MACOM Technology Solutions Holdings, Inc. (NASDAQ:MTSI) Q1 2023 Earnings Call Transcript

MACOM Technology Solutions Holdings, Inc. (NASDAQ:MTSI) Q1 2023 Earnings Call Transcript February 2, 2023

Operator: Welcome to MACOM’s First Fiscal Quarter 2023 Conference Call. This call is being recorded today, Thursday, February 2, 2023. At this time, all participants are in a listen-only mode. I will now turn the call to Mr. Steve Ferranti, MACOM’s Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.

Steve Ferranti: Thank you, Olivia. Good morning, and welcome to our call to discuss MACOM’s financial results for the first 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.

Steve Daly: Thank you, and good morning. I will begin today’s call with a general company update. After that, Jack Kober, our Chief Financial Officer will provide a more in-depth review of our financial results for the first quarter of fiscal 2023. When Jack is finished, I will provide revenue and earnings guidance for our second fiscal quarter, and then we will be happy to take some questions. Revenue for our first fiscal quarter of 2023 was $180.1 million and adjusted EPS was $0.81 per diluted share. Our financial performance translated to strong cash flow from operations of $38 million, and we ended the quarter with $595 million in cash and short-term investments on our balance sheet. Our book-to-bill ratio for Q1 was 0.9. This was the first time in eight quarters that our book-to-bill was less than 1.

Our turns business or revenue booked and shipped within the quarter was approximately 13% of our total revenue. Overall, our sales team executed well in Q1, albeit in a challenging market environment. On our last earnings call, we highlighted that demand was weakening in our three end markets. Today, I can report that the business environment has not improved. For this reason, we expect our Q2 book-to-bill ratio to be less than 1. Weakness is most prevalent at our largest 5G telecommunications and broadband access infrastructure customers as well as many of our data center customers. Generally speaking, our major customers in these markets are slowing orders, and they are focused on reducing inventory levels. Beyond our main customers, broadly speaking, demand is also weak.

However, one bright spot is that our Industrial and Defense end market continues to perform well, and demand for our products is strong. Additionally, our backlog entering fiscal Q2 remains at historically high levels despite the current softness in bookings. I think it’s important to emphasize that we balance our short-term financial goals with a long-term perspective. And despite the current slowdown, we remain confident in our strategic plan and our future growth prospects. MACOM is positioned to capitalize on a number of secular trends across our end markets related to growing bandwidth needs and increasing data rates, which in turn drive the need for higher power levels and higher frequency transmission signals. Our customer systems are more complicated than ever before and they need specialized suppliers like MACOM to provide high performance solutions.

Many of our products have long life cycles and produce revenue for years after they’ve been introduced with the potential to generate best-in-class financial returns. We view the diversity of our technologies, products and end markets as an inherent strength of our company, helping to provide financial stability. And finally, the quality of competitiveness of our products released to the market over the past few years is outstanding, and it continues to improve. Turning to our end markets for fiscal Q1. Industrial and Defense revenue was $77.2 million, down 1.8% sequentially, Telecom was $61.5 million, down 0.8% sequentially and Data Center was $41.5 million up 10.2% sequentially. The sequential growth in Data Center was driven by a combination of increased shipments of our Crosspoint switches and networking products, both of which had been supply constrained during much of FY2022, along with a modest increase in our high performance analog portfolio.

While we see softness in current large production programs, we remain engaged in a wide range of exciting new opportunities, which we believe will drive MACOM’s future success. I would like to highlight a few recent engagements to illustrate the breadth of our customer base and applications. All of these wins have multi-million dollar revenue potential. Our diode team continues to be a leader in the market for discrete control products in diode circuits, including high power switching and high power limiters. We have secured a new high power limiter socket on an Aegis shipborne radar platform. The team has also won new sockets on automatic toll detection platforms and achieved two design wins on an automotive wireless communication system. Our high performance analog, or HPA team, continues to diversify their revenue and has successfully penetrated a Tier 1 U.S. defense OEM with custom IC design wins.

The application is a mobile Manpack high power radio. They also secured a large IC development contract from a major customer to support next-generation and DDR memory test infrastructure. Our MMIC team is actively supporting various U.S.-based radar and satellite system requirements that utilize our trusted foundry and gallium arsenide technologies. Specifically, our MMIC team has won close to $10 million in development contracts across a wide range of customers, functions and solutions. Our metro long haul design team is supporting data center customers that are designing next-generation coherent light or ZR light systems, and we have won an 8x 200G driver in TIA socket to support a major U.S. Internet service provider with production ramping this fiscal year.

These wins validate that our products and solutions are compelling and that MACOM is a trusted partner to support critical or long-term programs. These examples also illustrate we are gaining market share in our core markets. Most of these wins are coming from new products, and we believe a portion of our future growth will come from our most recently introduced products, which everyone knows takes time to ramp up. As an example, we are excited to be sampling our new 10G XGS PON laser and customers have confirmed the product meets their system requirements. This market is a high volume market. And while today, we have no laser sales in the 10G XGS PON, we expect that to change over the next 12 months. In addition, our Lightwave team continues to successfully engage with customers on 25G DFB design wins.

More and more of our customers are completing their requisite 5,000-hour module HTL qualifications, which is required by the ISP or network end users. These wins will support future revenue beyond Q2. I would like to review a few key activities across the business. First, our engineers, sales and applications team will be attending the Optical Fiber Conference, or OFC, in March, where we will be highlighting our latest products to our customers in hosting eight live product demonstrations at our booth, including we will demonstrate a 200G per lane solution to support 1.6 terabit OSFP module designs. Our chipset solution includes MACOM’s industry-leading coherent drivers and transimpedance amplifiers along with a new photodetector offering.

200G per lane applications are the leading edge of high-speed data throughput in the industry today. We will also demonstrate MACOM’s PURE DRIVE solution for optical connectivity in conjunction with switch hardware from a leading U.S. ASIC supplier. Our PURE DRIVE solution comprises of a linear driver in transimpedance amplifier designed specifically for single mode and multimode PAM4 architectures that operate up to 800G. Our innovative chipset has been designed to support broad dynamic ranges, linear equalization and low noise amplification to enable direct connection to switch and server ASICs. This solution represents industry-leading low power, low latency solutions for 100G per lane optical communications. As previously announced, approximately two years ago, we established a company priority to transfer a 0.14 micron GaN on silicon carbide MMIC process from the Air Force Research Labs to our wafer fab in Massachusetts with the goal to commercialize the technology and make products for our aerospace, defense and commercial customers.

I’m happy to announce that the process is being released to production this month. We are excited to now offer our customers a state-of-the-art GaN on silicon carbide technology with industry-leading power density. In parallel with the transfer activities, our IC design engineers have been designing products on the process and we will begin introducing these products later this month. Our flagship mimic product from this process, which is available for sampling in sale today is the MAPCMP003, a Ka-band power amplifier designed for satellite uplink applications. This MMIC amplifier provides 10 watts of output power and delivers power-added efficiency or PAE performance, which is comparable with the best products in the market today. This process will support MMICs that operate up to about 40 gigahertz including power amplifiers, low noise amplifiers, high-power switches and transmit receive ICs as well as beam-forming ICs. We are very excited about achieving this production release and product launch milestone, and I congratulate the entire team for getting it done on schedule and on budget.

We believe this process opens a $300 million segment of the high-frequency GaN on silicon carbide MMIC market. As you may have seen in a press release issued earlier today, I am pleased to announce MACOM has entered into a definitive agreement to acquire the assets and operations of OMMIC SAS, a semiconductor manufacturer located near Paris, France. OMMIC has a 40-plus-year heritage in three, five materials and specializes in gallium arsenide and gallium nitride, epitaxy, wafer processing and integrated circuit design. The OMMIC team comprises of approximately 100 employees, including process engineers, skilled IC designers and technicians and wafer production staff. Today, the company has a small portfolio of differentiated products and compelling compound semiconductor processes suitable for microwave and millimeter wave applications in telecommunications, aerospace and defense.

This acquisition provides numerous strategic benefits to MACOM. First, OMMIC’s high-frequency processes and products expand and strengthen MACOM’s portfolio so we can better address our target markets. OMMIC’s team have spent years developing and refining their proprietary 100-nanometer and 16-nanometer MMIC processes, and we plan to build upon their expertise. Today, they offer very high-frequency products including true time delay, radar core chips, high-power amplifiers as well as low-noise amplifiers that have industry-leading performance. Simply put, OMMIC produces products that typically operate at higher frequencies than MACOM’s. Second, OMMICs material and epitaxial growth expertise is world-class, and we believe strengthening our material science expertise in epi growth knowledge and manufacturing capabilities is strategic, increasing our in-sourcing of epi growth across our entire business has the potential to simplify our supply chain, increase our gross margins on certain products and improve our products’ performance all of which improve our competitive advantage.

Photo by Christian Wiediger on Unsplash

Third, OMMIC represents a significant revenue growth opportunity. Historically, OMMIC has serviced a small customer base, many of whom were foundry customers. We believe we can grow their customer base and associated revenues significantly. Revenue growth will also come by leveraging MACOM’s larger IC design team onto their processes to accelerate expansion of their standard products portfolio and by emphasizing custom chip development work at major OEMs. We are also confident our larger global sales force can gain market share with their existing products. I’ll note several of OMMIC’s processes and products are already qualified by the European Space Agency or ESA for satellite use. Fourth, we see an opportunity to fully utilize their idle 6-inch wafer manufacturing capability to improve gross margins and profitability on both OMMIC and MACOM products.

While they have purchased and installed a 6-inch wafer production line, they have not yet transitioned their production to the 6-inch line. Today, OMMIC runs all production on their 3-inch line and notably, MACOM’s Massachusetts fab is a 4-inch fab. And finally, this acquisition significantly expands MACOM’s European presence, which will enable us to better serve European-based customers, which is a strategic focus for us. Having an engineering and manufacturing operation inside the EU will enable us to better access a wide range of customers in aerospace, telecommunications, industrial and automotive markets. We have a strategic goal to increase our European business to offset any potential future geopolitical headwinds from other regions.

The acquisition is structured as an asset purchase for consideration of approximately €38.5 million. MACOM will purchase OMMIC’s assets and operations using existing cash on hand. The purchase includes OMMIC’s existing business operations, intellectual property, real estate and facilities. We expect the transaction to close during MACOM’s second fiscal quarter. However, I would like to highlight that the transaction is subject to regulatory approvals and customary closing conditions. Jack will now provide a more detailed review of our financial results.

Jack Kober: Thanks, Steve, and good morning, everyone. The first quarter of fiscal 2023 was in line with our expectations with sequential improvements in revenue as well as record operating margin and earnings per share. Revenue for the first quarter was $180.1 million, up 1% quarter-over-quarter. The sequential increase was driven by a modest increase in data center revenue. On a geographic basis, sales to domestic U.S. customers represented approximately 49% of our fiscal Q1 results compared to 50% in the fourth fiscal quarter of 2022. Q1 sales to China customers represented approximately 23% compared to approximately 26% for both our Q4 and full year fiscal 2022. I would also like to highlight that sale to European customers over the past four quarters has been approximately 6%.

And as Steve highlighted, focusing on growing revenue in this region is a strategic priority for us. Adjusted gross profit was $112.7 million, or 62.6% of revenue flat sequentially. As we’ve discussed in the past, MACOM utilizes a flexible manufacturing model leveraging our Lowell and Ann Arbor fabs, as well as third-party foundries. This allows us to access a portfolio of proprietary leading process technologies and also provides financial leverage as business cycles change. Total adjusted operating expense was $53.9 million consisting of R&D expense of $33.9 million and SG&A expense of $20 million. Total operating expenses were down sequentially by $600,000 from fiscal Q4 2022 due to slightly lower R&D expenses. Adjusted operating income in fiscal Q1 was $58.8 million, up from $56.9 million in fiscal Q4.

Adjusted operating margin was a record 32.7% for fiscal Q1 sequentially up from 32% in Q4. We are closely managing our operating expenses as we balance investments in the business while maintaining profitability. Over the longer term, we see leverage in our operating model as we introduce new products and they contribute to future revenue growth. Depreciation expense for fiscal Q1 was $6 million and adjusted EBITDA was $64.9 million. Trailing 12 months, adjusted EBITDA was $244.7 million as compared to $234.8 million in Q4 fiscal 2022. Adjusted net interest income for fiscal Q1 was $1 million, up from $40,000 in fiscal Q4. The higher returns on our growing portfolio of short-term marketable securities more than offset the increased interest expense associated with our floating rate term loan.

Our adjusted non-GAAP income tax rate in fiscal Q1 remained at 3% and resulted in an expense of approximately $1.8 million. Our cash tax payments were $300,000 for the first quarter, down slightly from fiscal Q4 2022. We expect our adjusted income tax rate to remain at 3% for the remainder of fiscal year 2023 and into fiscal year 2024. Fiscal Q1 adjusted net income was $58 million compared to $55.1 million in fiscal Q4. Adjusted earnings per fully diluted share was $0.81, utilizing a share count of 71.4 million shares compared to $0.77 of adjusted earnings per share in fiscal Q4. Now moving on to balance sheet and cash flow items. Our Q1 accounts receivable balance was $112 million, up from $101.6 million in fiscal Q4. As a result, day sales outstanding were 57 days compared to 52 days in the prior quarter.

Our accounts receivable balance reflects an increase over prior periods due primarily to the increase in sales and the timing of shipments in the quarter. Inventories were $121.3 million at quarter end, up by $6.4 million sequentially. We had a modest increase in certain finished goods due to customer requested delivery postponements occurring during the quarter. Inventory turns were 2.2 times in Q1, down slightly on a sequential basis from 2.3 times in the prior quarter. The quality of our inventory remained strong and based on lower customer orders and shortening lead times, we expect to reduce our net inventory balance as we progress through fiscal year 2023. Fiscal Q1 cash flow from operations was approximately $38.3 million. As we’ve noted on our prior call, we experienced a sizable increase in cash flow from operations during our September quarter due to the timing of working capital items and our current fiscal Q1 figure represents a moderated operating cash flow level.

Capital expenditures totaled $9.6 million for fiscal Q1, up from $7.7 million in the prior quarter. We plan to continue to make CapEx investments to expand our fab capacity and expand technical process capabilities over the next few quarters. We still expect fiscal 2023 CapEx to be in the range of $40 million. As we’ve done in the past, we will continue to carefully manage our capital spending, balancing investments in new technologies, process development capabilities and efficiency programs with the overall profitability of the business. In addition to pursuing CHIPS Act funding, I would also like to highlight that we expect the CHIPS Act to provide an advanced manufacturing investment tax credit of 25% for certain of our capital expenditures placed into service after January 1, 2023.

This tax credit will apply to certain qualifying capital items, and we do not expect the associated cash from these credits to be received until fiscal year 2024. We expect these tax credits will be recognized as an offset to depreciation expense over time. And as such, we do not anticipate this tax credit to have a material impact on our financials for fiscal year 2023. Cash, cash equivalents and short-term investments for the fiscal first quarter were $594.7 million, up from $586.5 million in fiscal Q4 2022. Our first quarter gross leverage is down to less than 2.5, and our net debt is now less than $10 million. I would also like to highlight that during the quarter, the MACOM team has engaged in our annual stockholder outreach to better understand and discuss governance items with our top stockholders as we approach our annual meeting on March 2, 2023.

Before turning it back to Steve, I’d like to note a few items. First, our Q2 guidance includes plans to manage our discretionary spending down by approximately 10%, including reduced variable compensation, outside service fees and supplies expense to name a few. Through these efforts, we expect to support healthy margins and remain cash flow positive over the course of these business cycles. Second, MACOM is excited to acquire OMMIC’s valuable European-based operation. It’s new and differentiated technology, as well as a dedicated and talented workforce at what we believe to be a favorable valuation. In the short term from a financial perspective, OMMIC should not have a meaningful impact on our revenue or EPS. However, longer term as we invest in the business, we expect that it will provide growth and profitability opportunities, which will drive additional stockholder value.

I look forward to 2023 and the continued investments MACOM plans to make in our people, plant and processes, and also to welcome the OMMIC team to MACOM. I will now turn the discussion back over to Steve.

Steve Daly: Thank you, Jack. MACOM expects revenue in fiscal Q2 ending March 31, 2023 to be in the range of $166 million to $170 million. Adjusted gross margin is expected to be in the range of 61.5% to 63.5%. And adjusted earnings per share is expected to be between $0.76 and $0.80 based on 71.5 million fully diluted shares. This guidance does not include any revenue contributions or financial impact from the plant OMMIC acquisition. In Q2, we expect our sequential Industrial and Defense and Data Center revenues to be down slightly in the balance coming from weakness in our Telecommunications business. As I have noted, we maintain a long-term perspective on executing our strategy. We are confident that we can continue to improve our financials and take market share in the months and years ahead. Our product portfolio is stronger than it was one year ago, and we are confident we can meet or exceed our targets. I would now like to ask the operator to take any questions.

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Q&A Session

Operator: Thank you. Now first question coming from the line of Quinn Bolton with Needham. Your line is open.

Quinn Bolton: Hey guys. Congratulations on the strong 2022 results. I guess as we look into the first part of 2023, obviously, you’re guiding down for March on weakness and demand and some inventory correction. But do you have a sense, how long do you think the inventory correction across your end markets you will last? Do you think that’s largely a first half of the calendar year event and you see recovery and revenue as you look into the second half of the year? Or can you give us any sort of senses how you think the revenue pattern may look this year?

Steve Daly: Yes, good morning, Quinn. So it’s really difficult for us to be giving guidance on customers inventory trends. So I think that’s something that we would struggle to give an accurate answer on. When we €“ so that’s the sort of the first part of your question. And then when we look at the balance of our fiscal 2023 and we look at the markets and our backlog and make projections what we’re thinking is at least two of our three markets will be up. We believe I&D, Industrial and Defense, will continue to grow during the course of the year. And we also believe that our data center will continue to do well and should certainly grow on a year-over-year basis. The one area that we’re probably most concerned about is the telecom.

As everybody knows, we had a very, very strong FY 2022 with 30% growth. And so this year we do see that weakening. As I mentioned on my prepared remarks, 5G and the broadband markets are weak at the moment, and it’s difficult for us to understand when those might turn. And the other point I’ll make is generally speaking, there is a macro overhang on many of the €“ our markets. And so it’s difficult for us to make these longer-term projections. I hope that answers your question, Quinn?

Quinn Bolton: It does. Thank you, Steve. And then I guess, either for Steve or Jack, I guess as you look at the OMMIC acquisition, it sounds like they maintained manufacturing operations with the fixed expense of operating the three-inch fab plus having an idle six-inch fab. And so I guess, can you just walk us through sort of the impact as you close that transaction? It sounds like there’s enough revenue through that fab that largely offset any fixed expenses of maintaining those operations. Is that the right way to think about it?

Steve Daly: I think that’s right. I think you should think of their overall revenue run rate at sort of that 1% to 2% of our total revenue. So it’s a very low number today. And so our plan is as we talked about to not only build out the product line, market the product line globally, but also begin to migrate their products to the six-inch line. And in doing all of that, we think that the business has tremendous potential for growth. And let me just maybe highlight if I could. This is the first acquisition that the MACOM, new management team has done. And I just like to say that the rationale for this acquisition I think are important for investors to understand. OMMIC brings to MACOM an expertise that we don’t currently have today.