MACOM Technology Solutions Holdings, Inc. (MTSI) Earnings Call Transcript & Summary

Welcome to MACOM's Third Fiscal Quarter 2023 Conference Call. This call is being recorded today, Thursday, August 3, 2023. [Operator Instructions] I will now turn the call over to Mr. Steve Ferranti, MACOM's Vice President, 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 third 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 a more detailed discussion of the risks and uncertainties that could result in those differences, we refer you to MACOM's filings with the SEC. Management's statements during this call will also include discussion of certain adjusted non-GAAP financial information. A reconciliation of GAAP to adjusted non-GAAP results are provided in the company's press release and related Form 8-K, which was filed with the SEC today. With that, I'll turn over the call to Steve Daly, President and CEO of MACOM.

Thank you, and good morning. I will begin today's call with a general update on our business. After that, Jack Kober, our Chief Financial Officer, will provide a more in-depth review of our financial results for the third quarter of fiscal 2023. I will then provide revenue and earnings guidance for our fourth fiscal quarter, and we will be happy to take some questions. Revenue for the third quarter of 2023 was $148.5 million and adjusted EPS was $0.54 per diluted share. Cash flow from operations was approximately $46 million and we ended the quarter with $588 million in cash and short-term investments on our balance sheet. Our team did an excellent job in meeting our business and financial objectives, albeit in a challenging market environment. We are especially pleased with our cash flow as we manage our way through the down part of the cycle. Our book-to-bill ratio in Q3 was 0.9, which was a significant improvement over Q2. Our total company backlog decreased slightly quarter-over-quarter, although it remains at a healthy level. The bookings growth was driven primarily by our data center and defense customers. Our turns business or revenue booked and shipped within the quarter represented approximately 18% of our total revenue, which is approaching historical norms. While we are encouraged by the improvement in bookings, the broader demand environment remains weak in several of our served markets and in particular, with the telecom end market. I'll note that customer cancellations and pushout requests have slowed, which is a positive indicator. However, I would still characterize overall industry inventory levels as high with many customers still carrying excess inventory. Our external sales channel inventory did decrease in Q3, and we plan to manage our external sales channel inventories down again in Q4. Turning to our discussion of our end markets for fiscal Q3. Industrial and Defense revenue was $83.5 million, up sequentially, and it was a company record. Within the I&D market, demand for MACOM's products remains robust. And we continue to see numerous secular drivers within both the industrial and defense markets. Which have the potential to drive slow but steady growth from MACOM over the coming years. Applications include new satellite networks within the DoD, new AESA or active electronically steered antenna radar deployments, electronic warfare applications, secure communications and new very high-frequency electronic sensors. These applications require progressively higher frequency levels, more bandwidth and higher power levels in smaller form factors, which plays directly to MACOM's competitive strengths. Our goal is to expand our SAM within the I&D market and to establish differentiated products that span analog ICs, mimics in RF and microwave subsystems. Our portfolio has multiple growth initiatives, which we've previously discussed, including our high-frequency 0.14 GaN process, low-frequency MACOM pure carbide power amplifier products BAW filters, KV CAPS, ruggedized photonic subsystems and RF amplifier pallets. Our recent acquisition of Linear Communications Group is an example of our SAM expansion initiatives. As previously highlighted, the Linearizer team brings MACOM new design and manufacturing capabilities in microwave pre-distortion products for SATCOM and satellite payloads as well as microwave photonic subsystem products for defense applications. Over the past three decades, the Linearizer team has developed an outstanding reputation in the SATCOM industry and forged strong relationships with many leading TWT manufacturers, Tier 1 U.S. defense prime contractors, SATCOM ground station OEMs and satellite manufacturers. This acquisition strengthens our market position within the defense industry and improves our ability to capitalize on the estimated incremental $250 million TAM. Since closing the acquisition in March, we have initiated new R&D activities to combine our proprietary semiconductor technologies with Linearizer's, system design expertise to create more differentiated solutions for our combined customers. The industrial market continues to expand with new applications, including by way of example, traffic monitoring radars, automotive sensors such as LiDAR, industrial wireless IoT platforms, factory automation and robotics and wireless and laser-based instruments for medical applications. In short, we continue to build a unique and differentiated product portfolio of RF in microwave and millimeter wave and optical capabilities for the I&D market. While programs in the I&D market take a long time to enter production, the programs typically have long life cycles and carry healthy margins, which ultimately create attractive financial returns. Revenue for the telecom end market was $38.3 million, down 29% sequentially. The global telecom markets remain very challenging with weakness in China, slowing 5G deployments in the U.S. and elevated inventory levels at CATV and metro long-haul customers. Our telecom bookings have been weak for most of fiscal year '23 and at current levels, we believe we are under-shipping to end demand. In spite of the current market weakness, we continue to view telecom as an attractive market with large and diverse long-term growth opportunities. We believe this market has the potential to be one of our faster growth markets because design cycles are fast, volumes are high and customers typically select products based on performance rather than price. MACOM has compelling products for the telecom market from our diode and mimic portfolio to our analog ICs in optical or opto-electric analog IC products. While this year's order demand has been weak, our sales team have been doing a great job finding new customers and applications, which will drive our future growth. We believe our telecom revenues will improve in the near term when infrastructure deployments increase and as customers in sales channel inventory is depleted. New product introductions remain a core aspect of our growth strategy in the telecom market. As an example, over the past few years, we have expanded our portfolio to include high-power switch in LNA modules to serve 5G base stations, including macro cell, small cell, in massive MIMO active antenna systems and frequency bands up to 6 gigahertz. We've also developed a product line of high-power transmit and receive front-end modules or FEMs that operate in the 5G FR2 microwave frequency bands, which consists of multistage PAs, LNAs and a TR switch in directional couplers. MACOM's RF and microwave IC design expertise is compelling. Our chip designers have the ability to utilize a wide range of gas, GaN, SOI and CMOS processes for both internal and external fabs and as a result, we're able to select the process which achieves leading product performance. While this capability is ideal for 5G radios, our growth strategy is broader than the 5G infrastructure market, and our product line managers use the same technology to target other high-volume applications where we can differentiate. For this reason, we see a large telecom growth opportunity for MACOM over the next few years. Data center revenue was $26.6 million in Q3, down 31% sequentially. We still see excess inventories impacting customer demand, at lower 25G and 100G data rates. However, during the quarter, we were pleased to see customer demand for our 400G and 800G products start to accelerate. And this near-term trend will provide an opportunity for significant quarter-over-quarter growth. We have also seen an uptick in 200G short-reach PAM4 demand to address some new U.S. cloud deployments. MACOM has a focused product portfolio for the data center to support high-speed analog connectivity, and our products are used in optical transceivers, active optical cables and active copper cable applications. MACOM has been a leader in supporting the analog linear drive architecture across InfiniBand and Ethernet protocols because we believe linear drive in certain applications can provide lower latency and reduced power consumption compared to DSP-based solutions. We believe our solutions are gaining traction in the market, especially at the higher data rates. As an example, our linear drive products can support new deployments in artificial intelligence, machine learning and high-performance computing. Hyper-scale operators are in the early stages of 400G and 800G deployments today, and these customers are actively looking for ways to reduce complexity, DC power and cost. We believe we are well positioned to capture a portion of the market with our analog solutions. I would now like to review a few key events during Q3. We First, we continue to focus on developing cutting-edge semiconductor processes. In support of this effort, we were awarded a contract from the United States Air Force Research Labs or AFRL, to develop advanced semiconductor process technology related to gallium nitride on silicon carbide. The contract will support MACOM's research and development on process technologies used in millimeter-wave mimic products. We believe this contract underscores MACOM's technical leadership and commitment in high-power millimeter wave GaN on silicon carbide, and it will enable us to strengthen our competitive edge. This is a multiyear contract that has a total value of around $4 million. Our strategy is to provide customers with the industry's best-performing high-frequency gas and GaN mimic products. Future mimic products from advanced processes represent a large growth opportunity for MACOM over the next 2 to 5 years. Historically, mimics have been among the most profitable products within our portfolio. Second, we are pleased to announce that during the quarter, we were awarded a platinum supplier status by a U.S.-based Tier 1 defense contractor, and we were named as a global preferred supplier by a leading Japanese test and measurement company. Customer satisfaction is at the center of MACOM's business strategy, and these awards are a great recognition of our success in servicing these customers. I would like to congratulate the sales teams, application engineering, operations and all of the other critical members of the MACOM team who helped make these awards possible. Third, we are pleased that during the quarter, we formally established the MACOM European semiconductor center outside of Paris, France. This center bolsters our European presence and provides a manufacturing platform from which we can build upon to expand and better serve our European customers. The center also brings us an amazing team and a portfolio of high-performance mimic products. And finally, I would like to note that the integration of linear Communications Group acquisition is on schedule, and our teams have been excited to start collaborating together to win new business. Before I turn the discussion over to Jack, I would like to review one more item. In mid-July, the management team updated its long-term strategic plan. As a reminder, in July of 2020, we initiated a long-term new planning process, and this year was our fourth revision of the plan. As you would expect, the strategic plan analyzes our capabilities, the markets and potential areas for SAM expansion. It reviews our current technology portfolio, product road maps, competitive landscape, SWOT analysis and formulates a road map for growing revenue and profitability at a detailed product line level. We believe that in-depth long-term planning is essential for a semiconductor business, and this is a critical element of how we manage the company. We believe our strategy will strengthen and diversify our business and provide MACOM the ability to capture market share. We are excited to scale the business and achieve $1 billion in revenue. Jack will now provide a more detailed review of our financial results.

Thank you, Steve, and good morning, everyone. Our results for the third quarter of fiscal 2023 were within our guidance for the period. Revenue for the third quarter was $148.5 million, down 12% quarter-over-quarter. The sequential decrease was driven by weakness in telecom and data center markets with a slight sequential increase in industrial and defense. On a geographic basis, sales to domestic customers represented 49% of revenue flat sequentially. Sales to China-based customers were 16% of revenue, down from 20% in our fiscal second quarter. Despite sales declines in China, we continue to see additional growth opportunities in Asia and Europe. Adjusted gross profit was $89.2 million or 60.1% of revenue, down 200 basis points sequentially, driven by lower absorption of some of our fixed costs with the lower Q3 revenue levels. MACOM utilizes a flexible manufacturing model, leveraging our internal wafer fabs as well as third-party foundries, which we believe will provide financial leverage as the business cycles and revenue improve. Total adjusted operating expense was $52.2 million, consisting of R&D expense of $33.2 million and SG&A expense of $19 million. As expected, our total operating expenses were sequentially up by $3.6 million, mostly due to the incremental expense from our acquisition of Linearizer and the establishment of our European semiconductor center in France. Adjusted operating income in fiscal Q3 was $37 million, down from $56.6 million in fiscal Q2. Adjusted operating margin was 24.9% for fiscal Q3 sequentially down from 33.4% in Q2. Going forward, we expect our operating margins to improve as revenue recovers. Depreciation expense for fiscal Q3 was $5.8 million and adjusted EBITDA was $42.8 million. Trailing 12-month adjusted EBITDA was $233.1 million compared to $250.3 million in Q2 fiscal 2023. Adjusted net interest income for Q3 was $2.8 million, up roughly $700,000 from fiscal Q2 on higher investment portfolio returns partially offset by higher interest expense on our term loan. Our adjusted non-GAAP income tax rate in fiscal Q3 remained at 3% and resulted in an expense of approximately $1.2 million. Our cash tax payments were $1.2 million, down from $1.4 million in the second quarter of fiscal 2023. We expect our adjusted income tax rate to remain at 3% for the fourth quarter of fiscal year 2023 and through fiscal year 2024. Fiscal Q3 adjusted net income was $38.5 million compared to $56.7 million in fiscal Q2. Adjusted earnings per fully diluted share was $0.54, utilizing a share count of 71.4 million shares compared to $0.79 of adjusted earnings per share in fiscal Q2. Now moving on to balance sheet and cash flow items. Our Q3 accounts receivable balance was $105.9 million, down from $121.8 million in fiscal Q2 with our days sales outstanding remaining at 65 days. The decrease in our accounts receivable balance is primarily due to the timing of outstanding receivable collections as well as lower sales in the quarter. Inventories were $139 million at quarter end, up by $7.1 million sequentially, primarily due to inventory balances acquired through our European semiconductor center acquisition as well as increases expected to support future data center revenues. Inventory turns were 1.7x in Q3, down slightly on a sequential basis from 2.0x in the prior quarter. We recognize that at this stage of the business cycle, our inventory balance is at a multiyear high. However, the quality and mix of our inventory is strong and continues to support our strategic backlog. I would like to note that our turns business was the highest since our fiscal second quarter of 2022, and our book-to-bill also improved during the quarter, both of which we believe are positive indicators that will support improving inventory turns as we progress through fiscal 2024. Fiscal Q3 cash flow from operations was approximately $45.8 million compared to $32.5 million in fiscal Q2. The increase was due in part to increased accounts receivable collections. Capital expenditures totaled $3.3 million for fiscal Q3, down from $6 million in the prior quarter. Our full year 2023 CapEx and is now estimated to be $25 million based on the timing of payments and as we balance our capital spending with the growth and profitability of the business. Continued capital investments in our fabs, manufacturing capabilities as well as process and product development initiatives remain strategic priorities for us. Cash generation continues to be an important priority for us as we manage through changing business cycles, and despite the challenging demand environment in Q3, we generated cash flow from operations of $45.8 million and approximately $117 million year-to-date. Cash, cash equivalents and short-term investments for the fiscal third quarter were $587.6 million, up from $577.3 million in fiscal Q2 2023. During the third fiscal quarter, we utilized approximately $37 million of available cash to acquire the assets utilized to establish our European semiconductor center located in France. Today, our net debt remains less than $50 million, and our gross leverage is approximately 2.6x. Before turning the discussion back to Steve, I would like to note a few additional items. As Steve mentioned, we opened our new MACOM European Semiconductor Center, or MESC at the end of May and look forward to integrating the differentiated technology and dedicated workforce. We do not expect that ESC will have a meaningful impact on our revenue in 2023, and its associated operating expenses will result in slight EPS dilution. However, we are excited that it brings us new products, technology, manufacturing and customers. We are also pleased to announce today that we have paid off the $121 million that remained outstanding on our term loan. The term loan did not come due until May 2024. However, with increasing interest rates and our consistent quarterly cash generation, we felt it was appropriate to put this outstanding floating interest rate debt behind us and reduce our net interest expense by approximately $600,000 per quarter. And finally, as Steve mentioned, we completed our 5-year annual strategic planning process during the quarter, which we believe will result in increased stockholder value. I will now turn the discussion back over to Steve.

Thank you, Jack. MACOM expects revenue in fiscal Q4 ending September 29, 2023, to be in the range of $148 million to $152 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 $0.53 and $0.57 based on 71.5 million fully diluted shares. Sequentially, in Q4, we expect revenue in I&D and Telecom to be down and data center up. And finally, as you may have seen in the press release issued yesterday, I am pleased to announce the appointment of Wayne Strobel as Senior Vice President, Advanced Semiconductor Technology. A newly created position reporting to me. Wayne will be a key contributor to the development and management of our semiconductor technology roadmap. Wayne has over 40 years of experience in the RF and microwave engineering, and has served as a MACOM distinguished fellow of technology since joining MACOM in 2010. I would like to congratulate Wayne on this well-deserved promotion and the entire management team and I look forward to working more closely with him going forward. I would now like to ask the operator to take any questions.

[Operator Instructions] And our first question coming from the line of Tom O'Malley with Barclays.

I guess my first question, it's something that you've highlighted since you took over the company, just a strategic review process in July. You mentioned the $1 billion again. Can you just give us any update on the time line there? Could you talk about just the overarching growth drivers that get you to that $1 billion? And just the framework that you put together over the last month that's going to guide you from this point over the next couple of years?

Sure. So the timing of that is in the -- our fiscal '26 or early '27 time frame. Which is about a year or 1.5 years behind what we had sort of originally stated a year ago, primarily due to the softness in the market, slowing things down this year. When we look at our growth trajectory. We want to achieve at least our 10-year historical CAGR, which is about 14%. When we look at what's going to be driving our growth, it's primarily new product driven, not necessarily acquisition-driven. And I think more importantly, when we start to look at the P&L at that $1 billion to $1.3 billion run rate, we see an EPS close to $5. And so part of our strategy is to make sure that we are growing profitable revenue that's accretive to the business model. In terms of the specific product lines or segments that we're focused on. It's really the same markets that we've been speaking about over the past few years. Certainly, we believe telecom over the long term, will drive growth followed by industrial and defense and then the data center. And then the framework that I talked about is really some of those details that I spoke of in my prepared remarks, it's really an external review of market dynamics, looking at our capability to design and then positioning the company in a market where we know we can be successful.

Helpful. And then something, I guess, more shorter term than the overarching question there. But it looks like data center was a lot stronger, particularly, well, into the September quarter. You mentioned specifically higher-speed connections at 400G and 800G, is that the area of the data center business that you're seeing accelerate? And could you talk about different areas where you're seeing traction with those deployments?

You're correct that we are predicting strong growth in our fourth quarter for the data center business. In fact, we think it will be so strong that we'll have year-over-year growth within the segment. So this would represent 5 years in a row where the data center end market is growing. So we're happy about that. The growth is primarily coming from 400G and 800G short-reach applications. Typically, it's 100G per lane, and we have a very strong position with some of our latest products that are ramping quite quickly. We have not seen a general recovery in the lower data rate applications, sort of the standard 4/50G or 8/50G type applications. Where we see the growth is primarily short reach, 100G per lane. Some of these products are supporting linear drive applications. Most, if not all of the business is coming from PAM4 protocols. And so we do expect that good things in the quarter.

And our next question coming from the line of CJ Muse with Evercore ISI.

Yes. I guess first question, just to follow up on Tommy's question on the data center. You just highlighted year-over-year growth, which means roughly $10 million plus growth sequentially. And I guess, can you speak to kind of the trends that you're seeing in terms of kind of, I guess, AI data center trends versus kind of base case? And is there enough kind of spending on this high-speed connectivity related on the AI side to sustain growth in data center through the calendar year?

Right. So our primary focus for product development within the data center is analog solutions as well as optical photodetectors and lasers, those have been really the 3 areas that we focus on. And so wherever we can find an application, whether it's a pluggable transceiver CPO, an active optical cable or even active electrical copper cable, we want to sell our products into those applications. We have definitely seen an increase in what we would consider AI-related deployments and applications. And we've seen many examples where customers are excited to perhaps reduce the diameter of a copper cable by electrifying it and running it at a higher data rate over a slightly longer reach than they could have otherwise. And that's been a growth area for us. And then, of course, the linear drive, as we've talked about in the past, has many advantages over a DSP solution. And so we are seeing a bit of a convergence around this type of architecture and this is typically in areas where you have 100 gig switch effectively and you have 100 gig optical. And so -- this is an example where MACOM can insert 1 or 2 or maybe 3 or 4 different products that go into these applications. And the key here really for the customer is there's no gearbox, lower power consumption, lower latency and lower cost. And so of course, the challenge is designing these optical channels with just equalization or an analog solution for signal integrity is very difficult. So the design process is complex. And we've been working with major OEMs to support the growth of this part of our business.

Very helpful. I guess maybe a broader cyclical question. You talked about book-to-bill almost to 1 versus 0.5 last quarter. Turns normalizing. It looks like backlog somewhere close to $300 million, so still strong. Are you suggesting that we're nearing a bottom for the totality of your business? Or might it take a few more quarters for telecom to bottom?

So we try not to call the bottom, let's say, because we really don't know. And what we can say based on where we are today that for a year-over-year comparison, 2 of our 3 markets will be up. I&D will be up, data center will be up and telecom will be down somewhere between 20% and 25%. And as I highlighted in my comments that the inbound new business has been quite weak this year for telecom. We do expect at some point, that will turn. We see certainly great opportunities in the SATCOM market. With the deployment of a wide range of different satellite platforms, which we believe can provide certainly near-term growth opportunities. But it's very difficult for us to say sort of where the bottom is and what might happen 3 or 6 months from now.

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

Yes. Congrats on the order turnaround here. Steve, you talked about being able to support InfiniBand and Ethernet. You also said that for next quarter, it sounds like most of the growth is going to come from PAM4. So, does that mean InfiniBand is kind of further out? If you could just add any color to that, that would be great?

Yes. So most of our -- I would say more than 50% of our data center revenue over the past few quarters has been PAM4 related. And so we see that trend continuing as we go into -- our fiscal '24. So I would certainly highlight that point. The other point I would make, frankly, is that InfiniBand and Ethernet are both PAM4.

Perfect. And as a follow-up, you mentioned China revenue 16%. Is that predominantly pan at this point? Or do you still have some base station business there, just trying to understand regionally where the risks are and so on and so forth with that 16% revenue?

Well, I would say there's been a broad decrease in our China-based business. It's primarily on the optical side and 5G related. And so I would say that's the area that's the weakest. Areas where we see support would certainly be in some parts of -- some 5G networks we are supporting at a low level. But there's no doubt that this year is going to be a down year for our China business. And as it starts to come back, it will come back primarily due to the recovery from our data center and optical customers.

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

Yes. Thank you. I wanted to follow up on data center for a second. I just want to confirm. Are you suggesting that data center is up year-over-year in the fiscal fourth quarter or for fiscal 2023 as a whole? And I have a follow-up.

Sure. So from a data center point of view going into Q4, it would be up certainly quarter-over-quarter significantly as well as year-over-year. I would say, very strong double-digit quarter-over-quarter and high single digit year-over-year. And just to highlight that the color of our data center revenue has shifted quite a bit this fiscal year. The first half strength predominantly came from shipping backlog that was constrained in fiscal '22 due to supply issues. And we cleared out a lot of that backlog in the first half. Then in Q3, we effectively hit an air gap where there was very little demand on what I would consider our base business due to inventory issues. And now what we're starting to see is growth and demand for our higher data rate products for 400G and 800G that is just starting to kick in. So when you add all of that up, what you ultimately get is a growth year-over-year and growth quarter-over-quarter for the fourth quarter.

I guess is there anything to read into your prepared remarks on slowing sales in China. Is the reduction due to general market malaise and 5G infrastructure as you just called out? Or are you seeing competitive pressures there? Can you just clarify on that, that would be very helpful.

Yes. Well, our -- and just to come back to your last question, we -- so that you're perfectly clear, there will be a full year-over-year growth for our data center. That is what we're expecting. And then answering your question about China. So China, our revenues there have been trending down pretty much all year. We started, I think, in Q1, about 20% to 23% of our business was China-based. And now it's in the mid-teens. Most of that is due to 5G in front haul weaknesses as well as we just talked about the data center. I would say that there's always been a very competitive dynamic in China. And that competitive dynamic, I would say, is increasing. There's certainly more and more focus on supplying locally and having local vendors supply to local OEMs. And so I would say that, that trend is increasing, and some of that is due to geopolitical reasons. We have not been defocusing our efforts on China. Today, still some of the major telecom suppliers into the optical networks and whatnot are based in China. So we'll continue to service the market. We're not pulling back per se. However, I would also add that we are focused on developing our revenues in other areas, including Europe, and that's one of the main reasons why we decided to establish facilities and manufacturing inside of the EU.

And our next question coming from the line of Harlan L. Sur with JPMorgan.

Good to see the inflection in order activity, but can be quite now you right during this period of sort of macro weakness -- but it looks like dynamics are stabilizing, which is reflected by the decline in orders and pushouts. So quarter-to-date here in September, are bookings continuing to rise sequentially? And what's the turns assumption embedded in your September quarter guide?

So we're certainly very pleased with our 0.9 book-to-bill in the third quarter. And I would say that we have started the fourth quarter with strong bookings and it certainly would be our expectation that we can be somewhere around the 0.9:1 book-to-bill this quarter. That's our expectation. We'll see how August and September go. A lot of these programs that are coming in are also program-related, large program related. So in some instances, we have good line of sight. But I think your point about the choppiness is absolutely there. As I highlighted, the telecom market is still very, very weak. We see that many of our major customers still are carrying tremendous levels of inventory, including CATV customers. And then regarding your question about the turns, I think we're going to have a similar turns level in Q4 as we had in Q3.

And then congratulations on the close of the OMMIC deal. It looks like their operations are going to become the hub of your European semiconductor sector. Is the MACOM team going to be transferring some of its MACOM originated gas and GaN-based mimic technology to the OMMIC SAS, including your 0.14 micron GaN technology. And what's the revenue potential out of their current 3-inch manufacturing line?

So thanks for that comment and question. So just to highlight, we have -- we've had operations in Europe. We have a fairly large facility in Cork, Ireland. Where we have a design center, we do quality and reliability testing, and we have a fair amount of sales and finance and administration, supporting a lot of our international business. So Cork is certainly today, the main hub of MACOM certainly in Europe. We've also had a design center in Sophia, France for over 10 years, and they've done a super job supporting a lot of our high-performance analog product development. And then adding a wafer fab and a group that is expert at very high-frequency millimeter wave process technology really complements the portfolio. We do not have any plans to transfer any of our technology that we're running here, including the 0.14 micron process to France. Instead, we will continue to build and develop the technologies that they have been working on. And as a priority moves some of those process technologies from the 3-inch line to a 6-inch line. We haven't explicitly said what the revenue potential is of that fab, we probably wouldn't want to say that -- with that level of detail. But what I can tell you is right now, that is -- that fab is underutilized. We see a tremendous opportunity for growth and our sales team and our business development teams are very actively really turning the business around, and we see that will be a nice growth vector for us over the next 1 to 2 years.

And our next question coming from the line Vivek Arya with Bank of America.

This is Blake Freeman on for Vivek. Just kind of want to focus a little bit more on the Q4 guide. I know you gave color around data center. If you can provide kind of the sequential commentary maybe for the industrial and defense and telecom business, the magnitude of the declines in each of those areas, that would be helpful?

Sure. I'll say a word on that and then maybe Jack can add in. So as we've talked about, we do expect very strong data center growth, and we expect I&D will be down in the sort of mid-single digits in telecom and somewhere between 10% and 15% down sequentially. And Jack, I don't know whether you want to add to that?

Yes. I think I would just add we've developed a fairly strong backlog over the past couple of years, and we've eaten into that a little bit over the past couple of quarters. So I think with regard to some of those Q4 guide items that we have with industrial and defense and telecom being down, that's also coming on the back of lower than 1:1 book-to-bill. So we need to work some of those lower order patterns that we've seen going through the past couple of quarters through this Q4 time period. But once again, as I had mentioned, we do have a fairly strong backlog that supports the business going into Q4 and beyond.

Got it. And then just kind of following up on that, maybe specifically on the industrial and defense side. I know that's certainly across the industry. Several vendors observing some kind of digestion in the core industrial space. I was just -- I know the segment is kind of about 50%, 60% defense. So I was maybe kind of hoping you can kind of provide more specifics, maybe what you're seeing specifically on trends on the defense side and then any rates in core industrial markets that could be a little bit weaker or stronger versus others?

Yes. I would say, in general, our industrial business is weak and will remain weak in the near term. And most of the growth that we're getting in the I&D segment is coming from defense programs. Primarily radar programs, rate communication programs. I think we mentioned on last quarter's call, some heavy demand for international radios coming out of Europe that we have some content in. So the part of I&D today is weak. I talked about in my prepared remarks some of the new applications that we are going after within the I portion there. But generally speaking, it's weak and the other thing I would add is we're not really a good bellwether of the industrial end market, it's one of the smaller parts of our portfolio.

Yes. And Blake, this is Jack. I would just add that some of the inherent business that we have going through from a defense perspective, that can be lumpy at times. And I think the other item when you look at our industrial and defense end market is that it's quite diverse. There's a number of different things that work its way into the industrial category as well. So that helps us from a stability standpoint as well.

And our next question coming from the line of Matt Ramsay with TD Cowen.

Thank you very much, guys. Not to go back to the data center stuff, but you can't get through a call now without saying AI a few times, so we kind of got to have to go there. I wanted to ask about your 400 and 800 gig product portfolio. And particularly, you mentioned the linear drive differentiation versus DSPs. Maybe you could expand on that a little bit more from a technical perspective and also how you're thinking about the penetration of linear drive into those data center markets, where we are today, where that can go over time and what it represents as sort of a dollar TAM for your company?

Sure. So I'll try to provide a bit more detail. So where we see linear drive working is when you have 100 gig electrical lane matching up with 100 gig optical lane, that's the ideal application. So you can run that at 400, you can run that at 800, you can run that at 1.6 terabits as well. And when you use a linear drive architecture, you're effectively removing the function of the DSP or a CDR from the module and you're having the switch effectively manage the interface, the interface within the module, if it's a module. So there's benefits in doing that just from latency, cost, power consumption. And so that -- those are the benefits and you can eliminate the DSP and still be in a pluggable form. So you can use this for active optical cables. You can use this for pluggable cables. And so there's customers like that option because then they can use many vendors to support their deployments. what it requires is certainly a switch ASIC that and it requires now the module manufacturer to work very closely with the switch vendor. We demonstrated at OFC a few months back, 3 different module manufacturers with an interop with the Tomahawk 5 switch. So that was ideal for primarily short reach, and that's where MACOM has historically serviced the short-reach market. That's just sort of the lane that we're in. And what we sell into that market are drivers and TIAs, primarily in equalizers. So those are the sort of the 3 product sets. These are highly integrated silicon chips that have all sorts of creature features on them so that the customers can turn the knobs they need to turn to get the product working. And so where we stand right now is we have production at 100G, and we are pretty far along with 200G per lane as well.

That detail. I really do appreciate it. As my follow-up, I think it is encouraging to see book-to-bill up to 0.9%, and I think you guys indicated close to to1, hopefully, for the September quarter. Maybe you could give a little bit of color, if you could, on the 3 segments and how book-to-bill is trending in each of those are some well ahead of 1 at this point? And what those products might be? And are there certain end markets where we're still coming off the 0.5 that we were last quarter and working our way back up.

Right. Well, -- as in Q3, we'll see the same behaviors in Q4. It will be primarily industrial and defense and data center driving the bookings growth or recovery, let's say. We still see tremendous weakness across many of our telecom end segments, cable, test and measurement, 5G. These are still very weak. We don't expect recovery in the fourth quarter. In terms of the products and certainly many of the products that we've talked about in the past, a lot of our mimic products, a lot of our high-end gas and GaN products for military applications. There's a wide range of those are really supporting the growth within the defense sector. When we think about 2024, the growth drivers from a product set point of view, would certainly be GaN. GaN is -- we think 2024 will be a great year for us. We launched the 0.14 micron process about 6 months ago into production and our teams are in the process of getting their first design wins, which will turn into production next year. Certainly, on the data center side, we think in 2024, there will be more high data rate applications coming to bear and potentially ramping up. And then in the telecom area, the only real bright spot for us right now is what we're doing in the SATCOM market, both on the ground side and on the satellite side.

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

Yes. Steve and Jack, kind of a quick one. Steve, when you talked about your long-term drivers, you mentioned the order of telecom, industrial and then data center. As you try to get to your $1 billion goal by FY '26 or early FY '27, is that how you're thinking about growth to that $1 billion number? Or was that just a random order. And if I can flip the question, if that's not the correct order, what is the correct order as you think about it?

Yes. So that is the correct order. That's the way we think about it. But we're oftentimes wrong, more often wrong than right, when we make forecast. So you have to take that with a grain of salt. But when we look at our R&D spending and we look at the projects that are in our pipeline and where we want to position the company, we see that there's a lot of variability within the telecom space that is very attractive to us. And so we like the diversity. We like the long tail of customers that we can approach and it plays to a lot of our strengths. So we do end up spending a fair amount of our R&D dollars developing chips for that end market. Obviously, the A&D market is another great market for us. I think -- as I think I mentioned on the -- in the script, Q3 was a record for our I&D segment. And this year, we'll have great year-over-year growth for the full year. And we expect more good things to happen next year and the year after that as we start to bring into production some of the new programs that we know we're designed into. And the smallest piece of our business is the data center. I realize we get probably the most questions about the data center. But as I highlighted, we do have a narrow focus in the data center where we focus on analog solutions for short reach where we can insert high-performance connectivity chips or lasers and detectors. That is our strategy there. So that's a fairly narrow focused strategy.

For what we get things wrong all the time, Gus. I wouldn't be too hard on your stuff. A follow-up. You're seeing some pretty good pickup in the data center space. The kind of trend you're talking about typically don't go away in a quarter or 2. So is it a fair assumption to think that the activity in -- I'm sorry, the activity in 400 and 800 should stick around for a handful of quarters as you look maybe past the next quarter and a little bit more beyond?

It is possible, and it's very difficult for us to say. And we have certainly seen in the past examples where programs ramp up very quickly and then they ramp down very quickly. So we have to be cognizant of that. So while we're certainly excited about all the great things we're doing within the data center, we also recognize that it can be a very volatile business.

And our next question coming from the line of David Williams with Benchmark.

Steve, just quickly, I guess, on the magnitude of the inventory depletion that you still see needs to happen in the channel. And you've talked about -- I think you've mentioned tremendous a few times. So it sounds like a fairly heavy level of inventory digestion still needs to happen. But I just wonder if you could thought that for us.

Yes, sure. I'll make a comment and then certainly, maybe Jack can add to it. And as everybody knows, the manufacturing cycle times for many of our products can be in the range of 6 months, maybe longer, maybe shorter depending on fab and the technology. And as everybody knows, just 2 quarters ago, we had a run rate of $180 million. So when you're looking at our inventory today. And you relate that to sort of $180 million run rate, you could see that we are, as Jack said, carrying excess inventories at today's level, but not necessarily for maybe 1 or 2 quarters ago. So we are going through a digestion period where we need to move that inventory out into the market. And part of what we're also doing is making sure that our channels are not carrying excess inventory. And so we are definitely managing that down. We want to see more depletion and Jack, maybe you can add to that.

Yes, I think as we had discussed in some of our prepared remarks, we're working closely to monitor what's out in the channel and making sure we understand where things are going there. We have had some positive trends over the past quarter that are somewhat encouraging, but we will continue to monitor that. And with regard to MACOM's inventory, I described the uptick that we've seen, some of that uptick is associated with some of the acquisitions that we've brought on board when you look back over the past year, but we're also continuing to purchase inventory to support our backlog. And I think most notably, the data center backlog that we have.

Great. And Jack, in the past, you've talked about the flexibility in the model on the expense side. And just hoping you could give us a little more thoughts terms of modeling and what's appropriate. And if you're restraining growth the word development efforts here, but just kind of to the softer demand environment?

Yes. So we've been pleased with the gross margin performance of the business in light of the slowdown over the past few quarters. We've made a fair amount of structural changes to the business to manage the improvements that we've seen over the past couple of years from an overall gross margin standpoint. So we do have the flexible manufacturing model, as I had described with some of the products being manufactured in-house in our internal fabs and others that go to third party. So that helps us in terms of being able to mitigate some of the costs that we have with a portion of them being essentially variable. And then I think the other piece that I would like to highlight is our internal manufacturing fabs are generally medium volume. We don't carry the same large overheads like some of the mega fabs have. So that helps protect us too in periods where there may be a slowdown. And then as we look out into the future and hopefully, as we get back to some of the higher run rates that we were at from an overall revenue perspective, I think that will support improving gross margins as we go forward.

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

Just a quick clarification on the 400 and 800 gig. Is that almost entirely optical? Or are you starting to see copper applications, active copper cable starting to take off within that higher-speed PAM4 business?

We see both. And some of our chips are 4 lanes of 100 on a single chip, and you can use 2 of those to achieve 800. And the other thing I'll note, which is sort of a benefit of the linear driver approach is it can really work with a whole variety of architectures within the module, whether it's silicon photonic-based solution, whether it's DML or EML and also thin-film lithium niobate. So whatever technology the module vendor wants to use, we can support those including VCSELs as well if I didn't mention that. So very, very flexible technology from MACOM's point of view.

And a follow-up on linear drive. It sounds like your comments, it's mostly on the Ethernet around Tom Hawk 5, but InfiniBand seems like it's a much more close channel. You have effectively one vendor. I think that dominates that market so it would seem to me that InfiniBand could be a pretty significant opportunity for linear drive. Where do you think we are in adoption of linear drive in the InfiniBand market?

So we -- I would agree that we can service both sides or both protocols. And I think we, in fact, demonstrated a solution using InfiniBand application in OFC. So yes, we're supporting that as well.

And our next question coming from the line of Richard Shannon with Craig-Hallum.

Steve, I want to follow up on the point of response to an earlier question on GaN. I think you mentioned you're expecting a great year in fiscal '24. Maybe if you could help us understand those dynamics and maybe even quantify what you see as the opportunity for your -- for that in that year?

Sure. And I'll sort of define great as we develop the process and now we're selling it. So that we'll start selling it in 2024. So we're starting at 0 for our 0.14 micron process and we are getting design wins, and we expect to see growth in that fiscal year. So that's our -- right now, that's our definition of great. That's a win. And so our sales team, our business development team, our fab engineers are excited to make that happen. We haven't put a fine number on the goal, our internal goals, and we haven't shared that externally. And I think it's premature to do that. But we just look at that as another vehicle for growth. We have the full support from major OEMs here in the U.S. that want to use the technology. We're doing some novel things regarding R&D, as I mentioned on my prepared remarks, including bringing in sort of next-generation process steps to improve performance beyond what we currently have. And so certainly, we think next year will be a great year for can...

Okay. Perfect. And the last question for me on data center here. I just want to verify, I think you said, I just want to verify. Is all the upside here you're seeing is on the analog side or are you seeing any upside coming with lasers. Obviously, I had some great discussion in the last few quarters on what you're thinking about your laser portfolio, but it seems like it's all analog-oriented. Can you confirm if that's what you're seeing?

I would say it's true. The growth is coming from the analog side. And I would characterize our fiscal '23 is a building year for our optical products where lots of design-ins and lower revenue than we had expected. So that's been a disappointment. However, the team is making progress winning those design wins, not only add accounts here in the U.S. but also in China. And we're also working on new laser categories, including EMLs and arrays that are -- we have a lot of interest on that. So -- but to your point, yes, the growth for this year, for this quarter in the data center is driven by analog solutions.

Thank you. And I'm not showing any further questions in the queue at this time. I would now like to turn the call back over to Mr. Steve Daly for any closing remarks.

Thank you. In closing, I would like to thank our team for their continued hard work and dedication. Have a nice day.

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