MACOM Technology Solutions Holdings, Inc. reports earnings inline with expectations. Reported EPS is $0.54 EPS, expectations were $0.54.
Operator: 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 of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.
Steve Ferranti: 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 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’s statements during this call will also include discussion of certain adjusted non-GAAP financial information.
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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.
Steve Daly: 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 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 and 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 .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 and market. I’ll note that customer cancellations and push out 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 for 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 strength. Our goal is to expand our Sam within the I&D market and to establish differentiated products that span analogue ICs, MMICs, in RF and microwave subsystems. Our portfolio has multiple growth initiatives, which were previously discussed, including our high frequency .14 GaN process, low frequency MACOM pure carbide power amplifier products, BAW filters, KV CAPS, ruggedized photonic subsystems and RF amplifier palettes. 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 predistortion 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 and 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 remained 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 MMIC portfolio to our analogue ICS and optical or Opto electric analogue 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 and 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 and massive MIMO active antenna systems and frequency bands up to 60 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 and directional couplers. MACOM’s RF and microwave IC design expertise is compelling. Our chip designers have the ability to utilize a wide range of GaAs, GaN, SOI and CMOS processes from 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 the next few years. Data Center revenue was $26.6 million in Q3, down to 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 analogue 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 analogue 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 and artificial intelligence, machine learning and high performance computing.
hyperscale 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 analogue solutions. I would now like to review a few key events during Q3. 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 MMIC 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 GaAs and GaN MMIC products. Future MMIC products from advanced processes represent the large growth opportunity for MACOM over the next 2 to 5 years. Historically, MMICs have been among the most profitable products within our portfolio. Second, we are pleased to announce that during the quarter, we were awarded 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 helps make these awards possible. Third, we are pleased that during the quarter we formally established the MACOM European Semiconductor Center outside of Paris, France. The 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 MMIC products. And finally, I would like to note that the integration of Linear Communication 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 analyses our capabilities, the markets in potential areas for SAM expansion, it reviews our current technology portfolio, product roadmaps competitive landscape, SWOT analysis and formulates a roadmap 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.
Jack Kober: 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 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 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 Centre 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 it’s the associated — 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.
Steve Daly: 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 a press release issued yesterday, I am pleased to announce the appointment of Wayne Struble as Senior Vice President, Advanced Semiconductor Technology, a new — 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 — in 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.
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Q&A Session
Operator: [Operator Instructions] And our first question coming from the line of Tom O’Malley with Barclays. Your line is open.
Tom O’Malley: Good morning, guys. And thanks for taking my question. I guess my first question, it’s something that you’ve highlighted since you took over the company, it’s just a strategic review process in July. You mentioned the $1 billion again. Can you just give us any update on the timeline 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?
Steve Daly: Sure. Good morning, Tom. So the timing of that is in the — our fiscal ’26 or early ’27 timeframe, which is about a 1 or 1.5 year 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.
Tom O’Malley: Helpful. And then something I guess, more shorter term than the overarching question there. 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? Thank you.
Steve Daly: 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 400 and 100G 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 4x50G or 8x50G 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 protocol. And so we do expect that good things in the quarter.
Operator: Thank you. And our next question coming from the line of C.J. Muse with Evercore ISI. Your line is open.
C.J. Muse: Yes. Good afternoon — good morning, sorry. Thank you for taking the question. I guess first question, just to follow-up on Tom’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.
Steve Daly: Right. So, our primary focus for product development within the data center is analogue solutions as well as optical photo detectors and lasers. That — those are the — really the three 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 a 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 in running it at 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 one or two, or maybe three or four 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 analogue solution for signal integrity is very difficult. So the design processes is complex.