MACOM Technology Solutions Holdings, Inc. (NASDAQ:MTSI) Q4 2023 Earnings Call Transcript

MACOM Technology Solutions Holdings, Inc. (NASDAQ:MTSI) Q4 2023 Earnings Call Transcript November 9, 2023

MACOM Technology Solutions Holdings, Inc. beats earnings expectations. Reported EPS is $0.56, expectations were $0.55.

Operator: Welcome to MACOM’s Fourth Fiscal Quarter 2023 Conference Call. This call is being recorded today, Thursday, November 09, 2023. At this time, all participants are in a listen-only mode. I will now turn the call over to Mr. Steve Ferranti, MACOM’s Vice President of Corporate Development and Investor Relations. Mr. Ferranti, please go ahead.

Steve Ferranti: Thank you, Livia. Good morning, and welcome to our call to discuss MACOM’s fourth financial quarter and financial year 2023 financial results. 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.

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 fourth quarter and full year results for fiscal 2023. When Jack is finished, I will provide revenue and earnings guidance for the first fiscal quarter of 2024, and then we will be happy to take some questions. Revenue for Q4 was $150.4 million, a slight increase over the prior quarter. Adjusted EPS was $0.56 per diluted share, and operating cash flow was approximately $50 million. For the full fiscal year ending September 29, 2023, revenue was $648 million, and adjusted EPS was $2.70 per diluted share. Fiscal 2023 revenue and EPS were both down 4% year over year.

We completed two small but strategic acquisitions in fiscal ’23, which combined, contributed approximately 2% to our total fiscal year ’23 revenue. During the fiscal year, we eliminated all of our remaining short-term debt and funded these acquisitions using cash recently generated by the business. We ended the fiscal year with approximately $515 million in cash and cash equivalents. In Q4, our book-to-bill ratio was 1.1 to 1. In our turns business, our orders booked and shipped within the quarter was approximately 16% of total revenue. These are positive trends, and notably, Q4 bookings improved across all three of our end markets. Improvements were led by pockets of strength at certain defense and Data Center customers. Our total company backlog increased slightly quarter-over-quarter, and it remains at a healthy level.

We are starting the new fiscal year in a strong position. While we are pleased with the recent improvement in total bookings, in certain markets, orders remained weak in Q4. Demand continues to be weak in telecom and to a lesser degree in certain parts of the industrial markets, and we remain negative on the near-term outlook for these markets. However, more positively, we see growing demand in Data Center, aerospace and defense, as well as in satellite communication markets. Fiscal Q4 revenue by end market was as expected, with industrial and defense at $79.2 million, Data Center at $40.5 million, and telecom at $30.6 million. I&D was down 5% sequentially, Data Center was up 52% sequentially, and telecom was down 20% sequentially. Notably, our top 10 end customers represented approximately 30% of our total revenue in fiscal 2023, and no one customer was more than 10% of our total revenue.

We maintain a highly diversified customer base consisting of thousands of customers. Industrial and defense was a strong market for us during fiscal 2023, and revenues achieved a historic level. Fiscal 2023 represented our third consecutive year of growth within the IND market, with 8% year-over-year growth. In fact, the I&D market with 8% year-over-year growth. In fact, over the last three years, our I&D revenues achieved an 18% compounded annual growth rate. We believe our growth initiatives for this market are on track. Core to our strategy is expanding our serviceable addressable market or SAM within the I&D market by launching compelling new products. As a reminder, examples of new growth initiatives, which we’ve discussed in prior quarterly calls, includes our new 0.14 GaN on silicon carbide process, kilovolt capacitors or KV caps, and BAW filters.

These product lines are still in the early stages of their growth and product life cycles. One important area of the I&D market we are supporting is the RF over fiber segment. In these applications, customers convert RF or microwave signals into light by directly modulating a linear laser. This resulting signal can be transmitted over fiber with minimal signal degradation or loss versus traditional coax cable. Fiber provides a lower weight and more secure transmission compared to coax. RF over fiber is ideal for demanding applications like SATCOM ground station networks, distributed antenna systems, and many defense applications like secure communications, critical GPS systems, and radar systems, all of which require high reliability and long life cycles while operating in harsh environments.

MACOM’s strength in microwave and optical design, laser and detector technologies, and ruggedized packaging and subsystem manufacturing capabilities positions us for growth in this segment of the defense market. We are seeing a growing number of long-term program opportunities today. Another area of focus for MACOM in industrial and defense is further penetrating the test and measurement market. A notable recent new product introduction for this market segment is our optical clock recovery or OCR solutions. Here our high performance connectivity team is leveraging our PHY [ph], our high speed optical receivers, and high performance analog design expertise. MACOM’s OCRs can be used in our customer’s production test environment to validate their performance of their short reach 400G and 800G optical transceiver products.

Our telecom end-market revenues continues to be weak. In fiscal year 2023, telecom was down 24% year-on-year. Weakness in this market is broad based, spanning most of our larger subsegments including 5G, Metro long haul, cable infrastructure, and passive optical networks. That said, we believe the secular growth drivers for telecom remain intact. Global telecom infrastructure needs to expand capacity to carry higher data rates and more bandwidth all while having lower latency. As an example, recently a US carrier completed field trials in New York State which demonstrated 1.2 terabits per second of data over a single wavelength of long haul in a long haul metro application as part of an ongoing fiber optic upgrade. MACOM supported this trial with our products.

One segment in the telecom market which we believe is growing is broadband satellite communications or SATCOM and many of these ground and satellite systems operate at microwave or millimeter wave frequencies, which plays to our expertise. Telecom remains an attractive and diverse market and we see numerous opportunities to expand our position in this market. Our Data Center end market revenues grew sequentially in Q4. In addition, for the full fiscal year 2023, Data Center revenues grew by 6% year-over-year, growth that was primarily driven by high data rate short reach applications. The Data Center market continues to provide growth opportunities for MACOM and we expect new product introductions will be the primary growth driver for us in this market.

We are focused on designing and producing industry leading cross point switches, high speed TIAs and laser drivers for a wide range of applications. Our strategy is to be the first to market when data rates jump to higher speeds. As an example, we recently announced and demonstrated an industry-leading 200G per lane transimpedance amplifier or TIA for short reach applications and a 200G per lane linear equalizer for use in active copper cables. Both products will support 1.6T deployments. Data Center architectures continue to evolve. We believe many of today’s deployments require significantly more short reach optical and/or copper cable to make connections. Our high performance connectivity team offers an industry-leading portfolio of products at 50 G, 100 G, and 200 G per channel to support these requirements.

In some applications, our solutions enable lower cost, lower latency, and lower power consumption versus traditional solutions. Additionally, our linear equalizer products enable copper interconnects to be extended in reach and into higher speed applications. Previously, a market segment addressed with more expensive active optical cables, or AOCs, and pluggable transceivers. Our solutions have been tested with the latest generation of switch ASICs available on the market today, and our customers are pleased with the performance. Given we are at the start of a new fiscal year, I would like to review our long-term strategy, briefly recap some of last year’s accomplishments, and review our priorities for fiscal 2024. Simply put, our strategy is to focus on the highest power, highest frequency, and highest data rate applications in our three core markets.

We align our R&D and product development resources around these themes, and then, using our annual strategic planning process, establish near and long-term goals to strengthen our portfolio’s competitiveness and to position the company for future success. Our goal is to have our technical teams work closely with our customers to provide unique options for them to consider. By leveraging a wide breadth of unique technologies with world-class manufacturing strengths, we believe we can attract many customers and gain additional market share. We believe customers will seek out suppliers who can, over the long term, become strategic partners. During last year’s Q4 earnings call, we outlined our priorities for fiscal ’23. Our team made meaningful progress against those stated priorities.

As a reminder, a central theme we communicated then was to capture market share in ’23. We believe we’ve been gaining market share by increasing our new product offerings, expanding our technology base, and strengthening our presence in certain geographic regions. As I’ve mentioned, a key component of our strategy involves building a portfolio of compelling semiconductor processes to support high frequency and high power applications. The opening of our MACOM European Semiconductor Center expanded our manufacturing capacity, added epitaxial growth expertise, bolstered our European presence, and strengthened our design teams. This acquisition supports our strategic goal to establish a leadership position in very high frequency semiconductor [indiscernible] process technologies and products.

While this was a relatively small acquisition, we believe it is strategic and it brings us tremendous growth potential. We are confident our strategy will enable higher than average return on invested capital and therefore support our goals of establishing exemplary profitability and cash flow. In support of diversifying our revenues geographically, we are expanding our sales efforts across Europe. During Q4, we attended the European Microwave Week in Berlin, where we hosted a number of live demonstrations at our booth, which featured our latest products and technologies. In addition, we are pleased that the European Space Agency, or ESA, recently completed a site visit at our France facility. We intend to build new relationships with major organizations and customers across Europe with the goal of driving long-term revenue growth, diversifying our customer base and adding further stability to our overall business.

During the year, we introduced 170 standard products and increased an increase of 15% compared to last year. We also had great success with our custom IC development activities and we supported a wide range of customer-funded projects. We recognized that continued investments in expanding our design engineering, new product prototyping, and engineering test capabilities will ensure we move quickly and rapidly bring products to market and ultimately gain market share. As we look ahead to fiscal year 2024, we anticipate that the rate of new product introductions will further accelerate. In fact, we believe it is possible to launch 50% more products in FY’24 compared to FY’23. As we focus on fiscal year ’24, our priorities include extending our leadership in RF and microwave applications, taking market share on GaAs and GaN mimics, continuing to gain traction with our high-speed analoge solutions for short-reach data center applications, completing the integration activities of our recent and pending acquisitions, driving additional growth of our RF power, analog and lightweight product areas, building out and growing our module and subsystems business in select high-performance markets, ensuring management challenges, develops and rewards employees, and supports their needs to ensure they have a long and enriching career at MACOM and last, managing the business and strategy to enable us to achieve record earnings for the future.

In summary, MACOM has a wide range of products in production today. Many of these products have long life cycles and can produce revenues for years after they’ve been introduced. We view these business attributes as an inherent strength of our business model. And last, I’ll note that MACOM and Wolfspeed have been working collaboratively on a carve out of their RF business over the past few months. I would like to thank the integration planning teams from both companies for their great work. Our integration planning efforts include aligning the team we are hiring, their organizations, and the ERP and other data systems with MACOM’s infrastructure, so we are fully operational and independent at closing. I have no doubt this transaction will be a win for MACOM.

Jack will now provide a more detailed review of our financial results.

Jack Kober: Thank you, Steve, and good morning, everyone. Before getting into the details of our quarterly results, I would like to summarize a few items associated with our fiscal year 2023 financials. As Steve noted, fiscal 2023 was down approximately 4% from a top and bottom line perspective. Despite this, we’ve been able to maintain adjusted gross margins in excess of 60%, with full year fiscal 2023 adjusted gross margin of 61.3%. During fiscal 2023, we have maintained solid and consistent cash flow generation, which has allowed us to close and fund two strategic acquisitions with available cash and also pay off the remaining $121 million balance of our term loan that was scheduled to mature in May 2024. Now, on to our Q4 quarterly results, as well as some additional commentary on our full fiscal year 2023 and outlook on fiscal year 2024.

Revenue for the fiscal fourth quarter was $150.4 million, up 1.2% sequentially, based on growth in our data center and market. On a geographic basis, revenue from U.S. domestic customers represented approximately 46% of our fiscal Q4 results, down from 49% in fiscal Q3. We’ve been working to geographically diversify our business and are pleased to have a healthy mix of U.S. and international-based revenue opportunities. On a fiscal year ’23 annual basis, revenue from U.S. domestic customers represented 48%, up slightly from 47% in the prior year. A notable trend is our fiscal year ’23 revenue from the China market decreased, while revenue to our European-based customers grew compared to the prior year. Adjusted gross profit for fiscal Q4 was $90.3 million, or 60.1% of revenue, essentially flat from the third quarter.

Total adjusted operating expense for our fourth fiscal quarter was $53.1 million, consisting of research and development expense of $33.8 million and selling, general and administrative expense of $19.3 million. The modest sequential increase in adjusted operating expense was primarily driven by incremental costs from our recent acquisitions, partially offset by lower spending across the remainder of the MACOM-based business. Depreciation expense for fiscal Q4 was $6.3 million and $24 million for fiscal year 2023, essentially flat on an annual basis. MACOM’s asset base includes a variety of production and research and development equipment that we are continuously working to optimize, which has helped to keep our capital expenditures and the associated depreciation expense relatively stable over the years.

Adjusted operating income in fiscal Q4 was $37.2 million, up slightly from $37 million in fiscal Q3. For fiscal year 2023, adjusted operating income was $189.6 million compared to $211 million for fiscal 2022, resulting in a 200 basis point reduction in adjusted operating margin compared to fiscal 2022. For fiscal year 2024, our team plans to further integrate and optimize our acquisitions, further executing on incremental synergies and cost savings while running the entire business with a continuous improvement mindset and working to increase our operating margin over the course of the year. For fiscal Q4, we had adjusted net interest income of $4.2 million compared to net interest income of approximately $2.8 million in fiscal Q3. Fiscal year 2023, adjusted net interest income was $10 million compared to an expense of $2.6 million in 2022.

The increase in fiscal year 2023 adjusted net interest income was driven primarily by higher yields on our short-term investment balances. Our adjusted income tax rate in fiscal Q4 was 3% and resulted in an expense of approximately $1.2 million. Our net cash tax payments were approximately $100,000 for the fourth quarter and $2.9 million for fiscal year 2023. We expect our adjusted income tax rate to remain at 3% for fiscal year 2024. As of September 29, 2023, our deferred tax asset balance was $218 million as compared to $237 million at the end of fiscal 2022. We anticipate further utilizing our deferred tax asset balance through fiscal 2024 and into fiscal 2025, helping to keep our cash tax payments relatively low over these periods. Fiscal Q4 adjusted net income increased to $40.1 million compared to $38.5 million in fiscal Q3.

Adjusted earnings per fully diluted share was $0.56, utilizing a share count of 71.8 million shares compared to $0.54 of adjusted earnings per share in fiscal Q3. Now moving on to operational balance sheet and cash flow items; our Q4 accounts receivable balance was $91.3 million down from $105.9 million in fiscal Q3 due to improved shipment linearity and strong collection activity during the quarter. As a result, day sales outstanding were 55 days compared to 65 days in the prior quarter. Inventories were $136.3 million at quarter end, down sequentially from $139 million. Inventory turns were 1.8 times up sequentially in Q4 from 1.7 times in the prior quarter. We recognize that our inventory balance is relatively high and associated turns continue to be relatively low.

However, the quality and mix of our inventory is strong and continues to support our strategic backlog. Fiscal Q4 cash flow from operations was approximately $50.4 million, up $4.5 million sequentially. Capital expenditures totaled $5.8 million in fiscal Q4. Fiscal 2023 annual CapEx of $24.7 million decreased slightly from $26.5 million in fiscal 2022. Our operations and facilities teams are very disciplined and do a great job managing our capital expenditure budget. As we move into fiscal year 2024, we expect our capital expenditures to be in the range of $30 million to $35 million for the full year. Next, moving on to other balance sheet items. Cash, cash equivalents and short-term investments for the fourth fiscal quarter were $514.5 million, down $73.1 million sequentially, driven by the $121 million paydown of the remaining term loan.

I am pleased to note that as the end of our fiscal year 2023, we were in a net positive cash position of approximately $25 million after closing two acquisitions and paying off the term loan. Our balance sheet and cash generation remain sound and we continue to exercise leverage over our operations and discretionary spending to support MACOM’s target margins through ongoing cyclical pressure. In summary, fiscal 2023 was a solid year for MACOM and I am proud of our team’s performance and accomplishments and believe the diverse, resilient portfolio we have built will support future growth of the business. In addition, we are working with Wolfspeed to close our previously announced acquisition of their radio frequency business before the end of December.

As we have previously discussed, we expect the RF business to be immediately accretive to MACOM’s non-GAAP earnings and this acquisition is not expected to change MACOM’s long-term adjusted gross margin goals of being above 60%. We also expect the business to generate enough cash to provide a 100% return of the purchase price in around three years. We believe that based on the structure of the transaction, actions to be taken prior to closing, as well as post-closing synergies, we will be able to improve the current gross margins of the Wolfspeed’s RF business. That said, given MACOM’s and Wolfspeed’s RF business’s current revenue levels, we anticipate modest gross margin pressure immediately following closing, as certain post-closing synergies will take time to realize.

We believe the acquisitions announced during fiscal 2023 will be strategic for MACOM’s capacity, capability, and customer base for fiscal year 2024 and beyond. I will now turn the conversation back over to Steve.

Steve Ferranti: Thank you, Jack. MACOM expects revenue in fiscal Q1 ending December 29, 2023 to be in the range of $149 million to $153 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 $0.55 and $0.59 based on 72.2 million fully diluted shares. In fiscal Q1, we expect industrial and defense and telecom revenues will be down or flat quarter over quarter and data center revenues will be up 10% quarter-over-quarter. Our guidance does not include any contributions from the pending acquisition of Wolfspeed’s RF business, which we expect to close prior to the end of December. We maintain a long-term perspective on executing our strategy, and we are confident that we can continue to improve our financials and take market share in the months and years ahead.

Our level of engagement with leading customers is improving, and we have a robust opportunity pipeline. In short, we believe MACOM will be bigger, stronger and more profitable in fiscal 2024. 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 Tore Svanberg with Stifel. Your line is open.

Tore Svanberg: Yes, thank you. My first question is on the industrial and defense business, especially in the near term, Steve. You said there’s some puts and takes there, especially in the industrial. Perhaps some areas are still doing okay, but others are perhaps weak. So, could you just elaborate on which of the segments that are holding up versus those that may potentially be seeing some weakness?

Steve Daly: Sure. I would say, in general, across the board, our defense business is strong. So, that segment is doing quite well, and it’s our expectation that that strength will continue as we move into 2024. On the industrial side, I would say that there’s probably three areas that I would call out as being weak. One would be the medical segment, which we support primarily with MRI systems and things like that. Second would be general sensors. These could be automotive traffic sensors or industrial sensors and then the third would be our supporting the general RF and microwave testing measurement segment, where we see our major customer’s demand is quite weak.

Tore Svanberg: Yeah, that’s very helpful and as my follow-up for Jack, obviously, we’re not including any financials from the Wolfs [ph] acquisition this quarter, although obviously it sounds like it’s going to close before the end of the quarter, but you mentioned some gross margin pressure initially. Could you maybe expand on the magnitude of that? Are we talking about maybe a couple hundred basis points, or should we start to think about potential more dilution than that?

Jack Kober: Thanks, Tori. And I think you were referring to the Wolfspeed RF pending acquisition.

Tore Svanberg: Sorry, I apologize.

Jack Kober: That’s all right. I just wanted to make sure we were aligned. There may be some slight dip that we may see as we work through the closing, but I wouldn’t expect that to be that significant and to last for a longer duration. Our gross margin story remains intact, and expectations are to be back up into the 60% range. Even as we work our way through the closing and shortly after that time period, there’s a possibility that we could remain above the 60%. There’s just a lot going on that we need to digest as we work our way through the closing period and integration time period.

Operator: And our next question, coming from the line of David Williams with the Benchmark Company. Your line is open.

David Williams: Hey, good morning. Thanks for taking my questions, and congrats on navigating this challenging environment. I guess first maybe on the data center business, do you expect to see any seasonality there, and how long do you think this continuation of demand can be sustained? Is it throughout 2024? Do you see a period in which we might see maybe a step back in the data center, maybe slow a bit for you?

Steve Daly: Thank you for the question, David. So the data center, which is today our smallest segment, is probably our most volatile segment, and I would probably characterize the revenue as dependent on ramps, ramping up and ramping down, as opposed to seasonality, sort of calendar-based seasonality. Today what we see is, certainly we saw this quarter, very strong growth, primarily from short-reach applications, and we believe that growth will continue as we’re guiding 10% growth this quarter off of tremendous growth in Q4. As we look into 2024 and even into our fiscal 2025, we think the strength will remain, but there will definitely be a shift from what today is, let’s say, 400 gig and 800 gig demand to more 1.6 terabit-based demand, and we feel we’re on that cutting edge.

So we do believe there’ll be volatility over the next 24 months as things turn on and turn off, but generally speaking, we think we’re well-positioned and we’ll have a good ’24, and we’ll see how things shake out in our fiscal ’25.

David Williams: Thanks for the color. And then just, if I recall, most of the Wolfspeed acquisition, most of the products are expected to kind of flow through that industrial side. How do you think about this segment, just kind of given the macro weakness you’re seeing and we’ve been hearing about on the industrial side? Anything change there in terms of your short-term thinking and synergies or other fundamentals?

Steve Daly: Well, yes, and I think we have a lot of thoughts about the Wolfspeed business, and I really don’t want to comment on sort of how they characterize their business today. We’ll certainly do that on our next earning call when we talk very specifically about perhaps some of the changes we’re going to be making and some of the focus that we’ll make, but I would highlight that it’s a very strategic acquisition for us. They have compelling technology and growing markets, whether it’s A&E, industrial, or telecom. They have a tremendous built-in customer base today that really spans our industry, and they have a real strong portfolio of high-voltage, lower-frequency process technology that today MACOM does not have. So we’re very excited about it.

We’ve been working with the management team, as Jack mentioned. We’ve gone through and done a lot of work to make sure that the resources that we bring over support our growth as well as financial targets, and we think we’ve done a reasonable job there trying to sort of pick the team that will ensure success in the future. So very excited about that, but I really can’t comment about exactly their business today, and we’ll talk more about that after the close.

Operator: Thank you. And our next question, coming from the line of Quinn Bolton with Needham. Your line is open.

Quinn Bolton: Hey, guys. I’ll echo my congratulations on steady execution in a challenging market. Steve, I wanted to kind of follow up on a data center question. You guys have seen some pretty strong growth in September and forecast to continue to grow in December, admittedly off a low base, but it sounds like the transition to 400 gig, 800 gig, and in the future 1.6 gig modules is driving a lot of that growth. And I guess I’m wondering on the PMD side of the business, are you benefiting from a move back to more discrete PMDs that are silicon, germanium or compound semiconductor-based rather than CMOS-based as we move to those higher speeds? Do you see that trend to higher speeds benefiting your PMD portfolio?

Steve Daly: Right. So I would say that a few things. Certainly, the trend to the higher data rates is an area where we want to position ourselves. We use a wide range of process technologies, not just silicon-based, but also three, five based. And so we’ll make sure we bring the right technology to bear on the application. So I don’t necessarily want to comment any further in terms of what flavors or what process of technology we’re using for certain applications. That’s competitive information, let’s say. The other thing I’ll highlight is we have, while we are seeing very strong growth on the higher data rates, we are seeing a lot of weakness at the lower data rates, including the NRZ, both at 25G and 100G, whether it be AOCs or pluggable transceivers for the data center.

So our data center business is shifting. It’s a bit of a mixed bag, but the good news is we have some real bleeding-edge technology for those PMDs that you mentioned, specifically the TIAs and the drivers, the equalizers and we’ve really built out a really nice portfolio there. And I have to highlight that within each one of these product categories, there’s multiple products. We find that our customers are designing their systems in a very unique way. So oftentimes, we target applications and target footprints that are unique to those sockets and given the speeds and the data rates, we feel like that’s necessary. So this is not a commodity product. It’s not something that’s easily removed from a platform, let’s say and so for that reason, it has very attractive business attributes.