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M/A-COM Technology Solutions Holdings (NASDAQ:MTSI)

F2Q 2014 Earnings Conference Call

April 29, 2014 5:00 p.m. ET

Executives

John Croteau – President and Chief Executive Officer

Robert McMullan – Chief Financial Officer

Leanne Sievers - EVP, IR, Shelton Group

Analysts

Blayne Curtis – Barclays Capital

Steven Smigie – Raymond James

Harlan Sur - JPMorgan

Erik Rasmussen - Stifel, Nicolaus & Co.

Richard Sewell – Stephens Inc.

Operator

Good afternoon, and welcome to M/A-COM Technology Solutions’ Second Fiscal Quarter 2014 Financial Results Conference Call. At this time all participants are in a listen-only mode. At the conclusion of today’s conference call, instructions will be given for the question-and-answer session. (Operator Instructions) As a reminder, this conference call is being recorded today, Tuesday, April 29, 2014.

I would now like to turn the call over to Leanne Sievers of Shelton Group, the Investor Relations agency for MACOM. Leanne, please go ahead.

Leanne Sievers

Good afternoon, and welcome to MACOM Technology Solutions’ second quarter 2014 earnings conference call. I'm Leanne Sievers, Executive Vice President of Shelton Group, MACOM's Investor Relations firm. With us today are MACOM's President and Chief Executive Officer, John Croteau; and Senior Vice President and Chief Financial Officer, Bob McMullan. If you’ve not yet received a copy of the press release, you can access a copy on M/A-COM’s website at www.macom.com under the Investor Relations section.

Before I turn the call over to Mr. Croteau, I’d like to remind our listeners that management’s prepared remarks contain forward-looking statements, which are subject to risks and uncertainties, and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the safe harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those discussed today and therefore, we refer you to a more detailed discussion of the risks and uncertainties that could result in those differences in the company's filings with the Securities and Exchange Commission, including its Form 8-K filed today and its annual report on Form 10-K filed on December 5, 2013.

In addition, any projections as to the company’s future performance represent management’s estimates as of today, April 29, 2014. M/A-COM assumes no obligation to update these projections in the future, as market conditions may or may not change. Additionally, the company's press release and management's statements during this conference call will include discussions of certain non-GAAP measures and financial information. These financial measures and a reconciliation of GAAP to non-GAAP results are provided in the company's press release and related current report on Form 8-K, which was filed with the SEC today and can be found at the Investor Relations section of M/A-COM’s website. For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 30 days in the Investors Relations section of MACOM's website.

And now, I'd like to turn the call over to M/A-COM’s President and CEO, John Croteau. John, please go ahead.

John Croteau

Thank you, Leanne. Welcome everyone and thank you for joining us today. I’ll begin today’s call with an overview of our second quarter results, and then turn the call over to our Chief Financial Officer, Bob McMullan. Bob will review our financial performance in further detail. I’ll then conclude today’s prepared comments by providing an update on the progress we’ve made in integrating the Mindspeed acquisition and our guidance for the third fiscal quarter before opening the call for questions.

Diving straight into the results, Revenue for the second quarter was $107.5 million. Non-GAAP gross margin was 49.3%, with non-GAAP net income of $15.2 million or $0.32 earnings per diluted share. During fiscal Q2, revenue and earnings per share for the M/A-COM businesses came in above the high end of guidance, with non-GAAP gross margin improving 270 basis points from the prior quarter, rounding out another quarter of solid execution by the MACOM team.

Looking at our results by end market, Networks was up strong sequentially. This growth was slightly offset by softness in aerospace and defense, primarily due to program timing and a few customers. Multi-market was effectively flat, and automotive performed as expected, down slightly based upon what we believe are normal fluctuations in production at Ford.

Let me now turn it over to Bob to review our fiscal second quarter financials in more detail.

Robert McMullan

Thank you, John and good afternoon. During the course of my comments and John’s, all income statement amounts and percentages will be discussed on a non-GAAP basis. The non-GAAP measures discussed today exclude retroactive adjustments related to the Nitronex acquisition discussed in our press release. Nitronex’s operating results are included in our non-GAAP results on the date of acquisition. Management believes non-GAAP information enhances the understanding of our core operating performance and a reconciliation of each non-GAAP amount to the most comparable GAAP measure is included in today’s earnings press release.

Our fiscal second quarter was the first full quarter of the inclusion of Mindspeed’s results following the closing of the acquisition on December 18 2013.

Revenue was $107.5 million, representing a sequential increase of 28.7% compared to $83.5 million in the prior quarter, and an increase of 38.1% compared to $77.8 million in the fiscal second quarter of 2013. On a pro forma basis, revenue increased sequentially 2.8%. Revenue by end markets were the following; Carrier networks $38 million, 35%; Enterprise networks, $12.5 million, 12%; A&D $19.8 million, 18%; Auto $20.1 million and 19%; Multi-markets $17.1 million and 16% of total revenue. Domestic revenue represented 47% and international 53%. Our largest end customer continues to be Ford, representing approximately 18.7% of the total revenue. No other end customer represents more than 4% of total revenues.

Gross profit in the fiscal second quarter was $53 million or 49.3% of revenue. This compares to $38.9 million and 46.6% of revenues in the prior quarter and $34.6 million and 44.5% in the prior year’s fiscal quarter. Gross margins continued to improve quarter-over-quarter due to higher margins, product mix of revenue, including the addition of Mindspeed’s generally higher gross margin products.

Total operating expenses were $31.6 million compared to $22.7 million in the prior quarter and $19.7 million in the prior year’s fiscal quarter. Specifically, R&D expense for the fiscal second quarter was $17 million. This compares to the expense of $10.9 million in the prior quarter and $9.7 million in the fiscal second quarter of 2013. R&D as a percentage of revenue represented 15.8% in the fiscal second quarter, compared to 13% in the previous quarter and 12.4% in the prior year’s fiscal quarter. The sequential and year-over-year increase in R&D was the result of continued investments in high gross margin, new product development and the inclusion of Mindspeed and Nitronex investment.

Selling, General and Administrative expenses were $14.6 million compared to $11.8 million in the previous quarter and $10.1 million in the prior year's fiscal quarter. SG&A as a percentage of revenue represented 13. 6% in the fiscal second quarter compared to 14.2% in the previous quarter and 12.9% in the prior year's fiscal quarter. The increase in dollars is generally related to the broader sales organizations, while the decrease in percentage of revenue is greater leverage of G&A.

Income from operations was $21.4 million or 19.9% of revenue. This compares to $16.2 million or 19.4% of revenue in the prior quarter and $14.9 million and 19% of revenue in the prior year's fiscal quarter.

EBITDA was $24.8 million, up from $19.2 million and $17.6 million respectively.

For income taxes, our effective income tax rate for the fiscal second quarter was 23.5%, indicative of the continued benefits related to utilizing net operating loss carry forwards and other business strategies.

Our fiscal second quarter net income was $15.2 million or $0.32 per diluted share compared to fiscal first quarter net income of $12.1 million or $0.25 per diluted share and net income of $11.7 million or $0.24 per diluted share in the prior year’s fiscal quarter.

Share count was 48.2 million, 48.6 million and 48 million respectively.

Net cash from operating activities was negative for the first fiscal half by $5.2 million. Approximately $18 million represents transaction expenses and restructuring payments that are non-recurring from behind us.

Capital expenditures in the fiscal second quarter were $3.5 million or 3.3% of revenue compared to $2.1 million or 2.6% of revenue in the fiscal first quarter and $3.1 million or 4% of revenue in the fiscal second quarter of 2013.

Depreciation expense on property and equipment for the fiscal second quarter was approximately $3.4 million compared to $2.9 million and $2.6 million respectively.

Turning to the balance sheet. As of April 4, 2014, our cash and cash equivalents were approximately $63 million. During the fiscal quarter we used $25 million of our revolving credit facility for the acquisition of Nitronex, increasing outstanding long-term debt to $245 million.

Accounts receivable of $67.9 million compares to $66.5 million at the end of the prior fiscal quarter and $49.6 million at the end of the year ago quarter.

Day sales outstanding were up marginally 57 days compared to 56 days at the end of the prior fiscal quarter and 58 days at the end of the year ago quarter.

Inventory was $71.9 million compared to $88.7 million in the prior fiscal quarter, $57.2 million in the year ago quarter, eliminating the fair market value step-up reduction. Inventory turns were 3 times compared to 3.1 times in the prior fiscal quarter and 3 times in the year ago quarter.

Moving from our results to the fiscal quarter, M/A-COM is in the final stages of refinancing its bank revolving credit facility. We expect to close this week. The new facility is $450 million comprising of $350 million seven year term lease secured loan and $100 million revolving credit agreement. Initial draw down will be $350 million. This refinancing has many positive implications for M/A-COM including, less restrictive financial covenants, extended principal maturity, initial access to institutional lenders and credit agency ratings, and importantly greater available capital for future acquisitions. This is a significant capital transaction in the continuing evolution of M/A-COM.

Near term, the greater level of outstanding debt and higher interest costs will have a dilutive effect per fiscal quarter of an estimated $0.03 per share. We expect to redirect the capital to further acquisitions, which will increase our future earnings. M/A-COM is a disciplined consolidator and now a proven integrator of strategic acquisitions. We believe we have many attractive strategic opportunities as our industry undergoes consolidation. We do not at this time have an imminent transaction that will offset the near term dilutive effect of the refinancing. We are confident that refinancing will greatly enhance shareholder value in the long term as evidenced by the Mindspeed transaction.

I’ll turn the call back to John.

John Croteau

Thank you, Bob. This quarter was all about integrating the Mindspeed acquisition. During our first full quarter of combined operations, we closed the sale of Mindspeed’s wireless business to Intel and enhanced a definitive agreement to divest the CPE business to Freescale, which resulted in very substantial headcount and expense reductions. We exited the quarter with Ex-Mindspeed headcount of 206 people, down from 478 at closing on December 18, the previous quarter.

During the quarter we reduced our real estate footprint, combining or closing eight different Mindspeed offices globally. In addition, we integrated our information technology systems with complete and successful BI, BRP and CRM integrations. Our accelerated integration allowed us to beat the high end of our previously stated guidance $0.05 above midpoint and $0.32 earnings per diluted share. Put in perspective that $0.07 above pre-Mindspeed consensus for Q2 in line with our commitment to deliver $0.15 to $0.20 of accretion in fiscal 2014 as stated at the time of our announcement last November. I’m extremely proud of our team and their ability to execute on this multi-faceted rate acquisition and rapid integration. With the integration behind us, this is the last time you will hear the name Mindspeed in our discussion of M/A-COM’s financial projections and performance.

In addition I would like to provide a quick update on key announcements during the quarter. Early in March we were at OFC, the industry’s premier Optical Trade Show. Driving home our 100G optimal electronics leadership position, we announced three customer wins with Source Photonics, Molex and JDSU. In addition, we unveiled the industry’s first integrated CDR and modulated driver for CFP4 form factors, showcasing our ability to leverage our Silicon Germanium expertise to uniquely deliver products that lower power and reduce food price.

Looking strategically in longer term, at NAD earlier this month, we unveiled the industry’s first 12G SDI product family, which firmly establishes us as a preeminent supplier to the video broadcast industry. 12G SDI is the next gateway in the evolution of the serial digital interface standard in video production and broadcasts. It’s required to support 4K video resolutions at 60 frames per second over a single coaxial cable or optical fiber, something many previously thought unfeasible. By releasing the industry’s first complete 12G SDI chipset to complement our line of 12 gigabyte per second Crosspoint Switches, we are able to leapfrog the market and provide key building blocks to build 4K video production and broadcast systems today.

As I’ve highlighted previously, our RF microwave industry is on the cusp of a major transition from gallium arsenide to gallium nitride or GaN Technology. This shift will be felt far and wide, impacting our industry and others in profound ways for decades to come. We believe GaN technology will ultimately disrupt as much as 80% of our target markets and applications. And we are happy at the opportunity for MACOM to drive very significant share gains.

During the quarter, we made great strides towards facilitating this transition. First, we announced the acquisition of Nitronex. This acquisition immediately equips M/A-COM with the broadest portfolio of GaN based products in the industry, as well as a deep portfolio of fundamental intellectual property in the field of GaN-on silicon materials, process and device technology for RF and microwave applications. We believe we can use this IP position as an offensive weapon to erect and defend strong barriers to entry and further solidify our leadership position in these fields.

Second, during the quarter we announced an agreement with IQE, the world’s premier supplier of compound semiconductor material, which we believe is the first step to achieving our goal of scaling capacity and driving cost structure for GaN materials to mass market adoption points. This remains a major barrier to the adoption of GaN technology for mainstream commercial applications. At maturity, we believe that MACOM’s GaN and silicon technology will benefit from silicon cost structures that are three times lower than today’s highest volume gallium arsenide technology in handsets and 100 times lower than today’s GaN on silicon carbide technology which everyone other than Nitronex uses today. Let me repeat. This will deliver the industry’s highest compound semiconductor performance at a cost structure that’s three times to 100 times lower cost than incumbent technologies. We believe the combination of Nitronex and IQE will enable MACOM to drive this technology transition deeply and let’s establish premier positions in almost all commercial markets and applications that we address today. We expect these will be key for MACOM, driving sustainable growths\ and profitability for decades to come.

To conclude my comments, I want to reiterate that I’m very pleased with the strong execution in completing the Mindspeed acquisition in the first full quarter of combined operations. This sets the stage for realizing the full benefits of the operational and financial synergies, as well as cross-selling opportunities in the second half of our fiscal year.

Turning to our guidance. For the third quarter, taking into account our expectation that the sale of the CPE business will close in our third fiscal quarter, we currently expect revenues to be in the range of $108 million to $112 million and non-GAAP gross margin between 49% and 53%. Based on our expectation that our term B loan refinancing will also close this quarter, non-GAAP earnings per diluted share between $0.30 and $0.33 on an expected 49.3 million shares outstanding. If for any reason the term B doesn’t close this quarter, we expect that non-GAAP earnings will range between $0.33 and $0.36 per diluted share.

With that, operator, you can now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Blayne Curtis of Barclays. The line is open.

Blayne Curtis – Barclays Capital

John, maybe just on the outlook for the June quarter, is there any difference between your segments? You saw the weakness in A&D. Does that come back for you? And if you could just talk about your outlook for the carrier networks which your seeing some strong end market trend.

John Croteau

Sure, Blayne. Actually from an outlook standpoint, everything is up into the right. Every segment, every business unit, every product line is booked at a level that we’re confident will grow across the board. So there’s nothing that stands out more or less other than the fact that, as you noted, we did have a soft quarter for A&D. Backlog is consistent with that recovering to full and full recovery to the previous run rates.

Blayne Curtis – Barclays Capital

Got you. And then Bob, the OpEx actually came in a little bit better for March, obviously a lot of moving pieces with the two acquisitions. It seems like you’re guiding it up in June. Is that just Nitronex or can you -- and then can you talk about the synergies going forward. You were looking to realize those over the next couple of quarters. Did you get some of that earlier in March? If you can just walk through the different puts and takes that are available.

Robert McMullan

Yeah. Blayne, starting from the last question, we did realize the synergies quickly and efficiently in the first quarter here and that’s why we did a little better. But we do have some programs that are incremental expenses on the development side that do increase OpEx moving into the fiscal third quarter.

Blayne Curtis – Barclays Capital

Okay, got you. And then maybe a final one for John. Obviously again on Silicon, it’s quite disruptive. It comes with challenges as well. Can you talk about the milestones that you need to hit to get products here and does Nitronex have any real revenue today that you added in? Thanks

John Croteau

Sure, yeah. So Nitronex absolutely came with revenues. I don’t think that they’re material in the grand context of MACOM revenues today, but they’re not immaterial. And from an EPS stand point it’s -- the effect is relatively de minimis on the upside or down side. But your comments about again on silicon being disruptive and the status on where that stands, actually Nitronex was acquired by John Ocampo, our Chairman and Primary Investor about 18 months ago. So we’ve been working behind the scenes as a licensee of that technology in tracking and engaging with some lead customers and we pulled the trigger actually when we had convinced ourselves and those customers that the technology was fully ready for prime time in some mass markets without exception. So, the remaining aspects which we’ve made great progress with IQE and we continue to make great progress hopefully over the next quarter we can have some additional exciting announcements. Everything now from our perspective relates to the commercial aspects, getting the cost structure and the capacity in line. The technical challenges again on silicon we’re now convinced are behind us. Great question though.

Operator

The next question is from Steven Smigie of Raymond James. Your line is open.

Steven Smigie – Raymond James

Great. Thanks a lot and congratulations on the nice report and guide here. Real quick on the guidance. So can you talk a little bit about what the CPE impact is in the quarter? It seems like the guidance might have been even somewhat further ahead if that were still in the fiscal third quarter. So just curious about the CPE impact.

Robert McMullan

Hi Steven. Obviously if we kept it longer -- if we keep it longer, we will harvest the business if the transaction does not close. So we’re in a position to believe that it will close, not hard evidence. There’s third party items, conditions to closing that must be completed that neither party control in this process here, but they’re moving along. The business is not strategic. It is low on margin and whether it goes up or down, it doesn’t have a dramatic effect outside of the guidance that we have provided. If the transaction is completed, we’re comfortable with the guidance level across the topline and EPS level as well

Steven Smigie – Raymond James

Okay great. And then just following up on acquisition stuff. You’re talking a little bit about Nitronex. You talked about GaN-on silicon or GaN in general taking an 80% share going forward. John, I know you had a pretty positive experience I think at NXP with LDMOS, where you were able to take a lot of share. I think you talked about that. Can you share your experience with that and if that’s the similar type of opportunity you see here and what would you give some confidence in the big initiative you’re talking about?

John Croteau

It’s a great analogy. When I joined NXP, it was right about the time that they had on their LDMOS, silicon LDMOS roadmap and intersected Freescale. Part of that Freescale really had a free run in the LDMOS world with about 70% share in NXP and Infineon really trails far behind. Once the technology intersection occurred, we managed to drive fairly dramatic share gains. And so my old friends at NXP, I understand now they may actually be ahead of Freescale in terms of that LDMOS world. So it’s testament to the fact that semiconductor technology in these high performance RF markets is really a primary technology driver -- a primary market driver in terms of the ability to drive very significant share shifts, and your analogy is spot on. GaN-on silicon, both against gallium arsenide for the more traditional MACOM markets and in fact against LDMOS with the more power RF markets is a dislocator, a disruptive force and our clear agenda is to drive exactly those sorts of share gains. And I’d love to be able to do it in a similar timeline. It took us 3 or 4 years at NXP. And it would be wonderful if we could pull of the same thing again with GaN-on silicon.

Steven Smigie – Raymond James

Thanks. And since my first two were on acquisitions, let’s do my third one there. Obviously you’ve done some nice financing here or are about to. What are your first objectives in terms of this? I think you talked about it a little bit, but would you prefer to bulk up a little bit on maybe the defense side or where is the best opportunity? And should we assume it’s at least something like 10% accretive as an objective or something like that?

John Croteau

Yeah. We have some baseline financial metrics. There’s different types of M&A. You can see Mindspeed was a much larger transaction than Nitronex for instance. We also do things, like we did Optomai a few years ago which was a [free M&A] acquisition. But the major transactions that you’re referring to like Mindspeed, I would describe as follows. It’s all about adjacency and a lot of it has to do with bulking up in the areas where we have already identified our areas that we want to establish pre-eminent positions. In the case of Mindspeed, we had identified 100G optical as a strong market industry growth driver for the next decade. And that particular acquisition allowed us to really establish the broadest technology, broadest market footprint, just a pre-eminent position under the optical. Nitronex on a smaller scale did the same thing in this GaN space. So certainly one of the criteria I look for is an acquisition that allows us to as I said bulk up in the areas that we think will be the industry and market growth drivers.

Robert McMullan

And Steven, I would add the point when I say disciplined, it really translates to neutral to accretive in the first full fiscal year.

Operator

Our next question is from Harlan Sur of JPMorgan. Your line is up.

Harlan Sur - JPMorgan

Great. Thank you for taking my questions and solid job on the quarterly execution guys. You mentioned -- going back to some of the prior questions. You mentioned you are taking into account the CPE acquisition close in the June quarter. So does this mean that you are not including CPE revenues in your June quarter guidance or are you including partial revenues? And if you are including CPE partial sub quarter, how much of that is contributing to the June quarter guidance?

John Croteau

So it absolutely includes partial. I mean it’s still part of the company now. We are almost a month into the quarter, right? So obviously some is included. The way we describe it is the range of time of closing and the range of revenue is fully incorporated into our range of guidance. So if we manage to close on the CPE transaction, we will have no need to update guidance.

Harlan Sur - JPMorgan

Okay. But can you just give us a sense of what the June quarter revenue contribution from CPE could be, because if you do execute the transaction these revenues will drop off in the September quarter.

John Croteau

We don’t breakout any of our businesses by product line, our business unit. But suffice to say you’ll continue to see growth quarter upon quarter upon quarter under any condition.

Harlan Sur - JP Morgan

Okay, got it. Great. And then on the Nitronex acquisition on the manufacturing front, where do they do most of their manufacturing in-house? And if they do do it in-house, does the MACOM team have any plans to move the manufacturing to Lowell or to your partner GCS?

John Croteau

Yeah. So, the primary wafer fab for Nitronex over recent years has been a company called GCS in Southern California, where you get compound semiconductor manufacturer we use as well. GCS is a great partner. In fact we partnered with them to transfer GaN-on Silicon carbide technology, which is proceeding very nicely, a great company to work with. The end game, to answer your question is eight inch, not four inch, not six inch, but eight inch scale volume silicon manufacturers someone who we are talking and in fact we have eight inch wafers in line today and the way to think about it is, the real opportunity again on silicon is to leverage the scale volume for GaN and silicon on things like power conversion and LED lighting. And by comparison, our little RF and microwave space that we plan to continue focusing on is very small by comparison. I’m going to give you a metric here to put things in context. An entire year’s production for our entire RF and microwave industry can be serviced within a week or so from one eight inch silicon fab that services things like the power conversion market. So you can get economy of scale that we can really leverage by moving this to a real silicon cost structure.

Harlan Sur - JPMorgan

Great. And then on the technology front, obviously it seems like Nitronex figured out some sort of proprietary way of putting together GaN and silicon and enjoy the lower core structure of the silicon substrate that you’ve talked about. Any negative tradeoffs on the performance side to using a silicon substrate? And if not, does MACOM see their broader GaN based portfolio moving over to complete silicon based substrate over time?

John Croteau

Yeah. That’s a very insight question. So let me put it this way. Nitronex has been in existence since 1999, so 15 years of innovation in the field of GaN and silicon. A lot of the original work came out of NC State. They are based out of North Carolina, Nitronex is. They were the innovator for well over a decade that builds a lot of the innovations at the materials layer so epitaxial technology to be able to get RF performance out of silicon substrate as well as device layouts, as well as process techniques for that matter, as well as application technique to be able to get the performance. And the way to think about the performance is GaN is GaN, whether it’s on a silicon substrate or a silicon carbide substrate. The breakthrough that I referred to in the earlier question is we’ve now demonstrated exactly the same bandwidth and efficiency on silicon substrates as previously demonstrated on silicon carbide for a very small fraction of the costs, literary in order of magnitude at the end game and two orders of magnitude from today’s cost structure. The difference in the long run it has to do with power density.

Silicon carbide is a better thermal conductor. So for the very highest power applications like kilowatts, silicon carbide will have a long term niche play. For that reason we are still actively transferring the GCS silicon carbide technology into Lowell. That will have a long-term play in defense markets where capital light fab with domestic supply will have a long term play. But anything that is cost sensitive, so arguably 90%, 95% of the unit volume will very naturally evolve over to GaN and silicon. So hence being able to leverage the silicon side of the semi-conductor industry is a big deal.

Operator

Our next question is from Tore Svanberg of Stifel. Your line is open.

Erik Rasmussen - Stifel, Nicolaus & Co.

Thanks. This is Erik calling in for Tore. I wanted to get back to your earlier comment you said that you were on target for your accretion level of 15% to 20%. Are you still also on target for the %25 to 30% in fiscal 2015?

Robert McMullan

Erik, I’d like to make a correction. It’s not 15% to 20%

Erik Rasmussen - Stifel, Nicolaus & Co

Oh sorry, cents.

Robert McMullan

Cents, right. And so with the $0.07 if measured back we have annualized over the balance of the three quarters, you’ve got $0.21 just on this quarter alone.

John Croteau

And then if you want to annualize it to the four quarters, it would be $0.28. So I think the answer to your question is yes.

Erik Rasmussen - Stifel, Nicolaus & Co

Okay. It sounds good.

John Croteau

By the way we still have lots of source synergies that we can garner over the future quarters.

Erik Rasmussen - Stifel, Nicolaus & Co

Got you. And gross margins, any update on your target model there kind of given the favorable exits of some of the Mindspeed lower margin assets?

John Croteau

Yeah. You will continue to see the gross margin improvement quarter upon quarter upon quarter through the rest of this year. We have no endpoint. As far as I’m concerned we are investing in very high margin new products both on what was previously part of the Mindspeed portfolio, but certainly throughout the MACOM portfolio north of 70%. A lot of the growth that we are driving, like the optical business, is at very sweet gross margins. As we continue to grow we’ll see the gross margin continue to progress and we are not going to stop at 50. We are not going to stop at 55 and frankly we won’t stop at 60. So it’s all about being able to continue the growth to be able to improve the product mix.

Erik Rasmussen - Stifel, Nicolaus & Co

It sounds good and in earlier to relation you prior comment, you said you saw growth quarter of a quarter going forward. So is there any seasonality in your business that we should be thinking about or is it more CapEx dependent?

John Croteau

No. There really isn’t any seasonality frankly other than the summer period where things slow down a little bit over in Europe, but other than that we are not really exposed to any other consumer cycles. Very little that would be falling into any category of consumer and we think we can just sustain our growth rate at minimally two times the market growth rate and our real target is three.

Erik Rasmussen - Stifel, Nicolaus & Co

Great. Can I just sneak in one more? Obviously a lot of conversation on the call now about GaN-on silicon and GaN technology in general and you’ve said that your target will be 80% of your portfolio. When do you think though that you might start to see some of those improvements where you can actually see 80% of your portfolio on GaN or targeting GaN?

John Croteau

80% is our estimate of where things would end up. Nothing is ever black and white 100%. So 80% is a number in spirit which is the large majority of the markets and applications we address. That said, a lot of our markets, defense, aerospace, a lot of the network infrastructure are not fast moving. We’re not built on the upside and the down side, not exposed to rapid churn. So replacement takes time. I think among the fastest moving is the previous question about the base station industry. Moving 30% share plus in three to four years is about the fastest that I would envision. And if we can pull that off that would be exceeding everyone’s expectation including our own. But this industry is measured in decades, not quarters or years.

Operator

Our next question is from Harsh Kumar of Stephens. Your line is up.

Richard Sewell – Stephens Inc.

This is Richard calling in for Harsh. Thanks for taking my question and congratulation guys. I was wondering if you could start with stack rate ranking some of your remaining levers to get to your gross margin target. I know that you talked about the higher opportunity, growth opportunities with some higher margin businesses. But are there anything that you’re doing internally to get to those gross margin targets?

John Croteau

We continued to beat on cogs, continue to make progress. But realistically the basis points improvement and gross margin that will come out of cogs on a go forward basis is really dwarfed by the opportunity to change the mix. So that is one primary lever. So it’s -- to me, gross margin improvement is all about R&D and investing in new products and identifying and establishing preeminent positions in the areas that can actually yield and sustain high gross margins. And I think we’re very much on track to doing that.

Richard Sewell – Stephens Inc.

Great and then second question, looking at the aerospace and defense side, have you seen any changes in the pricing dynamics over the last couple of quarters?

John Croteau

I think the simple answer to that is no. We are not in part of the industry where there’s a lot of pricing as it relates to demands. I think the one thing that’s materialized in the past quarter that has to do with our aerospace and defense business which is actually quite positive is some of the consolidation that’s going on with some of our competitors, which is creating an opportunity for us. When people announce very high degrees of target synergies and begin laying off engineers in their networks and defense business, it frankly very quickly yields customer and revenue leakage. And I think we’re perfectly positioned to reap the benefits of that.

Richard Sewell – Stephens Inc.

Great, and if I can sneak one more in. Looking at your catalogue business, that’s been one area that you’ve improved dramatically over the last couple of years or so. How do you anticipate that looking over the next year as we look out?

John Croteau

It’s getting better and better and better. We’ve got a lot on focus both on the demand creation side and fulfillment side. We’ve been tuning our operations models to be able to rapidly react and capture upside business. I think we’re best in class, no question. We just launched a new website and today’s catalogue is conceptually the web. And in terms of ease of use and access to information, I would genuinely say based upon my prior employers, which are very strong catalogue sales companies, we are best in class. We use the best practice from those and others in the industry and actually innovated on top of that. So I think as we bring that web presence to bear and as we tune up our sales channel with integrating the -- not just the Mindspeed folks, but continue to hire and tune up our FAE support, I think we can just bring it to another level.

Operator

Thank you. In the queue there are no further questions at this time. I’d like to turn the conference over to John Croteau for any closing remarks.

John Croteau

Very good. A couple of final notes before we close today’s call. Bob and I will be attending the JPMorgan conference in Boston on Monday May 19 and would welcome the opportunity to meet with any investors planning to attend. And finally, I’m very excited to announce that MACOM will be hosting our inaugural Analyst Day in New York on Thursday May 29. This will be an invitation-only event. So please contact us at ir@macom.com if you’d like to attend. Thank you again for joining us for today’s call and I look forward to reporting our continued progress next quarter. Operator, you may now disconnect the call.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now all disconnect. Have a wonderful day

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Source: M/A-COM Technology Solutions' CEO Discusses F2Q 2014 Results - Earnings Call Transcript

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