M/A-COM Technology Solutions' (MTSI) CEO John Croteau on Q3 2016 Results - Earnings Call Transcript

| About: M/A-COM Technology (MTSI)

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

Q3 2016 Earnings Conference Call

November 15, 2016, 17:00 ET


Leanne Sievers - IR

John Croteau - President & CEO

Robert McMullan - SVP, CFO


Harlan Sur - JPMorgan

C.J. Muse - Evercore

Steven Smigie - Raymond James

Vivek Arya - Bank of America Merrill Lynch

Quinn Bolton - Needham & Co


Welcome to MACOM Technology Solutions Fiscal Fourth Quarter and FY '16 Financial Results Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded today, Tuesday, November 15, 2016. I will now 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 fiscal fourth quarter and 2016 earnings conference call. I am 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 earnings press release, you can obtain a copy on MACOM's website at www.MACOM.com under the Investor Relations section. Before I turn the call over to Mr. Croteau, I would like to remind our listeners that management's prepared remarks and answers to your questions contain forward-looking statements which are subject to risks and uncertainties.

Because actual results may differ materially from those discussed today, MACOM claims the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and refers you to a more detailed discussion of risks and uncertainties that could result in those differences in MACOM's filings with the Securities and Exchange Commission, including its current report on Form 8-K filed today, annual report on Form 10-K to be filed on November 24, [2015] and quarterly report on Form 10-Q filed on July 27, 2016. Any forward-looking statements represent management's views as of today, November 15, 2016 and MACOM assumes no obligation to update these statements in the future.

The Company's press release and management's statements during this conference call will include discussions of certain adjusted non-GAAP measures and financial information, including all income statement amounts percentages referred to on today's call unless otherwise noted. These financial measures and a reconciliation of GAAP to adjusted non-GAAP results are provided in 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 MACOM's website.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for at least 30 days in the Investor Relations section of the MACOM's website. And now, I'll turn the call over to MACOM's President and CEO, John Croteau. John, please go ahead.

John Croteau

Thank you, Leanne. Welcome everyone and thanks for joining us today. I'll begin today's call with an overview of our fourth quarter and fiscal year results for 2016 and then turn the call over to Bob McMullen, our CFO, who will review our financial performance in further detail. I'll then conclude today's prepared comments by providing a summary of our execution during the quarter and year, followed by guidance for the fiscal first quarter of 2017. Straight to the results.

I'm pleased to report that for our fiscal fourth quarter of 2016, revenue exceeded the top end of our guidance at $152.7 million, with adjusted gross margin coming in above the midpoint at 58.5%, with adjusted earnings coming in at $0.54 per diluted share. Looking at our end markets, networks was up 5% sequentially on the back of strong growth in metro long-haul, that more than made up for expected weakness in access and backhaul. Aerospace and defense grew 18% and multi-market was up 10% sequentially. In total, revenue grew 7% sequentially and 36% over our fiscal fourth quarter of last year 2015.

This caps our third year of outperformance, in which we delivered 32% compound annual revenue growth which more than doubled the revenue over that three-year period. Adjusted gross margin improved 970 basis points over those same years and more importantly, we expanded adjusted earnings per share by 47% compounded annually over that time period. This is testament to our balanced and diversified portfolio of investments across three secular growth drivers and within those secular growth drivers which consistently delivered results in all market conditions and allowed us to outgrow our industry by integer multiples. Now let me turn it over to Bob for to review our fiscal fourth quarter financials in further detail.

Robert McMullan

Thank you, John and good afternoon, everyone. MACOM has again delivered a premier FY '16 financial results, growing revenues 29.5% to $544.4 million, expanding adjusted gross margin 62 basis points to 58.1%, leveraging operating expenses to deliver adjusted EPS growth of 49.3% or $1.91, generating GAAP cash flow from operations of $79.2 million, up 135% and representing 75% of non-GAAP net income, improving free cash flow to $47.1 million and 45% of non-GAAP net income while continuing to invest in the growth of our business. From my perspective, an excellent year from a financial point of view.

Now to the fiscal fourth quarter. Revenue was $152.7 million during the fiscal fourth quarter, growing 35.6% over 2015 fiscal fourth quarter and increasing sequentially 7.3% over $142.3 million in the prior quarter. Revenue by end markets in the fiscal fourth quarter, networks $109.7 million and 71.9% of total revenues, up 5% sequentially. Multi-market $21.6 million and 14.1% of total revenues, up 10.3% sequentially. And aerospace and defense $21.4 million and 14% of total revenues, up 18% sequentially. As we noted in our last earnings call, MACOM's A&D business is expected to grow in FY '17 at double MACOM's target annual revenue growth rate of 20%.

Of the total network revenues in the fiscal fourth quarter, total optical revenues were $80.6 million, up 5% sequentially led by long-haul, metro and datacenter revenue growth, [of] 49% in the fiscal fourth quarter over fiscal third quarter. Non-GAAP gross profit and gross margin in the fiscal fourth quarter was $89.3 million and 58.5% of revenue, respectively, expanding from $64.6 million and 57.4% of revenues, respectively over Q4 of the prior fiscal year and $81.5 million and 57.3%, respectively on a sequential basis.

Adjusted gross margin quarter-to quarter improved as gross margins from our FY '16 acquisitions increased. Adjusted gross margin excluding our FY '16 acquisitions continue to exceed 60% MACOM's target gross margin rate at 61%. In terms of operating expenses for the fiscal fourth quarter, total non-GAAP operating expenses were $51 million, compared to $38.4 million in the prior fiscal year and $46.6 million in the prior fiscal quarter. Adjusted operating expenses were 32.8% over Q4 of the prior fiscal year and 9% sequentially, primarily due to higher variable expenses. Adjusted R&D and SG&A expenses were [$27.4 million] and $23.6 million, respectively in the fiscal fourth quarter.

Non-GAAP income from operations and operating margins were $38.3 million and 25.1% of revenue, up 46.5[%] and 7.7%, respectively over Q4 of the prior fiscal year, $26.2 million and 23.3% of revenues respectively and sequentially up 9.7% and 2.2% from $34.9 million and 24.5% of revenues, respectively. Adjusted operating margins expanded 190 basis points Q4 over the prior year and [60] points over the prior fiscal quarter.

Interest expense increased to $5 million due to the increase of our term B debt by $250 million, starting in the last month of the fiscal fourth quarter. Other income of $1.9 million represents revenue from a consulting contract from our auto business divestment that continues through FY '17, where we provide technical assistance to the buyer as requested from time to time. Our normalized non-GAAP income tax rate for the fiscal fourth quarter was 15%.

This tax rate was consistent with the prior fiscal quarter and the fiscal fourth quarter of 2015. We did not pay cash taxes in the fiscal fourth quarter. We did receive a $1.5 million refund during the fiscal fourth quarter.

Our fiscal fourth quarter non-GAAP net income and EPS were $30 million and $0.54 per fully diluted share, respectively, growing from $18.8 million and $0.34 in Q4 of the prior fiscal year and $27.9 million and $0.51 per fully diluted share in the prior fiscal quarter on a sequential basis. Non-GAAP net income grew [to] 59.5% over FY15 and 7.7% over the prior fiscal quarter. Fiscal fourth quarter adjusted EPS includes the effect of one month's additional interest expense from our term B offering which we did not anticipate in the adjusted EPS guidance announced in our last earnings call. Absent this additional interest expense, our adjusted EPS for the fiscal fourth quarter would have been $0.56 per diluted share, the midpoint of our guidance.

The share count used to compute non-GAAP EPS was 55.3 million fully diluted shares for the fiscal fourth quarter. Adjusted EBITDA or earnings before interest, taxes, depreciation and amortization was $44.9 million, up 50.2% from $29.9 million in our FY15 fourth quarter and up 6.67% from $42.1 million sequentially. GAAP cash flow from operations was $24.9 million in the fiscal fourth quarter, as compared to $5.5 million in the FY15 fourth quarter, increasing 352% and up from $19.2 million sequentially. Fiscal fourth quarter cash flow from operations represents 83% of non-GAAP net income, up from 29.3% in the fourth quarter of FY15 and 69% sequentially. After deducting capital expenditures, free cash flow was $17.6 million or 59% of non-GAAP net income in the fiscal fourth quarter, approaching our target free cash flow percentage as non-GAAP net income of 60%.

Turning to the balance sheet, at fiscal quarter end, our cash, cash equivalents and short term investments were approximately $356.8 million, up $266.2 million over the fiscal third quarter, including $243 million net proceeds from our term B financing closed on August 31. Accounts receivable were up over prior fiscal quarter to $108.3 million, up from $92 million sequentially. Day sales outstanding were 65 days, compared to 59 days at the end of the prior fiscal quarter.

Inventory was down $114.9 million, compared to $117.1 million in the prior quarter. Inventory turns were 2.2 times, compared to 2.1 times in the prior fiscal quarter. Long term debt was $576.3 million, inclusive of acquired capital leases and the previously noted term B financing proceeds.

We have $130 million of availability in an undrawn credit line. Capital expenditures in the fiscal fourth quarter were $7.2 million or 4.7% of revenue, compared to $7.1 million or 5% of revenue sequentially. Related depreciation expense for the fiscal fourth quarter was approximately $4.7 million, as compared to $5.3 million in the prior quarter. Our investments and capital expenditure exceed our current levels of depreciation expense, reducing our operating cash flow. We generated positive free cash flow of $47.1 million in FY '16, including capital expenditures of $32.1 million.

Before I turn the call back to John, as is customary based on our review of geographical distribution of FY '17 anticipated taxable income, we have determined our non-GAAP income tax rate for FY '17 will be 12%, commencing on the first fiscal quarter of 2017. Back to you, John.

John Croteau

Thanks, Bob. Let's dive right into our optical performance during the quarter. In aggregate, revenue from our optical businesses grew 5% sequentially and now constitutes 53% of our total revenue. Revenue from our metro long-haul business grew 49% sequentially. Put in context, revenue from our optical businesses grew 96% over the past year, across the entire portfolio from metro, long-haul, access, backhaul and datacenters.

As expected, [com] was essentially flat quarter on quarter. Looking ahead, visibility remains poor, as we expect a seasonally soft Q1, including the usual yearend inventory management effects over in China. In addition, fiber backhaul declined consistent with industry-wide reports of weakness in wireless infrastructure. Despite the recent softness in demands, we expect both of these markets to cycle back, as the inventory correction completes after the Chinese New Year. Tenders have already been awarded which we believe will revive demand in 2017.

More than offsetting this weakness, our metro long-haul business saw a blow-out quarter, with 49% sequential growth, with high visibility into continuing strong demands through the first half of next year. By our estimates, our leadership position includes over a 60% market share across linear, as well as limiting drivers, [QSFP2] as well as QSFP28, CFP DCO as well as ACO and across all protocols including NRZ, LR4, PSM-4, PAM4 and CWDM We believe this strength across products, regions and protocols, combined with our new-found breakout in datacenters will more than compensate for any short term weakness we see in our backhaul.

We've also concluded that our datacenter business is now large enough and important enough as a growth vector, that it merits that we speak to it separately going forward. So switching over to datacenters, we're proud to report that in FY '16, we enabled over 1 million 100G modules going into datacenter and enterprise applications. This number is beyond even the largest TAM reported by any of the market analysts to date and includes leadership positions in laser and VCSEL drivers, CDRs and TIAs. What's even more exciting, is that we believe this is just the beginning of a ramp that will see demand for 100G connectivity within datacenters triple over the next four years.

By our estimates, based on detailed bottoms-up analysis by customer, we've achieved over 60% share of the high-performance analog content going into these applications. Moving into the second half of 2017, we expect to more than double [port] shipments into these applications. We expect that with 100G optical market will continue to exceed current analysts forecasts over the next two to three years, primarily driven by cloud datacenter demands for high bandwidth conductivity. Building on top of this strong foundation of high-performance analog content, today we announced volume production of our family of 25 gig lasers for 100G connectivity across all datacenter protocols including CWDM, LR4 and LAN DWDM.

These lasers leverage our heavily patented etched facet technology and combined with our wafer scale manufacturing provide a combination of cost and capacity that's unmatched by incumbent laser suppliers. Lasers are only the first step into photonics, as we intend to build our leadership on the analog side and ride the anticipated tsunami of demand for bandwidth within cloud datacenters. Next spring, we expect to ship the industry's first integrated CWDM laser and photonic integrated circuit or L-PIC, further expanding our related [indiscernible] by factor of 4.

With that forthcoming commercial release of the L-PIC, MACOM's leadership position will span all semiconductor content, from the switch to fiber. Most importantly, these breakthroughs from MACOM have been recognized by the major cloud service providers. We're now viewed as a strategic asset that's poised to provide the critical optical products and technologies that help achieve very aggressive cost targets and enable mass deployment of 100G transceivers in datacenters.

Now with growing visibility into that opportunity in datacenters, we believe that the inflection point for this ramp is, if anything pulling in, from what we laid out at our 2016 Analyst Day. To close out my comments on the optical businesses, it's important to note that our optical models stand in stark contrast to those who service the captive needs of one standard, one part of the network or one transceiver supplier. Our success is much closer tied to secular growth, the insatiable demand for bandwidth in today's cloud-connected apps economy. That's why we believe our optical success is sustainable over the short-, medium- and long term.

Now moving on to active antennas and the first wave of MMIC success, as we predicted last quarter, we saw a breakout in aerospace and defense, as well as our catalog multi-market business on the back of high-performance MMIC portfolio. Now the really great news here is that we now expect our RF and microwave businesses to join optical, as an equally strong growth driver moving forward. The numbers speak for themselves.

Revenues from our A&D and multi-market businesses grew 18% and 10% respectively, quarter-on quarter further diversifying our growth vectors. We've successfully positioned MACOM to be the beneficiary of consolidation in our small corner of the semiconductor industry. These high margin monolithic microwave ICs or MMICs to fall right into our wheelhouse. Our strategy is to regain preeminent share from traditional competitors like the Hittite, TriQuint, RFMD and Microsemi as they undergo consolidation.

Delivering on our renewed and sustained investment in R&D, we announced 27 new MMICs products last quarter. This portfolio establishes a new benchmark of parametric performance compared to the incumbent offerings, highlighting our leadership position across low noise amplifiers, VCOs, gain blocks, wideband amplifiers, mixers and more.

More importantly, Tier 1 customers across satcom, military communications, industrial, medical, test and measurement have been actively soliciting us to replace prior generation products from other suppliers. Underpinned by existing purchase orders and customer forecasts, we now expect A&D to deliver twice the growth rate of our target operating market model through FY '17. This initial growth wave comes on the back of MMICs, not yet Tiles, as we outlined on our Analyst Day. Visibility has improved such that inflection point in this first wave MMIC opportunity is if anything, pulling in from what we outlined at our Analyst Day last March.

Now let's move over it again. Last quarter, we passed a number of key gates, realizing our ambitions with GaN. First, we successfully completed qualification of our Gen4 process. With this, we now have purchase orders in hand, with two key base station OEMs for initial production in the March quarter.

Before I dive deeper into that exciting news on the customer front, let me make some quick comments on recent legal developments. Six months ago, we highlighted Infineon's attempt to gain access to our burgeoning market for GaN RF products by improper means. It was regrettable, that they attempted to engage in such strong-arm and bullying tactics and from the outset, we had full intentions to vigorously protect our rights.

As many of you know, two weeks ago the court issued a very favorable ruling for us, that granted MACOM a preliminary injunction against Infineon. The court's decision confirmed MACOM's continuing exclusive rights to certain GaN on silicon RF fields under its license agreement with Infineon. Now let me emphasize here, this sends a message, not only to Infineon, that we take protecting our IP rights and the interest of our shareholders very seriously. Defending our intellectual properties is core to our success and we plan to vigorously litigate this case to its rightful conclusion.

Now coming back to our customer engagements, as I said, we have purchase orders in hand from two key base stations OEMs for initial production ramps that are scheduled to begin after the first of the year. That's our second fiscal quarter of 2017.

These solutions service mainstream frequency bands at 1.8 and 3.5 gigahertz, not the low-volume emerging bands that have been serviced by GaN to date. Achieving performance and functionality that's unachievable by incumbent LDMOS technology, our solutions deliver 6 points of better efficiency over LDMOS based designs in 55% less board space. This enables our customers to increase data throughput capacity by 1.5 to 2 times, by adding more channels to the remote radio head without changing its physical size or weight. Better efficiency can also save hundreds of millions of dollars in annual energy costs while operating in the field.

As we achieve cost parity with LDMOS in volume production, MACOM's Gen4 GaN power transistors will have a capability to uniquely meet the carriers need to improve data capacity, without adding significant costs to their hardware, again, within mainstream base stations and the LTE frequency bands. So summing it all up for GaN, we're now poised with performance attributes of GaN, combined with the commercial manufacturing scale and cost structure to disrupt a mainstream part of $1 billion LDMOS market and bay stations. We're now far enough along in our GaN efforts, with visibility into our end customer deployments that confirm that the ramp, similar to optical and MMIC, is if anything pulling in what we articulated during our Analyst Day.

With that, let's talk about next quarter guidance. As we've seen in previous years, the December quarter is expected to be seasonally flat. With the fiscal first quarter ending December 30, 2016, we expect revenue to be in the range of $150 million to $154 million which is still up more than 30% year on year. Adjusted gross margin is expected to be between 57% and 59% and adjusted earnings per share between $0.54 and $0.58, utilizing a 12% adjusted income tax rate on an anticipated 56.5 million fully diluted shares outstanding.

Wrapping things up with the fiscal year, with the close of 2016, we've now posted three years of unprecedented growth and profitability. We've delivered 32% compound annual growth, more than doubling revenue over the past three years. Adjusted gross margin improved 970 basis points over that same period. Most importantly, we have expanded adjusted EPS by 47% compounded annually over that time.

In summary, our model has clearly demonstrated the ability to deliver growth and profitability through good times and bad. Our business is diversified among multiple secular growth drivers and within those secular growth drivers. We complement organic growth with disciplined and rigorous execution on acquisitions.

This has enabled us to sustain high growth rates year after year and consistently through all market conditions. Furthermore, with added visibility into our next phase of growth drivers, datacenters, MMICs and GaN, we believe FY '17 holds the potential to deliver yet another year of similar growth and profitability. Operator, you can now open the call to questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from Harlan Sur of JPMorgan. Your question please.

Harlan Sur

Good afternoon, guys. Good to see the diversification in the business driving some growth here. OpEx is up almost $4.5 million sequentially or up almost 10% sequentially. I guess, overall trying to figure out is, what drove the significant growth? Is there some near term opportunity that the team is focusing on, because you did guide OpEx relatively flattish for the September quarter? And then how should we think about the OpEx trajectory on a go forward basis? And then I have a follow-up question.

Robert McMullan

We set up our compensation plans in the fourth quarter. Obviously, we had a pretty good year. So, as we go into guidance we have certain parts of the - we know where we're. We have approval on everything and finalize those numbers. So variable item that we absorbed going forward though, a portion of that represents that increase that you mentioned of about four and half. Represents a portion of the variable cost and so you will see expenses flat or slightly up in the fourth quarter based on the guidance gave.

Harlan Sur

And then congrats on completing the Gen4 getting orders from your two customers. You talked about receiving sort of initial production orders from these customers which will most likely in the March quarter. So help us understand if all goes well there when does the MACOM team really start to turn the spigot on and start to drive more, larger, more production type levels of shipment entities to base station customers. Is it the second half of calendar 17 had we think about that that we have to fully qualify.

John Croteau

Absolutely, so those initial production dates are in the March quarter. It's in the second half of the year that the ramp trends and harder. One thing is the initial programs with two specific solutions for those customers. What I mentioned last quarter is those are platforms that are poorest to proliferate within the customers to more programs. What I would anticipate is the banana performance in terms of delivery and so on, that could actually start painting critical mass and really proliferating in the second half. So we're cautiously optimistic. I can take this to customers are extremely passionate about adopting and are working and for various reasons. With Mary very strong opposition that they believe and quite deeply. We're off to the races, frankly.

Harlan Sur

Well as follow up. On the success of the catalog MMIC business, I mean this is been part of the diversification story, right because it's driven gross cross and be, given crisscross multi-market you're getting solid [ Indiscernible ] you talked about some of your competitors here. How is the team winning here? I mean, what is MACOM's differentiator here. Is it performance, is a costs, is it integration, help us understand what are some of the major drivers of success here.

John Croteau

Typically MACOM cost [ph] integration. The mix are relatively small scale integration. It is definitely performance we targeted next generation metric performance across each of these product families. But I think equally importantly we have positioned ourselves to kind of be on deck that has similar competitors have hit bumps in the road and are now focused elsewhere for various reasons undergoing consolidation.

We have literally got a who's who list of customers who frankly view us as the last guy standing who is really seriously and strategically committed to this category of product. And across multiple period versions of MMICs, MMIC is general category but anyone of a dozen product categories I would say, but that tight MMIC or to put it in context [indiscernible] before they were acquired had about $200 million MMIC business and putting context after 10 years Tycho [ph] make that $20 million MMIC business. So the playing field is wide open for us not just in the context of [indiscernible] but also the other guys I mentioned to be able to dramatically expand our share and drive growth in what is otherwise a modestly growing market.


Our next question comes from C.J. Muse of Evercore. Your line is open.

C.J. Muse

First question on the gross margin guide, it's now taking a little bit curious is that just the function of the slight topline decline and/or just mix shift and I guess bigger picture thinking about the growing mix of datacenter and continued strength in MMIC in calendar '17 how should we think about gross margin uplift through the year?

John Croteau

CJ, so the guide again is subject to mix, not necessarily revenue level. We're still cautious in the transition. We have had improvement as I mentioned in my remarks with respect to the 2016 acquisitions. There's still a bit of a burden carrying into next quarter that lends itself to the guidance there is some things that are very positive. We have completed the integrations and the swap outs from the manufacturing at the two plans we are closing we will moved at the end of the quarter. So I think we're just a little in-line from the making that all work.

We saw improvement the five best which we noted as now using more of our components. It has improved and there is still some improvement there as well. To the bigger question over the year I think as we look forward and the mix continues to move and the growth rates that we've experienced this past year to continue and the mix of products that we have, these are at or better than corporate average as we introduce them. So, as we have stated, we're still confident timing of bidding question but not having long term some place over the fiscal 2017 timeframe we will get overall for the company at that 60% growth margin level.

Robert McMullan

Yes, if I can build on that a little bit. Some of the areas that we’re talking about being seasonably soft in China counter-intuitively are some of our highest margin business. So not only is there seasonality on the top line but there's a seasonality impact on the mix.

C.J. Muse

I guess is my follow-up can you talk about the plan to use some proceeds with the Term B financing?

John Croteau

Yes, excellent question, CJ. We have been monitoring the debt markets over the course of the last 12 months. We came upon a market situation that was very, very favorable. We matched the terms of the original Term B loan we did in 2014, in May of 2014. The offering was extremely well-received, we could have raised another $100 million but not necessarily in-line with our overall, FiBest management and leverage targets that we want to stay to, but we took an opportunity to reload. We have talked about the finishing of the integration of our existing acquisitions and as obviously we're looking to expand through acquisition. If the opportunity is there, we have a regular pipeline that is more or less a backlog it doesn't mean that everything in a pipeline is actually a transaction, but we're ready to move forward.

C.J. Muse

Just sneak one last one, what should we be thinking about for interest and other expense for the December quarter. Thanks so much.

Robert McMullan

The incremental increase in interest expense is on an annual basis, it is about $12 million. It is a floating rate loan. The market to that rates have been up a little bit but longer term I anticipate to stay reasonably in the same level. So it's about $3 million to $4 million a quarter.


Our next question comes from Steven Smigie of Raymond James. Sir, your line is open.

Steven Smigie

I was wondering if you could talk little bit more about the GaN business and the opportunity there. It seems like we’re about to really hit the stride in terms of the ramp there? More in context of multi-year scenario, can you give some thoughts as it looks today and obviously overtime where do you hit 25% of the market GaN and 50%, or 100% and is it necessarily all cannibalistic or LDMOS or can it be canopy just added as well.

John Croteau

Well I guess the scenario where it's additive our observation is where a year or two ago it was more of a technology evangelism state. I think universally even that LDMOS guys have acknowledged and recognized the fact that the market is ready for wholesale transition. I think the difference of opinion as to how quick it will move. My observation is in the past for instance the transition from prior VDMOS and other technologies, the LDMOS once they start moving, they move fast.

It's not unrealistic to say that we could grow into a natural share condition. This market has operated with kind of a duopoly or oligopoly supply that I would expect that we could grow into that position over the next three years. Our aspiration is to be a very clear number one and I think given the position we have now validated legally in terms of the intellectual property that we hold for what is realistically the only version again that can supply the mainstream part to the industry. I think we're very well position to do so. We have the support teams in place. We have a value proposition very clearly demonstrated to everybody who matters and the customer is no longer even question that.

I think the remaining challenge we're going to have which is the challenge we're always want to have is being able to scale that operationally from a production standpoint both wafer supply, backend assembly and test. It's not trivial to be able to supply millions of units of this class of device. We have got the team on board now that’s been done there done that with previous generations of technology. So there's no questions, we're out of the gate in the fiscal second quarter and it's - I think it going to be quite right.

Steven Smigie

A quick follow-up on that was as you mentioned the lawsuit you have the injection. What is the next [indiscernible] and then a real follow-up question was on the new lasers introduced, it seemed like you got 70% share that was in PON, what's the opportunity here for the new lasers. Could you give share on this? Thanks.

John Croteau

Sure. So in terms of the outlook of the litigation with Infineon, common practice is once you achieve the preliminary injunction, it's kind of game, set and match I think one would hope rational minds would prevail and we would reach settlement but you never know. It could drag on for two years which, you know, it is what it is. I can tell you the dominant majority of the stuff that we really cared about in litigation that we were passionate about has already been awarded as part of the preliminary injunction.

So we're off to the races and that’s if anything is just a distraction frankly on a forward basis. On the other issue in terms of the opportunity with 25 gig lasers, I would say our value proposition and the economic benefit of the Etched Facet technology in datacenters is potentially dwarfs that of EFT and PON and the reason is where in PON we were displacing incumbent vendors with very mature technology, very stable technology that they have been supplying and be it with a superior cost structure and capacity capability.

In datacenters there were no entrenched competitors, in fact the people have been supplying to-date have been supplying basically repurposed telecom [ph] lasers which are really optimized for the capacity that's required for datacenters. The Etched Facet technology I mean we meet from a [indiscernible] performance standpoint everything that the incumbents do but for a small fraction of the price these are very rich ASPs, there is lot of economic leverage to deliver to our customers to be able to drive the cost structure's as we talked about in our analyst day we have the opportunity with the self-aligning EFT the safety stuff to leverage in the second calendar quarter, the June quarter we will be rolling out production of the LPS [ph] which profoundly changed the cost structure for that front end analog content for datacenters. So that is a breakout for us this year that is not unlike kind of growth that we have with PON last year where PON is saturated and will be a cash cow funding all the stuff, datacenter is absolutely a fantastic opportunity all on the back frankly of the Etched Facet technology.


Our next question comes from Blayne Curtis, Barclays. Your question please.

Unidentified Analyst

This is Tom O'Malley [ph] on for Blayne Curtis. Can you provide some color on what segments are stronger and weaker heading into the December quarter?

John Croteau

Yes, so long-haul ends up strong. We have good visibility. The real issue with that is shaping from a seasonality standpoint while the orders have been placed for deliverability after the first appear. So it is really a timing standpoint. That's where is it the year-end inventory protects totally predictable. PON remain soft. Ever since for the last three years ever since we had high-speed on board, that time was always seasonably soft. The explanation is that people tend to not take up the ground to winter season for laying of fiber.

There's a demand seasonality with the addition of the inventory effects. So, a couple of her key optical markets just seasonally softened, but the comeback roaring in the March quarter. Once lighting there is the Chinese the year that temper settle little bit. Then, that June and September quarters are as you look is the past four quarters we delivered that has been well prefigures a similar shape. In the AMD business we continue to progress the MMICs, the design option customer option remain strong we have some elements of seasonality there but less so.

Unidentified Analyst

You guys had a lot of times talking about MMIC about how is ground-based radar is progressing and can give us an update on the progress in Norman, Oklahoma.

John Croteau

Yes, so we shipped, we completed the production unit that is in bold and it's going to be installed in Norman, Oklahoma. I have not heard that that has been completed. It may have been, that field trial. I can tell you there is a lot a red hot activity among our customer base and people preparing to respond to RFPs prepared to be able to ship production for that radar installation. I think they are very interesting developing in the past week with the new administration talking about infrastructure investment.

There's nothing more logical for infrastructure from our standpoint been doing what is drastically needed in the us which is upgrading the aircraft control infrastructure and weather forecast infrastructure - so by all sense of customer activities in terms of preparation partnering, that is looking more and more real. But, again, the question we have, short term, we have explosive growth opportunity in advance of the as we articulated on the back of the minute content. So we do not have to wait for tiles to drive our growth for next year.


[Operator Instructions]. Our next question comes from the line of [indiscernible] of Stifle. Your question, please.

Unidentified Analyst

The first question is on GaN. So John based on our due diligence, we're starting to see GaN popping up in people supply chain and I'm just wondering how you can balance that because on one-hand that could mean an acceleration of maybe GaN coming earlier but then on the other hand you sort of keep an eye on all the IP out there so how do you balance those two?

John Croteau

Yes, so I can tell you there are a lot of people talking GaN, if you look at the actual operational requirements to deliver our power transistors into that market it is notoriously it's a roller coaster and unpredictable. In my previous life I saw demand increases literally doubling within 30 days. You have to have a supply chain which is CMOS like an nature meaning you have to be working out of factories that can handle surge capacity and be able to deal with just regular capacity and be able to scale up and down both ways. That is exactly what GaN on silicon does and which we uniquely and underscored with the legal developments over the past quarter.

We uniquely have customers recognize that. There are early generation niche programs, new frequency bands that have been serviced by GaN on silicon carbide. But realistically from a supply chain and cost structure those sources are regardless of who it is simply aren't not prepared to be able to handle the main stream that’s why fundamentally what we're doing is we're attacking the heart of that $1 billion market not the periphery.

Unidentified Analyst

Question on the optical business, you talk about [indiscernible] share of the high-speed analog and I was just wondering with that refer to drivers, TIAs and CDRs across all standards or was that more of a common in regards to certain of those components for certain standards.

John Croteau

No. In fact, I want to emphasize that it's across all sectors. We're not talking about some playing statistical games where in some narrow niche we have large markets shares. This is across all standards, all protocols, 60%.

Unidentified Analyst

And last question, you're mentioned you’re now going to be breaking out datacenter. So I assume you’re going to be breaking out datacenter revenue starting in the December quarter, is that the way I should think of it?

John Croteau

Yes. We will be just like we started talking about PON and metro long-haul providing color on the overall dynamics. We will be doing that on datacenters on a go forward basis. When we actually rolled up the datacenter number it ended up frankly larger and larger growth than we anticipated. It's over growing PON basically. Our investments are almost 100% in datacenter in that category of product. The opportunity for further growth just in that category is great but the fantastic thing is there is yet again the same TAM available for lasers sitting right next to the high performance [indiscernible] content.

As I mentioned with the EFT technology we're extraordinarily well-positioned, arguably better position to capitalize and command even greater market share with that. And then right behind that is the silicon photonics that we LPIX that we had talked about at the analyst day which are we have wafers in-line that we expect to be shipping production. So it's that close, it's the reason why I made the comment that if anything timelines are pulling in. I didn’t even anticipate that we would be this far along with the analog, never mind the lasers and the silicon photonics. So I think that is going to be a very hot topic not just in the December quarter but throughout 2017 and beyond.


Our next question comes from Vivek Arya of Bank of America Merrill Lynch. Your question please.

Vivek Arya

I had long term and one question of fiscal 2017. On the longer term side, the concern with optics in the past has been that it has been a lot of boom-bust cycles, that's why there is one large optics vendor, but this cycle every optical vendor appears to be doing quite well. So maybe the question is what is different about this cycle versus what we have seen in the past. Why is this cycle more sustainable and if everyone is doing well, who's losing share or is it just that the file is getting so much bigger than everyone do well for some time?

John Croteau

No there are some losers I'm reluctant to talk about the competitors that are not performing well. I can tell you and our part of the market, guys who - we do as a sustainable position will be [indiscernible] in terms of the analog content. So it really is down to they with us on the Metro long-haul side. Semtech tends to compete more on PON and the moving into datacenter space for the analog content.

There is no question, we’re right now in a very sweet spot as it relates to metro build outs, layering on top of long-haul build-outs. I guess you can make an argument that it's more sustainable given the fact that the exploding demand for bandwidth is real this time and customers are already talking about moving on to 400 gig and they are still in the process of deploying 100G. So there seems to be an insatiable demand. That said, our working assumption is each one of these segments within optical will have its day, PON 2.5 gig PON may soften for a bit, 10 gig PON is right behind it but there is typically you can have a Valley before the peak with 10 gig. That's okay. Metro right now is carrying the day. The whole datacenter thing opportunity for us with cloud service providers is arguably as big as everything we have done so far on the telecom service provider side. And that’s a totally different CapEx driver. We assume that the boom and bust will remain, that is characteristic with markets and our answer to that is to diversify.

Robert McMullan

Yes just add to that point, Vivek. We play in all geographies with multi-diversity of carriers. So Japan, China, North America Europe you know we're probably as John says the leader but we're probably the most diversified in terms of market

John Croteau

Yes there is another dimension subtly here Vivek. We passionately adhere to component model. We don't have to sell everything to everybody and by no means do we leverage people out by bundling things. We have customers who build their own lasers and were more than happy to sell their high performance analog stuff and they respect us for it. The same thing, when we bring the rollout merchant markets silicon photonics stuff they can use our stuff or not. And customers respect us for that. You know we know our position. We have [indiscernible] but we only address the sub-segments in the market and customers and opportunities that are high margin. The rest of the people we use are capability as a reference design. We coach and work with our customers that help them do a better job using our components, using our optical assembly expertise. So I think we have got a very different model from what a lot of other people are pursuing. I will leave it that way.

Vivek Arya

As my follow-up question, I think you recently raised some money and I think M&A has been one preferred use of cash in the past, but just strategically given the growth opportunity in front of you would you prefer to continue to do sort of smaller backend technology type transactions or do think there is an opportunity to take the next step and do something larger than what you have done before?

John Croteau

We have done both, transactions of various sizes we're not shy. We're not meek and mild. But, at the same time, we're not megalomania and to us it's all about discipline. We want to pay the right price, the asset regardless of the size should be accretive, it should be accretive to gross margins, it should be accretive to operating margins. It should be accretive to earnings. There aren't a lot of assets available out there, but when they become available at the right price you can be sure that we are going to act.

Robert McMullan

And the other point is as we talked about in integrating these acquisitions we don't talk so much about the investment that’s been going on over the past GaN has been multiyear investment where once these products turn on that investment mode is behind us as it is in the 25 gig laser for example and we're just selling product. So we have capacity to do other things.


Our final question comes from Quinn Bolton of Needham. Your question please.

Quinn Bolton

There are two quick questions on optical and then one of the new products, just on the a clarification optical, John, the 60% share you’ve in TIAs and drivers, was that a long-haul Metro comment or was that datacenter or was it inclusive of all those segments?

John Croteau

Two independent comments, they both happen to be 60% share. So one is on Metro long-haul, 60% share across all standards, so again whether it's limiting or linear drivers whether it ACO versus DCO all standards again. We're playing in terms of taking subsets to the TAM and claiming high percentage so it's across everything. And then separately the revelation we came to is our HPA, this is high-speed stuff, kind of behind the scenes we haven't talked a lot about it. Didn’t want to telegraph a competitive move but they really shifted from a focus on PON which is very cost constrained in that product category, more of commodity over to datacenters and they have had a breakout in the past year.

When we added things up - bottom-up customers we realize two things. One is from everything we could see we had 60% share of all analog content across all those and at the same time the numbers added up to enabling over a million points, a million ports [ph] which is in excess Forever One what anybody is reporting. So it's clear that data center that 100G connectivity within data center is off to the races unequivocally which is fantastic news and this first wave of products being the analog content we've already established a great position.

Quinn Bolton

Just on the optical business I know you said the long-haul Metro group grew 49% quarter on quarter I think you said PON was flat datacenter obviously grew. Just wondering was there part of the business outside of I guess fiber backhaul that was soft. I guess with all the growth I would've thought you might have had better than 5% sequential growth on optical. I'm just wondering if I missed something.

John Croteau

PON is an equally number and as we had predicted remain flat quarter on quarter so that kind of diluted the growth. So the fiber backhaul was not inconsequential amount of business that we had, that softened at the same time as PON and that’s what brought the number down to 5%.

Quinn Bolton

Lastly, obviously you talked about great new opportunities in MMICs, in datacenter lasers and GaN on silicon. I'm just kind of wondering if you look at calendar '17 for those three opportunities. Are they all roughly the same revenue opportunity? There is one significantly overshadow the others, I'm just thinking now each of those sound like they can easily become $10 million $20 million opportunities over the course of the years. Just wondering if I'm thinking about the right way in terms of contribution to the topline?

John Croteau

Interestingly we're just going to the analysis looking at some of these SAMs and they each add up to the 2019 timeframe pretty clearly the $1 billion number in terms of TAM, SAM opportunity and we're extremely well-positioned for the reasons I described in the scripted remarks. In each one of those predicting how big they are [indiscernible] and start getting to predicting the minds of the customer and how quickly they move but I will leave you with this interesting concept.

We've been fully invested in datacenters. We've been fully invested in GaN. We've been fully invested in MMICs with negligible revenue contribution. The operating leverage as those things turn on and add on top of the growth drivers that brought us today, notably the Metro long-haul stuff , you know it's layers upon layers of growth contribution that we do not have to materially add - you do have to add some but I think we can limit operating expense increases to you know arguably half the rate of sales increases and we can blast through that 30% operating margin and really march over the coming years to 40%. That’s very real. I mean all the things that we talked about have real first tier customers, valid value proposition and what's before us now is almost entirely operating scaling operations which I said before is the problem you want to have.


Thank you. At this time I would like to turn the call back over to John Croteau for any closing remarks.

John Croteau

Great. So before closing today's call I'm pleased to announce we recently hired [indiscernible] as VP of Investor Relations. Steve comes to us with a long-standing relationship within the financial community which is the by-of his time at Sky Works as well as his years of experience as a sell-side analyst.

This is a new position within MACOM it's aimed at good helping to further enhance investors understanding and appreciation of MACOM's growth opportunities and ultimately enhancing shareholder values.

I would also like to add that to highlight several investor conferences we will be attending over the next few months. We will be at the Raymond James Technology Conference in November on December 5th and 6th followed by the Barclay's Global TMT in San Francisco on December 7th and 8th. We also plan to attend the Bank of America Merrill Lynch Conference in Boston on December 15th and Needham's Conference in New York on January 10th and 11th. If you would like to request a meeting while we're in your area, please email us at IR@MACOM.com. That concludes our remarks and we appreciate you joining today's call. Operator you may now disconnect the call.


Thank you sir and thank you ladies and gentlemen. You may disconnect your lines at this time. Have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!