in so many areas. Radar, communication systems, and electronic warfare requirements across space, airborne, ship-borne, and ground-based platforms can drive significant growth for our type of semiconductor products. In summary, our target markets contain significant growth drivers, and we believe our differentiated technology will provide MACOM a competitive advantage to capture market share. I'd like to review some major accomplishments across the business during Q2. As previously announced, we released to production our 0.14 GaN on silicon carbide semiconductor process. Today, we have approximately 20 new MIMIC designs being processed in the FAB. Initially, the target applications will be high-volume ship-borne and airborne radar programs and various SATCOM and telecommunication systems. On a related note, our FAB equipment team has recently completed the installation of a new backside via etch tool and an atomic layer deposition or ALD tool to support this and other next generation GAN processes. During the quarter, we made our first production shipments from our new bulk acoustic wave or BAW filter product line. Our BAW growth strategy is to focus on high performance applications in industrial, telecommunications, and defense applications. In March, our technical team successfully demonstrated performance of a newly designed high power transmitter subarray panel this was an important contract milestone and we will now begin work on the full array we expect this program will lead to similar opportunities in the next 12 to 24 months notably this transmitter is designed with almost 100 make on rf content a few trends in the data center market include we are seeing Demand declined for NRZ products as new systems are moving more and more to PAM4. Current product demand for 100G AOCs as well as 100G CWDM4 in LR4 is weak. We expect this to continue for one or two more quarters. We are seeing strengthening production demand and growth in 100G DR1, 400G, and 800G. Most of this demand is supporting AI and high-performance compute applications. During the past few months, we have secured numerous design wins for laser drivers and TIAs for 400ZR and ZR Lite to support coherent systems for data center campus applications. And a few notable items on the RF power products. We have been selected by a Tier 1 defense prime to support an L-band radar program with a custom-designed amplifier sub-assembly. We expect this large program will begin to ramp production within the next six months. We expanded our pure carbide portfolio to include products specifically designed for industrial RF power cooking and heating applications. And ST Microelectronics delivered FET devices from its newly qualified GaN on silicon process. This material will enable us to design our next-generation GaN on silicon amplifier products to support low-power and lower-cost RF amplifier applications. And during Q2, we received numerous initial orders that have significant long-term revenue potential, including an IC design contract to support a long-range automotive FMCW LiDAR application, a pilot order from a Tier 1 base station OEM for a new 5G massive MIMO front-end module, and initial diode orders from both Japanese and German customers to support their new tactical radio production programs. In March, we attended the Optical Fiber Conference, or OFC, where we highlighted our newest products and hosted eight live product demonstrations at our booth. One demonstration which gained a lot of attention was our linear drive products that support single-mode and multi-mode PAM-4 architectures at 800G. The linear drive architecture enables power savings compared to re-timed solutions and a significant cost reduction due to the elimination of the DSP chip from the optical module. Our demonstration showcased 800G link performance and interoperability with Broadcom's Tomahawk 5 switch using OSFP modules designed by Eoptolink, Hisense, and Cloudlight. The demonstrations confirmed post-FEC error-free operation with multiple orders of magnitude margin over the standards requirements. Additionally, we demonstrated NVIDIA's 800G modules, which we believe will be ideal for applications like artificial intelligence, machine learning, and high-performance computing. The linear drive architecture is protocol independent and can support InfiniBand, Ethernet, as well as other low-latency interconnects. We believe our first-to-market linear drive products and associated intellectual property position us for growth as this new architecture is adopted. Before I turn the discussion over to Jack, I would like to review two recent acquisitions. In early March, we completed the acquisition of Linearizer Communications Group, a private company located in Hamilton, New Jersey. Linearizer is expert in microwave predistortion linearization, microwave electronics for satellite payloads, and microwave photonic subsystems, or RF over fiber, for defense applications. Linearizer designs and manufactures custom products for space, SATCOM, and defense customers. Their customers are primarily U.S.-based, and the revenues will be reported as part of our industrial and defense and telecommunication market segments. I'm excited to welcome the entire Linearizer team to MACOM. Linearizer is a well-run, profitable business with great management, great employees, great technology and customers, and a 31-year track record of success. By combining our proprietary semiconductor technology with their component and subsystem design expertise, we can create even more differentiated solutions for our combined customers and further penetrate the relevant markets. Together, we make a powerful combination. And in January, we announced a definitive agreement to acquire the assets of OMIC, a semiconductor manufacturer located outside of Paris, France. The transaction has a few more hurdles to clear, and currently, we expect to close in our fiscal third quarter. This acquisition of key manufacturing capabilities and technologies will expand our millimeter wave frequency gas and GAN portfolio, increase our wafer manufacturing capacity with an operational 3-inch and idle 6-inch production line, add epitaxial growth expertise, bolster our European presence, and strengthen our MIMIC semiconductor process and IC design teams. This acquisition supports our strategic goal to establish a leadership position in very high frequency semiconductor mimic processes and products. Jack will now provide a more detailed review of our financial results.

Thanks, Steve, and good morning, everyone. Our results for the second quarter of fiscal 2023 were in line with our guidance for the period. Revenue for the second quarter was $169.4 million, down 6% quarter over quarter. The sequential decrease was driven mostly by the telecom end market, as well as a decrease in the data center market. On a geographic basis, sales to domestic customers represented approximately 49% of revenue, flat sequentially. Sales to China-based customers represented approximately 20%, down from 23% in our fiscal first quarter. Sales to Europe-based customers over the past four quarters approximate 7% of our revenue, and we are focused on growing sales in this region. Adjusted gross profit was $105.2 million or 62.1% of revenue, down 50 basis points sequentially. Total adjusted operating expense was $48.6 million, consisting of R&D expense of $31.3 million and SG&A expense of $17.3 million. Total operating expenses, as anticipated, were sequentially down by $5.3 million due to lower variable compensation, professional fees, and discretionary spend. Adjusted operating income in fiscal Q2 was $56.6 million, down from $58.8 million in fiscal Q1. Adjusted operating margin was 33.4% for fiscal Q2, sequentially up from 32.7% in Q1. Our higher adjusted operating margin compared to fiscal Q1 demonstrates the flexibility in our operating model as we continue to manage internal investments to changes in business cycles. Depreciation expense for fiscal Q2 was $5.8 million, and adjusted EBITDA was $62.3 million. Trailing 12 months adjusted EBITDA was $250.3 million compared to $244.7 million in Q1 fiscal 2023. Adjusted net interest income for fiscal Q2 was $2 million, up roughly $1 million from fiscal Q1 on higher investment portfolio returns. Our adjusted non-GAAP income tax rate in fiscal Q2 remained at 3% and resulted in an expense of approximately $1.8 million. Our cash tax payments were $1.4 million, up from $300,000 in the first quarter of fiscal 2023. We expect our adjusted income tax rate to remain at 3% for the remainder of fiscal year 2023 and into fiscal year 2024. Fiscal Q2 adjusted net income was $56.7 million compared to $58 million in fiscal Q1. Adjusted earnings per fully diluted share was $0.79, utilizing a share count of 71.4 million shares compared to $0.81 of adjusted earnings per share in fiscal Q1. Now, moving on to balance sheet and cash flow items. Our accounts receivable balance was $121.8 million, up from $112 million in fiscal Q1. As a result, day sales outstanding were 65 days compared to 57 days in the prior quarter. The increase in accounts receivable is primarily due to shipment linearity, with the majority of our shipments occurring later in the quarter, as well as AR from the linearizer acquisition. Inventories were $131.9 million at quarter end, up by $10.5 million sequentially, primarily due to additional inventory in connection with the linearizer acquisition. Inventory turns were two times in Q2, down slightly on a sequential basis from 2.2 times in the prior quarter. We feel the quality of our inventory remains strong, and despite lower customer orders and shortening lead times, We do expect to reduce our net inventory balance as we progress through fiscal year 2023 and into fiscal year 2024. Fiscal Q2 cash flow from operations was approximately $32.5 million as compared to $38.3 million in fiscal Q1. The decrease is mostly a result of the timing of accounts receivable and accounts payable payments during the quarter. Cash generation continues to be an important priority for us as we manage through changing business cycles. Capital expenditures total $6 million for fiscal Q2, down from $9.6 million in the prior quarter. Our full fiscal year 2023 CapEx is now estimated to be $35 million. We are carefully balancing capital spending with the profitability and cash generation of the business and maintain our plan to make critical investments in FAB capability and processes during fiscal 2023. Next, moving on to other balance sheet items. During the second fiscal quarter, we utilized approximately $51 million of available cash to close the linearizer acquisition. As a result, cash, cash equivalents, and short-term investments for the second fiscal quarter were $577.3 million, down from $594.7 million in fiscal Q1 2023. Our second quarter gross leverage remains less than 2.5 times and our net debt is less than $50 million. Before turning the discussion back to Steve, I would like to note a few additional items. First, we are pleased to have closed the Linearizer acquisition in March, and we are working to integrate the team with MACOM. We expect that Linearizer will not have a significant short-term impact on our revenue and will be modestly accretive to our bottom line. Over the long term, when combined with Macom's brand and infrastructure, we believe the business will offer long-term growth opportunities. We are excited to welcome the Linearizer team to Macom. Second, we continue to work toward the closing of OMIC with its differentiated technology and dedicated workforce. As previously discussed, in the short term and following the closing of the transaction, we do not expect that OMIC will have a meaningful impact on our revenue and that it will be slightly dilutive to our EPS. However, over the long term, as we invest in the business, we expect it will provide growth and profitability and drive stockholder value. Additionally, I'd like to note that we continue to make progress with our new product introductions and have plans to release 30% more products this fiscal year compared to last year, which we expect will support revenue growth over the long term. Also, during the June quarter, we are looking forward to updating our five-year annual strategic plan which has historically included a comprehensive plan to expand our SAM, develop our technical capabilities, and grow our product portfolio. We view this as an important process where we develop an in-depth plan and set goals across the entire business to build on our strong financial foundation, setting growth, profitability, and investment targets for the next five years. And finally, given the current business environment, we plan to carefully manage our expenses during the second half of the fiscal year. I will now turn the discussion back over to Steve.

Thank you, Jack. MACOM expects revenue in fiscal Q3 to be in the range of $145 to $150 million. Adjusted gross margin is expected to be in the range of 59 to 61%. And adjusted earnings per share is expected to be between 52 and 56 cents, based on 71.5 million fully diluted shares. This guidance does not include any revenue contributions or financial impact from the planned OMIC acquisition. In Q3, we expect industrial and defense revenues to be up and data center and telecom revenues to be down for the reasons we've previously discussed. As I've noted, we maintain a long-term perspective on executing our strategy. Our product portfolio is stronger than it was a year ago, and we are confident we can meet or exceed our targets. Finally, As we model our second half financials, we expect our full year FY23 revenues and earnings to be down approximately 4% to 5% and gross margins to be over 60%. I would now like to ask the operator to take any questions.

Certainly. Ladies and gentlemen, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, press star 1-1 again. In the consideration of time, we ask you to please limit yourself to one question and one follow-up only. Please stand by while we compile the Q&A roster. And our first question, coming from the line of Matt Ramsey with Cowan-Yelan is open.

Yes, thank you very much, guys. Good morning, and thanks for taking my questions. I guess the first question, Steve, if you could And we appreciate, by the way, the detail and the extra stuff in the script about the near-term trends. I realize there's a lot going on in the macro. So what I'm really interested in is just – it does not surprise me, I guess, that given the macro environment that you guys have had some push-outs of orders. What I'm really trying to understand is the orders that turned into full-on cancellations Did that surprise you? Anything different going on there other than just sort of inventory digestion? I mean, the things that you make oftentimes are single source and have extremely low obsolescence risk. So I'm just trying to understand, should we read all of this as just a temporary push out of a whole bunch of programs and things will resume? Or were there real program cancellations that we should consider? And if so, in what segment? Thank you.

Thanks for the question, Matt. So first I would say that the cancellations that we've had probably fall into two categories. The first would be customers managing their inventory and exposure, which we would put in the category of normal business operations given the climate today. And then the second category would be more along the lines that customers have decided to cancel the programs or they lost business, And so they were truly eliminating the demand, let's say, for those products, for those programs. We saw most of that in older networking programs that we've been supporting, I would say, where typically those products also would be in the category of non-cancelable and not returnable. So oftentimes when we see those type of cancellations, there's associated cancellation fees. So those are really the two categories that I would call out regarding the cancellations. I think the total dollar value is in the range of about $10 million, a little over $10 million in the period, which is abnormally high. It should be close to zero on a regular basis. So, yeah, we were surprised by those cancellations, and we think over time that number will drive to zero.

Got it. Thank you for that color, Steve. I guess as my follow-up question, you guys, you said there at the end of the script that you're expecting revenue for the year down 4%. So that would imply, I think, a little bit of a bounce back, but not much in the September quarter. So maybe from the 147.5 to 150 ballpark. Is that sort of the right math? And then how do we How do you guys think about the recovery from here back to some level of normal run rate business? And if you have any visibility at all there on timing of any recovery by segment, that would be helpful. I understand that a lot of this is moving quickly, and some of the things that happened in order bookings in the last quarter were unexpected. But we're just trying to get just a ballpark sense of timing to recovery here would be really helpful. Thanks, guys.

Thanks, Matt. So I think I'd just like to highlight first that it's very important that we do talk about bookings. And Jack and I have been reporting the book-to-bill ratios for now about four years, and we think that's probably one of the most important metrics to discuss on these quarterly calls. What we've seen over the past four years is certainly a lot of strength in the bookings. Back in fiscal 2020, Our book-to-bill ratio was about 1.1, close to 1.2. In fiscal 21, it was about 1.2. And then last year, last fiscal year, it was 1.1. So all of that suggests that there is growing demand, a growing interest in MACOM's products. It also, over that same period, allowed us to build a very, very strong backlog for times like this when things start to slow down. There was a period, I think, towards the end of Q3, we had a backlog over $400 million. And what we've seen in really the first quarter, where we had a 0.9 book-to-bill, and then the second quarter, a 0.5, we've seen our backlog come down, but it's still around $300 million. So we still have a significant amount of backlog, and this is high-quality backlog within 12 months' delivery. And so we have pretty good, when we talk about this quarter and even next quarter, in light of the weak bookings, we still have a lot of confidence in our ability to execute and deliver and hit the targets we want to. And so we did think it would be helpful to provide some directional information about the fourth quarter to give investors comfort that we are still in a very strong position. So I just wanted to highlight that. And by the way, as you know, the factors that drive bookings are certainly manufacturing cycle times. We've seen those coming down. Inventory levels at customers is high, so they're ordering less. And then, of course, the risk buys for new programs. We are seeing a lot of smaller orders coming in that are really targeting new programs that will ramp not only towards the end of our fiscal year, but the beginning of next. So when we add all of that up and then we look at our sales forecasts, We do think things will slowly improve. We don't think it's going to be a rapid return to, let's say, strong bookings because we do have to work through the inventory situation that we're currently looking at. So I think the comments that I made in my prepared remarks about the trends improving is probably as far as I want to go. We don't know what Q4 bookings will be. We'll have to wait and see. There is certainly a lot of uncertainty around the markets. But I think what's very important for today is investors understand that we're sitting on a very strong backlog. And when we apply a conservative book to bill on top of that, we think year over year, we should be able to achieve between 4% and 5% decline in revenue, which is not ideal. but I think it's a reasonable outcome given the market environment.

Thank you. And our next question coming from the lineup, Tom O'Malley from Barclays.

Good morning, guys, and thanks for taking my question. And I also appreciate the script where you guys took all the good ones earlier. So thanks for making us think a little bit today. But I just wanted to ask, I think Matt just covered the revenue side, but if you do the math on the, on the earnings down five implies a pretty good step up in the gross margin for September as well. Could you just address one? Do you think that the June 60% is the bottom from a gross margin perspective? And then just given the fact that that revenue is kind of flattish at that midpoint of four to 5%, how do you get that leverage of a couple hundred basis points going into September from a gross margin perspective? Thank you.

Hey, Tom, this is Jack. So just as we looked out over Q3, I think the midpoint of the guide is that 60% number. And going into Q4, we haven't gotten down to that granular level, but it would probably be somewhat consistent with that at that lower revenue volume. And obviously, we've seen a bit of a step down here in the June quarter versus the March quarter that we just completed from an overall gross margin point of view. I think a majority of that is volume related. We've been very pleased with the gross margins that we've had, which have exceeded 60%, I think, going back over the past nine or ten quarters. And I would also highlight, you know, with the revenue levels that we've put out there for the upcoming June quarter, if you look back to a comparable period from AECOM, it probably goes back to the end of 2020 or early 2021, and our gross margins were probably in the mid-50s at that point in time. There's been quite a bit of things that we've done structurally to improve the gross margins over the past couple of years, which we've obviously seen that in the incremental increases that we saw in the past. So if we can get that top-line volume back, that will help support improvements in gross margins. And then one of the other items that we've talked about is the new product introductions that we've had over the past number of years. That has also helped. Obviously, new product introductions will continue as we go forward, and that will further support improvements in the gross margins as we get into fiscal year 24 and beyond.

I kind of have one out of left field here, but you guys, I'm not sure intentionally or not, didn't mention the CHIPS Act in the script, and that's something that you brought up in the past. Obviously, it seems that things are moving a little sideways there. Can you just talk about your current efforts there, what you're hearing from the government, and if you still view that as something that you would like to participate in in terms of receiving the funds? Thank you.

Thank you for the question on the CHIPS Act. So as we've said previously, we are active, and on previous calls we outlined our strategy and approach and what we were looking for. Because we have engaged the government and submitted various paperwork, we are under a bit of a gag order sort of on a go-forward basis. We really can't talk about and won't talk about in public the details associated with our strategy now that we've engaged the government. Other investors should know we're looking for opportunities, but we really can't go into any details going forward.

Thank you. And our next question coming from the line up, Harsh Kumar with Piper Sandler. Your line is open. Harsh Kumar, your line is open.

Okay, thank you. So, guys, again, thank you for all the color. This was super helpful. I had a quick question, Steve. First of all, at 145 and let's say 150 that you're suggesting, a million in revenues for September, I'm sorry, the June and the September quarter, is it fair to say that you are massively or significantly undershipping versus the sell-to? In other words, you're burning the excess inventory, and do you think this kind of level is a good enough number to burn the excesses let's say by the end of the September quarter, will you have some excess inventory as you get into the next fiscal year?

So Harsh, I think we are under shipping in certain areas. So generally, yes. But it's also very difficult for us to, you know, get a sense of what might happen in the September quarter. I can tell you that we are being more aggressive looking at what we call the point of sale report and the sell through within all of our sales channels. So we're becoming very, very focused on looking at that data on a more regular cadence, let's say, because that is such an important factor. I would also add, which sort of aligns to your question, that we want to bring our channel inventory down, and that is part of our strategy in the back half as well. And so that is factored into our guidance.

Fair enough. And then from the other one, Steve, you mentioned sort of two categories of products. You mentioned cable and China pawn as having several quarters of inventory where the recovery might be more longer term. So I guess it begs the question almost that that seems to spill into next year fiscal year. Is that a fair assessment of that particular business? And then part two of that question is, you know, a lot of the analysts that follow your stock also follow some of the compute companies. So AMD reported not too long ago, I think one or two days ago, and NVIDIA both suggesting that compute data center seems to be bottoming. And I guess I'm trying to string your statement with what they're seeing, whereas you're saying, you know, hey, things are going to slow down a little bit. Those guys are saying things are going to accelerate a little bit. Is that just a timing difference or, yeah, let's just leave it at that. Is that just a timing difference or is there something else going on in your opinion? I'd love to get your views.

Sure. So on the first part of your question regarding cable infrastructure and broadband as well as China Pond, I think in the case of cable, that is going to have a slower recovery than the pond market. So we would expect going into next year, to be at higher volumes or a healthier environment for PON. We think cable will be stretched out a little bit more, mainly because we know our lead customers, and there's multiple customers, are sitting on significant inventory. So they have to burn that through. We think we'll be seeing orders in about two quarters to help us set up for fiscal 24th. And then regarding your question on compute, and specifically sort of high-performance compute, that is a very active area for MACOM, as I talked about in the script, especially our chips supporting 800G applications. These are typically less than 100 meters, less than 500 meters, and inside the data center where our customers want to move high performance high volumes of high-speed data. And so that's an area where we are seeing some strength. But unfortunately, that strength is muted by the slowdown with CWDM4, a lot of the SR programs, a lot of the NRZ programs that we've been involved with in the past. So the weakness outside of, let's say, the higher-speed PAM4 area is causing our data center revenues to, in aggregate, be down significantly in Q3 and in Q4. But that doesn't speak to what we think will be a really nice setup for next year as our customers are pushing us to ship and ramping us on those higher speed programs. As I mentioned in the script, we feel like we are in a leadership position there. These are products that were not just developed within the last 12 months. These are products that we've been working on for over two years. For us to be able to demonstrate operating modules at OFC with the Tomahawk 5 switch would suggest that we have been working deeply with not only module manufacturers, but also switch manufacturers, and to your point, companies like NVIDIA.

Thank you. And our next question, coming from the line up, Gwen Bollman from Neatham & Company. Alan is open.

Hey, guys. I'll echo the thanks for the color on the bookings trends by in-market. I guess, Steve, maybe just if you could help us, what is the normal backlog position for the company if you're $300 million today? That looks like it's about a quarter and a half of forward revenue. Is that a more normal position? Is backlog normal? normal backlog, perhaps even lower than that?

So that's a great question. And I guess the answer would be you can never have enough backlog. And over the past four years, almost every quarter and almost every fiscal year, we've been driving that number up. And so with all the things we're doing with growth in terms of new products, improving our SAM, launching proprietary technologies, we would expect over time, over the long term, that backlog is always going up. And so that is our expectation. And when we don't see that happening, we're disappointed. And I think Jack has also sort of talked about over the past year or so that we have been consistently hitting record backlog numbers. And we, as we've also talked about, mentioned that about 20% of our revenue is coming from new products. So what's clearly driving the growth is all the great things our engineers are doing within the business units to put very compelling products in the market. So I would say there is not a normal level. The number should always be going up, and when it's not going up, you know, we are pedaling twice as fast to make sure it does go up. And so you can be sure that our sales teams, our business unit, our leadership, we are on the road, we're engaging customers, and we're, you know, early on, About two quarters ago, I highlighted the priorities for this fiscal year, and one of them was taking market share. And so we'll do that by engaging our customers at their facilities and having our apps teams and designers doing custom designs for them. And so all of those good things are happening, and it's our expectation that over the long term, that number always goes up.

Understood. And then a more specific question on data centers. You've talked now for several quarters about weakness in the NRZ, the CWDM4, the short reach. It sounds like that business will offset some of the strength in 800 gig or the PAM4 side of the business. But as you get into the June and September quarters with that business continuing to decline, can you give us any sense what percentage of the data center business would still be represented by those NRZ or kind of more legacy products exiting this fiscal year, is that still something you would expect to be an overhang or a headwind in fiscal 24, or is it down to pretty inconsequential levels by the end of fiscal 23 that you're really set up for growth in the 400, 800 gig PAM, the direct drive, the equalizers, and some of the newer data center products?

Yeah, so certainly the NRZ is becoming a smaller percentage of the total, and a lot of that business is China-centric as they're building out and deploying modules that are 25G short-reach type, either AOCs or pluggables. And so it's not clear to us when that eventually goes to zero, let's say. we would expect at some point it becomes a de minimis amount. That might happen over the next 12 months. It may take two or three years. We just don't know. So I can tell you that when we think about deploying R&D resources, we want to always be working on the highest speed applications, as we talked about earlier, and also taking some of those same resources and getting them engaged in other markets, including telecom and defense. And as we've talked about over the long term, we believe that industrial and defense and telecom will outgrow the data center and market primarily because there's so many differentiated opportunities in those other markets.

Thank you. And our next question coming from the line of, sorry, Sandberg with Stiesel, Yolanda Salfin.

Yes, thank you. I just had a question back on the sort of, you know, consumption level, especially in data center and telecom, because, you know, based on my math and sort of directionally how you think about the business in the June quarter, it looks like both data center and telecom will be down about 20%, 30% sequentially. So what are some of the areas that, you know, are potentially now running below consumption and where, you know, what are some of the segments where you still think there's going to be some excess inventory exiting the June quarter?

Right. So, Tori, thanks for the question. You're right. And as we move from Q2 to Q3, as I highlighted, we believe industrial defense will be up sequentially, perhaps, you know, 9 to 10 percent and certainly over 10 percent year over year. So we're happy about that. Telecom and data center will be down. Data center probably more down than the telecom. As we've talked about, a lot of the legacy NRZ programs are dragging the aggregate number down. In telecom, the areas that are weak are certainly 5G pretty much across the board, whether it's on the optical side or on the RF side. Metro long haul, where we have a very strong position, is also going to be weak in this current quarter. And I would say that cable TV that we talked about before is also an area of weakness. So, you know, when we think about what's going to happen in the September quarter and when inventory is sort of level off, it's very difficult for us to say. And that's why we sort of highlighted that we do expect our Q3 bookings to begin to improve. And that is a leading indicator of inventories coming down across all the markets. But I think it's just too early to be specific on what actually might happen this quarter. I mean, as you saw in Q2, there was a significant reduction in bookings. And so we have to let things play through here.

Well, that's great, Collar. Thanks for that. And then on your own internal inventories, I think you said you intend to bring that down throughout the year. The inventory days stand at 187 right now. So, you know, do you have a target either by days or by dollars that we should track?

Yeah, Tori, this is Jack. We're targeting to bring that down. Obviously, it's going to depend on order flow to some extent as we work our way through this. We've looked at it, and from a target standpoint, we're targeting to try and get our inventory turns up above that two number that we had for the current quarter, targeting something probably closer to three over the long term. We know we've got some work to do to get there. We were obviously building some some strategic supplies over the past year or so. We still have those. We do an analysis of our inventory. We feel our inventory is very healthy. And as we work through things over the next couple of quarters, we expect to see some overall reductions. And we also had in the quarter the linearizer acquisition, which drove a majority of that increase that we had seen quarter over quarter. So that was an acquisition-related activity that drove our number up from an absolute dollars perspective.

Thank you. And our next question coming from the line of Vivek Arya with Bank of America. Your line is open.

Hi, this is Blake Freeman. I'm from Vivek. Thanks for taking my question. Just the first one, kind of going back to gross margins. If I look at the last time sales were down double digits sequentially, gross margins fell much more than 200 basis points that you're guiding for the June quarter. So the portfolio has certainly changed since then, but just kind of curious if you can elaborate on what gives you confidence that gross margins won't see further declines. kind of amid the second half challenges.

Sure. Thanks, Blake, for the question. Maybe I'll make a few comments and then Jack can add to those comments. So as we talked about, we do have a significant portion of our current quarter in backlog. So that gives us some visibility into the range. And as Jack also highlighted, when we were down at these revenue levels back in fiscal 21, Our gross margins were lower, but we know that the mix is favorable. Our cost structure is favorable. Our ability to execute and the efficiencies within our operations are all favorable. So even at those same revenue levels, we're seeing significant improvement in the gross margins. And, of course, the strength of the portfolio is providing a nice tailwind. So with that, maybe, Jack, you could be more specific.

I think that was a helpful answer. summary that you had gone through, Steve, um, you know, once again, we're, we're in a much better position than we were a number of years ago in terms of how we manage our costs, um, our flexible manufacturing model where certain of our products are, uh, fabbed outside, you know, has less of an impact on our overall gross margin. And even the, the mix that we have through products that are fabbed, uh, you know, we're not a mega fab where, uh, you know, a dip, a slight dip in, uh, in revenue can have a more significant impact on the gross margin. So we are somewhat insulated from that perspective versus some of our peers that may be out there that are higher volume operators.

Got it. And then just a quick follow-up as well, just on kind of the OpEx side of things. As you kind of just, as we kind of go through second half headwinds, but also prioritize investment in new product lines, I guess, can you quantify how you think OpEx should trend through the next few quarters and so forth?

I think if you look to the midpoint of our guide, we're probably in the $50-ish million, which is a bit of a step up from where we ended this current quarter, which was around $47 million of total OPEX. Some of that is linear acquisition coming online for a full quarter. But we will continue to make investments. We've talked about our new product introductions as being an important area for us, so we will continue to focus on making some of those R&D investments where they make sense. But, you know, one thing that we've stated many times before, we'll keep a close eye on our operating expenses as we go forward and make sure we manage those expenses in an appropriate manner.

Thank you. And our next question, coming from the line-up, David Williams with Benchmark. Your line is open.

Hey, good morning. Thanks for letting me ask your question. So quickly, I wanted to see if maybe you had any color around maybe the CapEx spending plans that you're seeing within maybe carriers and service providers. Are you seeing major changes in the CapEx or just maybe just some programs that are being shelved here in the near term?

Right. Thanks for the question. So I'm probably not the best person to ask that question regarding the sort of what the the industries are doing with their capital spending. We have sort of seen directionally that there is increased spending with 5G. It depends on the country, of course. We see that the data centers are continuing to invest. I mean, they're having massive layoffs on one side of their business, but they're investing heavily in equipment on the other sides of their business. And so that capital investment will certainly flow down to companies like Macom. So I think it's very difficult for us to sort of talk about those higher level capital spendings because we're so far removed from how those dollars flow. But I would highlight that there are secular growth trends that favor MACOM. For example, the defense industry is growing, not only here in the U.S., but also internationally. all of the, not all, but many, if not most, of the NATO countries are increasing their spending on defense equipment. And they want to build that equipment locally. And so companies like MACOM can support, you know, European defense contractors. I talked in the script about participating in some tactical radios for German customers, for example. And so there's... tremendous opportunity for us in the defense industry with the technology that we have. When we think about telecom, most of the systems that are being deployed today are moving to higher frequencies. When you start to look at the number of companies that can support those platforms with high-frequency semiconductors, you can pretty much count those companies on one hand, and we are one of those companies. And our strategy is to be stronger and be a leader with high-frequency semiconductors semiconductor technology. When you layer on top of that our gallium arsenide and GaN, gallium nitride, and GaN on silicon carbide capabilities at those higher frequencies, it really starts to look differentiated. So the telecom market is, we believe, going to continue to grow. There's lots of, you know, sort of exciting growth opportunities. We talked about some of the LEO constellations on the script. And then last, the data center. You know, we want to participate at the highest data rates. And as things become commoditized or move to lower data rates, that's when we will step out and we'll put our R&D resources in other areas. So while we're not so focused on the capital spending of sort of the end user community, I would highlight that our three core markets will have secular growth over the next decade, and we're in a great position to take advantage of that.

Thanks, Wes. Great color there. And secondly, maybe for a follow-up, just anything in terms of China and the demand that you're seeing there. I know you touched on this a bit earlier, but just kind of thinking about maybe demand trends or even inventory issues there just around that market would be helpful. Thank you.

Sure. You know, China is a very important market for us. In the first quarter, About 23% of our revenue or about $40 million was coming from Chinese customers. This past quarter, the percentage dropped. And so now in absolute dollars, that's around $33 million. So it's certainly come down. I don't think that these numbers represent the potential of that market. I would say right now it's a very muted market in the sense that 5G deployments or even a lot of optical module build-outs. There's a lot of uncertainty around the volumes and sort of what's going to happen next. I would say, generally speaking, things are improving as COVID is sort of behind the local economy, and now things are opening up, and that's a positive trend for companies like Macom. And the last thing I'll add is that there's certainly sort of a headwind of against U.S. semiconductor manufacturers selling products into China. And we recognize that, and we will make sure that our strategy addresses that.

Thank you. And our next question, coming from the line-off, Carl Ackerman with BNP Peribus. Your line is open.

Yes, thank you. Steven Jack, in your prepared remarks, you noted that your optical transceiver partners have said that new orders would be down 30% to 40% from the prior year. Is that just specific to your own NRZ products, and is that weighted more toward telecom, or is it more weighted toward data center? Any comment on that would be helpful.

I would say that was a broad statement across all data rates in NRZ and PAM4, sort of excluding the higher-end PAM4 products. And I would say that that's more heavily weighted towards data center. We think that when telecom turns on, not only will we have a very strong position with front haul, with not only our electrical products, drivers and TIAs and CDRs, but also optical products, including lasers and photo detectors. And then the last thing I'll add is that we do think that metro long-haul business is relatively weak right now. We think that will start to strengthen in about one to two quarters.

That's very helpful. Maybe to dovetail on that last part, you noted growing design wins for 400 gig ZR. So I guess I'm not sure if that's in reference to this metro opportunity, but Could you discuss your opportunity on ZR products over the next maybe even year or two as you're starting to win some of these designs? Thank you.

Yeah, I mean, it's certainly very early, but what we are seeing is customers developing coherent products that will be used in and around the data center. And so we have with our metro long haul technology, which are generally These are generally high-end semiconductor processes for long-distant applications. We are seeing sort of a reset on that technology to apply it to things like 400ZR Lite. So it's primarily in two product areas. It is drivers and TIAs, and generally it's for applications around 20 to 40 kilometers. That's sort of... how we would classify that segment, let's say.

Thank you. I'm showing no further questions in the queue at this time. I will now turn the call back over to Mr. Daley for any closing remarks.

Thank you. In closing, I would like to thank all our employees for their hard work and dedication, which made all these results possible. Have a nice day.

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