Credo Technology Group Holding Ltd (NASDAQ:CRDO) Q2 2023 Earnings Call Transcript

Credo Technology Group Holding Ltd (NASDAQ:CRDO) Q2 2023 Earnings Call Transcript November 30, 2022

Credo Technology Group Holding Ltd misses on earnings expectations. Reported EPS is $0.02 EPS, expectations were $0.03.

Operator: Ladies and gentlemen, thank you for standing by and welcome to the Credo Semiconductor Second Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I will now like to turn the call over to Dan O’Neil. Please go ahead, sir.

Dan O’Neil: Good afternoon. Thank you for joining us today on our earnings call for our fiscal 2023 second quarter. Joining me today from Credo are Bill Brennan, our Chief Executive Officer; and Dan Fleming, our Chief Financial Officer. I’d like to remind everyone that certain comments made on this call today may include forward-looking statements regarding expected future financial results, strategies and plans, future operations, the markets in which we operate and other areas of discussion. These forward-looking statements are subject to risks and uncertainties that are discussed in detail in our documents filed with the SEC. It’s not possible for the company’s management to predict all risks nor can the company assess the impact of all factors on its business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements.

Given these risks, uncertainties and assumptions, the forward-looking events discussed during this call may not occur and actual results could differ materially and adversely from those anticipated or implied. The company undertakes no obligation to publicly update forward-looking statements for any reason after the date of this call to conform these statements to actual results or to changes in the company’s expectations except as required by law. Also during this call, we will refer to certain non-GAAP financial measures, which we consider to be an important measure of the company’s performance. These non-GAAP financial measures are provided in addition to and not as a substitute for or superior to financial performance prepared in accordance with U.S. GAAP.

A discussion of why we use non-GAAP financial measures and reconciliations between our GAAP and non-GAAP financial measures is available in the earnings release we issued today, which can be accessed using the Investor Relations portion of our website. With that, I’ll now turn the call over to our CEO. Bill?

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Bill Brennan: Thank you, Dan. Good afternoon and thank you to everybody for joining the call. During this call, I’ll review Credo’s fiscal Q2 results and share why we remain excited about our future prospects. After I conclude, Dan Fleming, our Chief Financial Officer will provide a detailed review of our financial results and expectations moving forward. Credo is a pure play high speed connectivity company. We built our first solutions for the ethernet market and are extending into other standards based markets as the need for higher speed connectivity increases exponentially. Today, our product families include integrated circuits or ICs, active electrical cables or AECs and service chiplets. Our intellectual property or IP solutions consist primarily as SerDes licensing.

Our connectivity solutions address both electrical and optical applications at port speeds currently ranging from 50 gigabits per second, up to 1.6 terabits per second. All our product and IP solutions leverage our unique application specific SerDes portfolio, enabling us to deliver optimized, secure and high speed solutions with better power efficiency and cost. This has led to high growth rates with hyperscale customers and the ecosystem of suppliers that provide the infrastructure to these data centers. Credo continues to be one of the fastest growing companies in the semiconductor industry, and I’m pleased to report that we achieved record revenue of $51.4 million in the October quarter, an increase of 94% year-over-year and 11% sequentially.

I’ll now give a brief update on our progress across our various solutions, starting with AECs. For AECs, we continued to deliver strong execution as the pioneer of this product category. In-rack, low speed cable connections have historically been made with passive copper DACs, as single lane speeds increased 100 gigabits per second, DACs become obsolete due to signal integrity and physical size constraints. The industry assumption has been that when DACs are dead, optical cables or AOCs would take their place. Credo saw an opportunity to develop a broad product family of AECs that deliver half the power, half the cost and with 10 times better reliability than AOCs. We also saw the opportunity to offer compelling functionality that enables our customers to innovate on server rack and switch rack architectures.

Industry analysts are now forecasting AECs to grow to a multi-billion dollar market in the next four to five years. We continue to ramp volumes with our first customer as they broaden deployments of the new dual tour architecture enabled by the Credo AEC. We expect the ramp to continue in the calendar ’23 and we’re developing multiple AEC solutions to solve for their future roadmap of higher speed deployments. I’m happy to report that Credo has completed the stringent qualification with our second hyperscale customer. We expect to begin our revenue ramp near the end of this fiscal year and expect meaningful contribution in fiscal ’24. In addition, we are engaged in developing advanced AEC solutions with this customer for their next generation server rack and switch rack applications, as they move to 100 gig single lane speeds.

We have also further broadened our traction in the market, we’re currently in qualification with a third hyperscale customer for a 400 gig port switch rack application and yet with another hyperscale customer we’re engaged in developing AECs for two future architectural deployments. Although hyperscalers are clearly our primary focus we’ve sold our AECs to dozens of customers, including data centers, 5G carriers, networking OEMs and ODMs, as well as others in the ethernet ecosystem. Finally, Credo is very proud to have introduced the industry’s first 1.6 terabit per second connectivity solution at OCP, which will be a critical enabler for the 51 terabit per second switch generation. This reinforces Credo as the leader in the AEC market. Now moving to our optical solutions category, as we do across all our product solutions, Credo focuses on delivering disruptive solutions that are optimized for speed, reach, power and cost.

Our optical solutions include DSPs, laser drivers and TIAs found in both optical modules and AOCs, and span the breadth of applications with 50 gigabits and 100 gigabits per second single lane speeds, including 50 gig, 64 gig, 100 gig, 200 gig and 400 gig modules. In the October quarter, we announced several new 100 gig per lane products, including our (ph) 800 and 400 optical DSPs with integrated drivers and they’ve been met with great customer enthusiasm. In addition to engaging the optimal module customer base directly, our go-to-market strategy has grown to include the joint development model or JDM that is focusing on the end customers of our optical module manufacturing partners. These include data center, 5G, PON and fiber channel end customers as a means to have the end customer pull Credo’s through to design wins by specifying our solution.

To-date, we’ve been successful with JDM engagements with two hyperscalers and a Tier 1 OEM. We are now actively engaging all data center customers directly and teaming with optical module partners to jointly pursue our end customers. I’m pleased with our progress as we now have line of sight on new engagements with several data center and 5G customers across a wide range of applications including 200 gig, 400 gig, 800 gig and 50 gig solutions. I’ll note that we see the process from initial win to qualification to volume ramp as taking longer in the current environment than we had anticipated a year ago. With that, our rent material revenue shifted somewhat, but our opportunity remains the same. We continue to play the role of the structure in the optical market and we will gain share over time given the distinct efficiencies we deliver in the combination of performance, power and cost.

Based on our increasing customer traction, we look forward to announcing meaningful customer wins and growth in our optical business. Regarding our Line Card PHY solutions, Credo has established leadership for ethernet Line Card PHY solutions at 50 gig and 100 gig per lane speeds. This includes MACsec PHYs for high security applications needing encryption, as well as retimer and gearbox solutions. Our customers again include leading hyperscalers and networking OEMs and ODMs. As single lane speeds increased to 100 gig, the demand for Line Card PHYs increases due to the signaling integrity challenges that come with higher speed copper connections. We also see a trend toward greater demand for encryption driving increased demand for MACsec PHYs. A highlight from the OCP show in October was meta showing the use of our Osprey 800 MACsec PHY in one of their critical deployments.

Also in October, we announced our screaming Eagle 100 gig per lane solution, a long reach DSP retimer device with 1.6 terabits per second of bandwidth. This product has received great market reception, due to its combination of performance and power efficiency. We have sampled it to many leading OEMs and ODMs and are already kicking off design engagements. Based on our current market position, product positioning and customer engagements, we expect solid growth and continued share gain in the market. And finally, I’d like to give an update on our SerDes IP licensing and SerDes Chiplet business. We’ve received very positive feedback from customers on our five nanometer and four nanometer 112 gig IP SerDes announcement and it confirms that Credo solution offers a 40% to 50% power advantage over our competition depending on the reach required in the application.

This highlights the Credo has extended what we refer to as our N minus one process advantage, which means to compete with the power efficiency of Credo’s five nanometer and four nanometer solutions, our competitors will need to move to three nanometer. As every industry seeks to lower its carbon footprint, Credo’s Core SerDes technology is delivering on the need to lower electricity use. We’re also an early leader in the chiplet market and are in production with multiple customers. Notably, Tesla selected Credo certified the N chiplets for their Dojo supercomputer program. Going forward, we’re excited about the prospects for chiplets in light of the UCIE consortium. This Intel led consortium where we’re a contributing member is coalescing to standardize the broad use of chiplets inside servers.

In summary, we remain highly encouraged about Credo’s prospects due to our current solutions and production near and mid-term opportunities we’re deeply engaged in and longer term opportunities in emerging markets. Today, we remain focused on delivering strong accretion in our fiscal ’23 and we continue to expect to achieve at least $200 million in revenue, representing more than 88% growth, compared to fiscal €˜22. I’ll now turn the call over to our CFO, Dan Fleming, to provide more details on our second quarter and give guidance on Q3.

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Dan Fleming: Thank you, Bill, and good afternoon. I will first review our Q2 fiscal ’23 results and then discuss our outlook for Q3 of fiscal ’23. As a reminder, the following financials will be discussed on a non-GAAP basis unless otherwise noted. I’m pleased to share with you that in Q2, we achieved another quarter of record revenue at $51.4 million, up 11% sequentially and up 94% year-over-year. Sequential growth was driven by strong revenue growth of our products, which also reached a record of $48.1 million for the quarter, up 33% sequentially and up 143% year-over-year. This growth in product revenue was led by a continued wave of AEC adoption. The fundamental driver of our product growth a strong HSBC expansion outlook at the highest speeds remains in place in the face of an uncertain economic and geopolitical landscape.

Our IP business generated $3.3 million of revenue in Q2. IP remains a strategic part of our business, but as a reminder, our IP results may vary from quarter-to-quarter, driven largely by specific deliverables to pre-existing contracts. While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q2 was 6% IP well below our long-term expectation for IP, which is 10% to 15% of revenue as the timing of IP deliverables and therefore IP revenue recognition shifted during the quarter. We continue to expect IP as a percentage of revenue to come in above our long-term expectations for the fiscal year. Due to the revenue mix between product and IP this quarter, our gross margin came in at 54.9% below our guidance range.

However, more importantly, our product gross margin was 52.6% in the quarter, up 80 basis points sequentially and up 4.8 percentage points year-over-year. This product margin expansion is principally due to leverage from our strong product growth. Total operating expenses in the second quarter were $25 million within our guidance range and up 37% year-over-year, as we scaled the organization for growth. I think it’s important to note that this is considerably below our 94% year-over-year revenue growth. We generally expect that our top line will grow at least twice as fast as our OpEx for the foreseeable future. With this, we expect to continue to deliver considerable leverage in the business. Our OpEx increase was driven by a 38% year-over-year increase in R&D.

As we continue to invest in the resources, to deliver innovative solutions. Our SG&A was up 34% year-over-year, as we continue to build out public company infrastructure. We delivered operating income of $3.4 million in Q2, an improvement of $5.6 million year-over-year, but down 41% sequentially. Our operating margin was 6.6% in the quarter, an improvement of 15.1 percentage points year-over-year, but down 561 basis points sequentially, due to revenue mix that resulted in lower gross profit. We delivered net income of $2.4 million in Q2, an increase of $5.7 million year-over-year, and down 55% sequentially. Cash flow from operations in the second quarter was $1.8 million, an increase of $27.7 million year-over-year and an increase of $14 million sequentially.

CapEx was $5.7 million in the quarter, driven by production mask spending. And free cash flow was negative $3.9 million, an increase of $25.7 million year-over-year and an increase of $13.6 million sequentially. We ended the quarter with cash and equivalents of $240.5 million, a decrease of $3.2 million from the first quarter. This decrease in cash was a result of continued working capital investments to support our top line revenue growth. Our accounts receivable balance decreased to 5.5% sequentially to $51.8 million, while days sales outstanding decreased to 92-days, down from 107-days in Q1. Our Q2 ending inventory was $47.8 million, up $10.8 million, sequentially as we continue our product ramp. Now turning to our guidance for the third quarter, we currently expect revenue in Q3 fiscal ’23 to be between $54 million and $56 million, up 7% sequentially at the midpoint and 73% year-over-year.

We expect Q3 gross margin to be within a range of 59% to 61%. We expect Q3 operating expenses to be between $25 million and $27 million. And finally, we expect Q3 weighted average diluted share count to be approximately 160 shares. And with that, I will open it up for questions.

Q&A Session

Operator: Thank you. Our first question comes from the line of Quinn Bolton with Needham & Company.

Quinn Bolton: Hey, guys. Congratulations on the strong product results. Bill, I guess, I wanted to start on the AEC business. Several questions, it sounds like you continue to expand your hyperscale relationships, but wondering if you can sort of talk about the growth in the — I think you mentioned a couple of these guys looking at switch applications rather than server applications and was hoping you could expand on that thought? Is this the distributed to segregated switch chassis applications for the third and the fourth hyperscaler, as well as I think you mentioned the switch application for your second hyperscaler?

Bill Brennan: Yes. Let me say that we really have two opportunities for AECs within the switching hierarchy and the server racks as well. So the largest opportunity that we see are server racks and the market forecasters show that, that market in comparison to the disaggregated chassis or what we call switch racks market, it’s probably a five to one. Now in the switching architecture, it’s really a big choice between sticking with what has traditionally been most popular, which is a big chassis filled with switches connected internally over a backplane. To the segregation, which means pulling those switches out of the chassis and basically stacking them vertically in a rack, those backplane connections become connections between the switches within the rack, 2.5 meters or less.

And so we fully expect that over time each data center customer is going to make their own decision about the architecture that they pursue, but it’s good. We’re encouraged with the fact that as switching lane speeds increase to 50 gig and 100 gig that for those customers that are moving or have been using switch racks, compared to chassis that our solution is naturally getting picked up.

Quinn Bolton: Understood. Second question just on the competitive landscape for the NIC to ToR application, I know the first couple of hyperscale you’re working with, I believe you’re using proprietary or non-standard cables? Are you seeing any evidence that those customers are looking to second source those designs? Or do you feel pretty comfortable that Credo remains the sole source of those cables for the foreseeable future, which hopefully would extend that at least a few quarters?

Bill Brennan: So I think that there’s still question that the data center customers generally speaking want multiple sources. So that’s absolutely part of the world that we live in. My feeling is that more and more as the data center customers recognize that they can add functionality to an AEC that they haven’t even been able to think about with racks or optical solutions. The idea of having this fabric become more intelligent, it’s natural that the team that we’ve built, which is a large team of engineers and different functions to be able to entertain specific requests for added functionality to the AEC. So we’re open for business. If the engineers within the data centers that we’re working with have ideas, we’ll entertain those ideas as a way to make their jobs easier, make the innovations better from their end from a server rack or switch rack perspective.

Now competitively, we’ve talked about the competitive moat that we’ve established and the fact that I’ve got the team that’s doing the full system integration. It’s not as if selling a chip to a copper cable manufacturer really opens that door for this kind of innovation. So I think that, yes, we naturally see competitors, we naturally see our customers wanting to secondsource. And I think that we still haven’t seen competitors in the wild in the labs of our customers. We’ve heard about competitors’ attention to enter the market. We’ve seen static demos where they’ll have a cable that’s not hooked up to anything and they will describe what the cable does. And we’ve seen demos with eval boards that are connected to passive copper cables. So these are far from actual qualification at a hyperscaler.

And I think that, I think when we look at the OCP Conference in October, it was a really great measure of our leadership, especially in contrast to the other competitors. I think that anybody that attended the conference could not avoid seeing purple, which is the color of our cables. We were the purple AECs were ubiquitous from end-to-end on the show floor. And to note the progress that we’ve made year-over-year, last year we showed the world’s largest router to-date, a three rack deployment that made up of 350 terabits per second router. This is built with 400 gig ports, each with eight lanes of 56 gig or 50 gig. This year, we showed the clear benefit of going faster from the lane speed and wider with the number of lanes. And so we introduced our 1.6 terabits per second AEC at this show, 16 lanes of 100 gig and we demonstrated that same capacity or that same bandwidth, the 350 terabits per second in a single rack deployment.

And so this was one of many, many demonstrations that we gave and it was just clear anybody to show that just physically if you can see it, we’re far ahead of our competition.