MACOM Technology Solutions Holdings Inc (MTSI) 2017 Q1 法說會逐字稿

Good afternoon and welcome to MACOM's fiscal first-quarter financial results conference call. At this time are participants are in a listen only mode.

(Operator Instructions)

As a reminder, this conference call is being recorded today, Tuesday, January 31, 2017. I will now turn the call over to Steve Ferranti, Vice President of Investor Relations at MACOM. Steve, please go ahead.

Thank you, Karen. Good afternoon everyone and welcome to MACOM's first fiscal quarter 2017 earnings conference call. Joining me today are MACOM's President and Chief Executive Officer, John Croteau; and Senior Vice President and Chief Financial Officer Bob McMullan. If you have 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 John, I'd like to remind everyone that management's prepared remarks and answers to your questions contain forward looking statements, which are subject to certain 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. For a more detailed discussion of the risks and uncertainties that could result in those differences, we refer you to MACOM's filings with the Securities and Exchange Commission, including its current report on form 8K filed today, annual report on form 10K filed on November 17, 2016, registration statement on form S4 as filed on December 21, 2016, and amendment number 1 there too filed on January 18, 2017.

Any forward looking statements represent management's views only as of today, January 31, 2017 and MACOM assumes no obligation to update these statements in the future. The company's press release and management's statements during this call will include discussions of certain adjusted non-GAAP measures and financial information, including all income statement amounts and percentages other than revenue 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 the company's press release and related form 8K, 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 also be available via webcast for at least 30 days in the investor relations section of MACOM's website. With that, I'll turn the call over to John for his comments on the quarter.

Thank you Steve. Welcome everyone, and thanks for joining us today. I will begin today's call with an overview of our first quarter results for 2017, and then turn the call over to Bob McMullan, our CFO, who will review our financial performance in further detail. I will then conclude today's prepared comments by providing a summary of our execution and key highlights during the quarter, followed by an update on the AppliedMicro closing and guidance for the fiscal second-quarter of 2017.

Straight to the results. I am pleased to report that for our fiscal first-quarter of 2017, revenue came in at $151.8 million. Adjusted gross margin was 57.2%, with adjusted earnings coming in at $0.57 per diluted share. Looking at our end markets, as we guided, top line revenue for the quarter was essentially flat due to expected seasonality across our businesses. Networks and multi-market were flat to slightly down sequentially, but up year on year 31% and 48% respectively. Aerospace and defense grew sequentially due to strengthen high performance MIMICs, and was up 20% year on year. Now let me turn it over to Bob to review our fiscal first quarter financials in more detail.

Thank you, John and good afternoon everyone. I will review MACOM's fiscal first quarter results and financial position, and then a high level summary of AppliedMicro's results for its quarter ended December 31, 2016 before turning the call back to John. Our revenue was $151.8 million during the fiscal first quarter, growing 31% over the 2016 fiscal first quarter and seasonally down modestly compared to the $152.7 million in the prior quarter.

Revenue by end markets in the fiscal first quarter. Networks, $108.4 million and 71.5% of total revenue, up 31% year over year. Multi market, $21.4 million and 14.1% of total revenue, up 48% year over year. And aerospace and defense, $22 million and 14.5% of total revenue, up 20% year over year. Of our total network revenue in the fiscal first quarter, optical revenue was $82.3 million or 54.2% of total revenue, and up 38.1% year over year, led by Long Haul, Metro and DCI revenue, which was up 85.5% year over year. Non-GAAP gross profit and gross margin in the fiscal first quarter was $86.9 million and 57.2% of revenue, respectively; compared to $68 million and 58.7% of revenue respectively year over year and $89.3 million and 58.5% respectively on a sequential basis. Adjusted gross margin declined sequentially due to slightly lower revenue from higher gross margin products.

In terms of operating expenses in the fiscal first quarter, total non-GAAP operating expenses were $45.9 million, compared to $40.3 million year over year and $51 million sequentially. Adjusted operating expenses were up 13.9% year over year and down 10% sequentially, primarily due to lower variable compensation expenses.

Adjusted R&D and SG&A expenses were $27 million and $18.9 million respectively in the fiscal first quarter. Non-GAAP income from operations and operating margins were $41 million and 27% of revenue, up 47.8 % and 12% respectively year over year, and up 6.9% and 7.6% respectively on a sequential basis. Adjusted operating margin expanded 310 basis points year over year and 190 basis points sequentially. Net interest expense increased to $6.7 million due to the full quarter's inclusion of our additional Term B debt of $250 million issued in August.

Other income of $1.9 million represents revenue from the consulting contract from our auto business divestment that will continue through FY17. Our normalized non-GAAP income tax rate in the fiscal first quarter was 12%, down from the previous 15%, due to the expanding mix of international revenue managed by our offshore entities with lower tax jurisdictions. As for cash taxes, we did not pay cash taxes in the fiscal first quarter and received a $700,000 refund during the quarter.

Our fiscal first-quarter non-GAAP net income and EPS were $31.8 million and $0.57 per fully diluted share. Respectively growing from $21.8 million and $0.40 year over year, and $31.1 million and $0.54 sequentially. Non-GAAP net income grew 45.6% year over year and 5.6% sequentially. Non-GAAP EPS grew 42.5% year over year at and 5.6% sequentially. The share count used to compute non-GAAP EPS was 55.6 million shares fully diluted for the fiscal first quarter.

Adjusted EBITDA or earnings before interest, taxes, depreciation, and amortization was $48.4 million, up 44.5% from $33.5 million in our FY16 first quarter, and up 7.8% from $44.9 million sequentially. GAAP cash flow from operations was $20.4 million in the fiscal first quarter, as compared to $15.5 million in the FY16 first quarter, increasing 31.6% and down from $24.9 million sequentially. Fiscal first quarter cash flow from operations represents 64.2% of non-GAAP net income, down from 71.1% in the fiscal first quarter of 2016 and 82.7% sequentially. The timing effect of an increase in our 2017 fiscal first quarter working capital is the reason for the decline.

After deducting capital expenditures, free cash flow was $15.5 million or 48.7% of non-GAAP net income in the fiscal first quarter, compared to $8.8 million and 40.7% of non-GAAP net income in the fiscal first quarter of 2016, and $17.7 million and 58.8% sequentially. Fiscal first quarter free cash flow was lower due to higher working capital.

Turning to the balance sheet, at fiscal first quarter end, our cash, cash equivalents, and short-term investments were approximately $377.7 million, up $20.9 million sequentially. Accounts receivable were $112.2 million, up from $108.3 million sequentially. Day sales outstanding were 67 days, compared to 65 days. Inventories were up to $115.2 million, compared to $114.9 million sequentially. Inventory turns were 2.3 times, compared to 2.2 times.

Long-term debt was $587.1 million inclusive of capital leases. We also had $130 million of availability in an undrawn credit line. Capital expenditures in the fiscal first quarter were $4.9 million or 3.3% of revenue, compared to $7.2 million or 4.7% of revenue sequentially. Depreciation expense for the fiscal first quarter was approximately $5.5 million and compared to $4.7 million sequentially. Our capital expenditures were lower, essentially funded by depreciation expense for the first time from a cash flow perspective.

Now I will provide a high level overview of AppliedMicro's non-GAAP results for its quarter ended December 31, 2016. In AppliedMicro's fiscal third, or December quarter, its last full quarter as a public company, revenue, gross margin and Non-GAAP EPS were in line with consensus estimates. It is important to note the consensus revenue includes AppliedMicro's compute business. Revenues associated with the communication processors has been end-of-life by AppliedMicro.

MACOM will report revenue and associated expenses from the ARM-based products as discontinued operations. For these reasons, post close, investors should not view AppliedMicro's prior consensus revenue as translating to MACOM revenue. AppliedMicro ended its December quarter with approximately $73 million in cash and equivalents.

Looking to MACOM's fiscal second quarter, the partial quarter inclusion of AppliedMicro's revenue will increase enterprise and data center source revenue and will be a measurable market. Considering the expected hyper growth potential, we plan to add our data center revenues to AppliedMicro's revenues, and report data center and enterprise separately, excluded and independent from our optical revenue. We believe enterprise and data center opportunity is another secular growth driver, further diversifying our markets and revenue sources.

As we have previously communicated, one of the assets of AppliedMicro is approximately $500 million in reliable net loss operating carryforwards. We plan to integrate AppliedMicro into our international operating structure, allowing us to lower our effective US tax rate. MACOM now believes, based on the mix of worldwide taxable earnings and current income tax rates, our long term permanent tax rate will be 10% in future quarters. Back to you, John.

Thanks, Bob. Let's dive right into it. In aggregate, revenue from our optical businesses was slightly down sequentially and grew 38% year on year. They now constitute 54% of total revenue. Red-hot demand in Metro Long Haul and data centers was offset by seasonal weakness and our correction in PON in China. Demand in Metro Long Haul remains insatiable, as 100 G deployments in global Metro networks continue to ramp and China shifts from backbone to provincial deployments. Revenue was up sequentially and grew 69% year on year across the entire Metro Long Haul portfolio. Visibility remains very strong, with growth continuing to be capacity limited in the March quarter.

Elsewhere in optical, PON was seasonally weak and further aggravated by three second-tier competitors, who are liquidating inventories as they exit the business. Our value proposition and market position with Etched Facet Technology remains strong, so we are allowing this correction to run its course with the goal of sustaining share and minimizing ASP erosion after the inventory flushes this quarter. We believe that end market demand in PON remains solid, such that as the supply chain normalizes, these headwinds will turn into tailwinds and contribute to growth in our June and September quarters.

Now moving on to data centers, last quarter we highlighted success in what we expect will be our next major growth driver for MACOM. Data center revenue was up strong sequentially and grew 114% year on year. We now have enabled more than 30 customers, servicing enterprise and cloud data center applications with laser and VCSEL drivers, CDR's and TIAs. These devices are enabling 100 G optical modules across all standards and formats --- from SR, PSM4, CWDM4 and LR4 servicing all major cloud service providers.

We anticipate growth to further accelerate in the second half as we ramp lasers for 100 G data center applications. We're deeply engage with laser design-ins and vendor selections at more than 25 customers, again, across the LR4, CWDM4 and PSM4 applications. We expect lasers to be a significant contributor to growth moving into our fiscal third and fourth quarters.

To close out my comments on our optical businesses, this quarter is a great example of the merits of diversifying our business portfolio and not falling into the trap of servicing the captive names of one standard, one part of the network, or one transceiver supplier. We are able to withstand a very substantial correction in PON this quarter, counterbalanced by strength in Metro Long Haul and data centers. Allowing our optical businesses in aggregate to grow 38% year on year.

Each of these optical sub segments is notoriously cyclical. Yet, regardless of the mix on a quarter-to-quarter basis, we remain confident that our optical portfolio will deliver strong growth due to the insatiable demand for bandwidth in today's Cloud Connected Apps Economy. We are uniquely diversified across Access, Metro, Long Haul and Data Centers and not just in China, but in North America, Japan and Europe. And we are not overly exposed to any one customer, one standard, or one platform.

With that, let's move over to GaN. This quarter we delivered on orders for initial production builds that I previously highlighted at two major customers. It still early yet, but we are making solid progress, tuning the boards for customer qualifications and field trials. I'd like to highlight two new developments, two leading indicators that we're on the right track. First, one of those customers has asked us to negotiate a global purchase agreement for base station business, which they only require of strategic vendors that they plan to ramp to significant share of wallet. Second, one of them has now asked us to bid on a 900 MHz platform, in addition to the earlier 1.8 and 3.5 GHz programs.

Subtle, but very important is the fact that when customers consider new sources for legacy narrowband programs, where LDMOS has thrived, they do so with a major shift in suppliers in mind, and with the intention of qualifying that GaN supplier for all frequency bands. This significantly improves our SAM model. We now believe that GaN adoption will end up widespread at all frequency bands simultaneously. Which would provide us access to the full $1 billion TAM and base stations.

This is exactly what I saw with the adoption of LDMOS many years ago. When the first movers adopted LDMOS technology, it triggered a domino effect. Base station OEMs know they can't be left behind with outdated power amplifier technology. I believe this domino effect can only be enabled by someone like MACOM, who can deliver the benefits of GaN at the required cost structure, and more importantly, with the supply chain flexibility to support search capacity for global wireless infrastructure deployments. At this juncture, our ability to execute operationally will determine the magnitude and slope of the GaN revenue ramp over the coming quarters and years.

Now, moving over to MMICs. As reported we previously, the really big news for MACOM is that the growth rate of our RF and microwave businesses is now poised to match, if not exceed, our optical businesses. The driver of this today is MMICs. Last quarter MMICs across all of our end markets were up sequentially and grew 38% year on year. We continue to exploit a void in the marketplace that's left as competitors undergo consolidation. We've launched 33 new MMICs over the last year with Tier 1 customers sponsoring these new products across our catalog of networks and AMD portfolios.

It's also worth mentioning, we've completed the Metelics integration on schedule and on budget. The Londonderry and Sunnyvale sites are now closed, with manufacturing fully transitioned over to Lowell. With that behind us, we are now squarely focused on integrating AppliedMicro.

Speaking of AppliedMicro, last Thursday we closed the transaction. We're now heads down executing our 100 day plan to integrate productivity and divest the compute business. We received unsolicited interest from numerous parties since we announced the definitive agreement, and we believe we will be able to find a good home for the compute team within that 100 day window.

Now that the transaction is closed, I can speak more freely about our view of the upside potential of the portfolio coming over with AppliedMicro. With the geopolitical storm that's brewing around cybersecurity, the move to hardware-based encryption, specifically MACsec, as well as PAM4, have given the AppliedMicro team a seat at the table for architectural discussions with the world's leading enterprise and cloud data center providers. AppliedMicro is way out in front as a strategic supplier of MACsec to all of these major OEMs, helping secure their network links with hardware encryption, which is critical in this age of cybersecurity at 100 gig and beyond.

With the closing of the transaction, we can expand those architectural alignments to include analog and photonic roadmaps which we expect will far outpace the sales of MACsec itself. When you see the list of all the major OEMs who are adopting MACsec, as well as PAM4, for 100 gig to 400 gig applications, you'll understand why we believe cloud data centers have the potential to be yet another explosive growth driver for MACOM. Not only is MACsec expected to be material contributor to growth, but it's an accelerant in our ability to ramp the rest of our portfolio and data centers.

So, that brings us to PAM4. In the March quarter the AppliedMicro team is on track to deliver initial production units to our lead customer, a world leader in network infrastructure equipment, who tells us that they expect to be in production with single-lambda PAM4 transceivers in the second half of this year, 2017. Furthermore, at least four of the six major cloud data center players have already made the architectural decision and are poised to move forward, focusing their efforts on single-lambda PAM4 as their standard of choice for 100 gig and beyond.

Beyond the initial customer ramps, we believe that broad industry adoption of PAM4 will be unlocked by the ecosystem of companion analog, laser and photonic components. This is something that MACOM can uniquely enable. As of this March quarter, we're also sampling units of companion lasers and analog components for single-lambda PAM4 to be followed by integrated L-PICs later this year. Because of the explosive growth opportunity in enterprise and cloud data centers, we will break this out and speak to it as a separate secular growth driver for the company, independent from optical going forward.

So wrapping it all up, we are now targeting multiple major growth waves in our industry. We're riding the optical super cycle, we are leading the technology transition to GaN and RF, we are filling the vacuum for MMICs that has been created by industry consolidation, we are securing the internet with hardware encryption for cybersecurity, and we are servicing the exploding demand for productivity within cloud data centers. We're not just diversified in optical, we are diversified across multiple end markets and multiple secular growth drivers. Again, this is the reason why we're confident we can continue to outperform, as we have for the past three years, despite the inevitable ebbs and flows and market gyrations in the semiconductor industry.

With that, let's talk about next quarter guidance. For the fiscal second quarter ending March 31, 2017, we expect revenue to be in the range of $180 million to $186 million. Adjusted gross margin is expected to be between 58% and 61%. And adjusted earnings per share between $0.59 and $0.63 on an anticipated $64 million fully diluted shares outstanding. Operator, you can now open the call to questions.

(Operator Instructions)

Harlan Sur, JPMorgan.

Good afternoon, thanks for taking my question. Maybe if you could just help us clarify given this is the first quarter of inclusion with AppliedMicro. So on the two-thirds of the AMCC business you're recognizing here in the March quarter, are you including both the connectivity and embedded businesses or just the connectivity businesses?

It includes both Harlan, but the compute business will be treated as discontinued operations and the embedded business has really been end of life, and so they push their numbers up, which is not the real run rate going forward.

So on that note, on the embedded business, if we look at the proxy, I think that AMCC's forecast was for that business to decline like 60% over the next 12 months, so is that how we should be modeling this segment over the next 12 months or do you guys have a different view of the revenue decline for embedded?

It could be even a bit faster.

Yes, it can be faster. The other thing I'm not sure that's mentioned is, that tends to operate a very low gross margin. So the quicker we do it, the more gross margin dilution we experience. So and there's scenarios where the buyer for the ARM business takes the embedded business. So you really got to be careful including pretty much any of that revenue in the model.

Okay, got it. And then, on a brighter note, like on the growth prospects on A&D, that business grew 20% year over year in the December quarter. I think you guys have had a view that, and it's been going quite strongly given the strength on the MIMIC design wins that you've had, I think the team has had a view that A&D business would grow about 40% type of growth rate over the next few quarters. So I guess the question here is, do you guys still anticipate 40% growth rates on a go forward basis for A&D?

Yes for the year on year, for the entire year, 2017 versus 2016, we are still anticipating more than 40% growth year on year. And we're, as you know, we are well into our second fiscal quarter. So the visibility is pretty good on that at this juncture.

Great, just one last question. So can you just give us an update on the L-PIC to silicon photonics products? This is a product that has pretty high level of integration. Are you guys still on track to kind of start ramping this over the next few months and is this going to be more for -- I believe it's going to be more for data center applications, but if you could just confirm. Thank you.

Sure, yes. The initial L-PICs is absolutely targeted at data centers NRZ 100 gig. It is right on track in terms of qualification. Anybody interested, you might want to go to OFC, you will see it in action as production units. And the good news is, the assembly process, we call the self aligning EFT technology, is operating spectacularly. So that is going to be a fantastic compliment to the AppliedMicro portfolio -- and actually in advance of the AppliedMicro portfolio for NRZ applications. So it's one of the reasons why we are so bullish for the cloud data center opportunity.

Great, thank you.

You're welcome.

C.J. Muse, Evercore.

Good afternoon and thank you for taking my questions. I guess first question around AMCC, can you quantify what you are including in terms of the March guide, partially for AMC both from connectivity and embedded? And I guess as a follow on to that, can you talk about the PAM4 large customer? I'm curious as that business ramps in the back half of the year given the resources that they will presumably require, how we should layer in the margin impact for that business for you guys?

One of the things we're very cautious about, I will start with some of the latter parts of the series of questions, is we don't like to preannounce our customers' product plans. If you understand the market for PAM4 and single-lambda, you can probably infer from that who the lead customers are. But Bob, you want to speak to the --

So we really don't want to be bifurcating two businesses because we run as one business. But in a range, we're in line with our consensus and the balance is plus or minus around what makes up the difference with the AMCC revenue in the forward quarter.

Yes, if you break it down it's a pretty logical mathematical equation this quarter. On a go forward basis, the caution we have is as AppliedMicro telegraphs, they began an end of life exercise with the embedded business that started well before we got involved. So that's going to be tailing off fairly rapidly, so you got to be careful on the forward quarters.

Helpful. And I guess as a quick follow up, I think I read in one of the registration statements that you had NOLs of $1.23 billion, I think you've been talking about $600 million plus, so can I infer from that that a portion of the NOLs will stick with compute upon that asset sale?

No. It's not the way it works. So on the 382 change of control, there is a limitation based upon fair market value of the acquired business. With that calculation of fair market value, which is about $772 million times the rate, you're limited by that calculation as to what you can use in total NOLs. So, the difference dissipates into the world of not being used, unfortunately. Or fortunately, depending on the value you look towards AMCC.

Got you. Very helpful, thank you.

You're welcome.

Steve Smigie, Raymond James.

Great, excellent. Just wanted to follow up, as we think about June, I know you don't like to guide that far out, but if you only have a partial quarter of AMCC in March, so are you going to give any color on what maybe AMCC could look like in June at this point and we could maybe call ourselves on June, or how we should think about seasonality now for June?

So we traditionally do not have seasonality in our June quarter. I don't expect it with the acquired business. We are going to -- again, don't like to identify these businesses and that's why we pointed to the enterprise and data center revenue category, because there is complementary and product overlaps that push and pull each other. But overall, I think if you were to look at the trend by quarters, in line with the shaping of MACOM, I think from this point here you'd see similar shaping for the balance of the year.

Okay, great. And then, it sounds like you guys continue to make progress on GaN, it feels like this is a year where you get some production revenue or maybe calendar 2018 is the year where maybe you see more substantial revenue. Should we think about the 2018 revenue as probably an order of magnitude -- or maybe not an order of magnitude but multiple or larger returns of revenue in 2018 versus 2017?

No question, I think that's not an unfair assessment. There is material contribution in the back half of the year that's again beginning to ramp. It just layers on top of the other things that are turning on. Bob maybe commented that there isn't seasonality, I would actually describe our third and fourth quarter as the absence of negative seasonality, so maybe that's seasonality. So I mean traditionally our third and fourth quarter are pretty strong, you start layering in the GaN of stuff and it starts looking better and better. But no question, talking about our top line numbers are big enough now that GaN has to get sizable to have a material contribution to our growth and there's no question 2018 would be the year where that happens.

Again, riding on top of cloud data centers, Metro Long Haul seems to have a lot of juice to continue at least for another year. So it all layers in nicely. But that's not an inaccurate description. And it's coming off a small enough number that an order of magnitude is pretty easy, to be honest. The question is how many multiples of an order of magnitude.

And again, once we get through the field trials and the customer qualifications, we'll have a much better sense. As I mentioned, customers now asking us about global procurement agreements --- that is a clear indicator they're looking to move forward and turn on significant share of wallet. Same thing when they're exercising us a 900 MHz programs. That a clear indicator they are looking at a wholesale transition from a supply chain standpoint. So all the indicators are good, but there's still a lot of execution before us.

If I could just sneak one quick one in on -- John, you have a lot of experience in this space. Can you talk about if there's any second sourcing? So let's say you have a major OEM, you win certain platforms and even within a specific platform you might win, could you share that platform fifty-fifty with somebody? So how many suppliers would an OEM adopt within a specific platform, how many suppliers did they adopt?

So when a program goes into production, there's no such thing as a second source. During the development process they will have two or three runoff, typically two, more is a risk, a contingency in terms of technical execution. But once the business is awarded, it is impossible to have two sources. The behavior of the devices and the designs are different, so there's no way to have two sources.

The way they achieve the spirit of what you're describing is, these base station OEMs are very mature and controlled in terms of awarding programs to stick handle share of wallet within their overall purchase. They're buying $200 million plus each of power transistors and for a given year, depending on how different vendors are performing, they will have targets increasing or decreasing for each of those vendors. But on a program by program basis, they're sole sourced.

Okay that's really helpful, thank you.

You're welcome.

Blayne Curtis, Barclays.

Just looking at the March guidance, maybe you can talk about the core MACOM segments just directionally. Are they all growing or are you seeing any seasonality?

So A&D, consistent with the question the line of questioning earlier, that's going to have a strong quarter. Networks is going to have a strong quarter. And multi market is kind of a neutral quarter. The way I describe that when I look into it, that kind of surprised me when I looked at it, but basically our catalog MMICs are selling into applications that are ramping more aggressively. And customers that we described as A&D and networks, multi market is basically other, so there's no reason why that's not growing, it's just our MMICs are very hot on the A&D and the networks side right now. But as you would expect, as you start getting into our second and especially our third and fourth quarter, things lift pretty materially.

Got you. And then maybe just talk about that, in the second half you talked about 100 gig lasers, can you talk about what you need to accomplish to get these to revenue?

Design wins and orders. We launched three lasers, I think it was about 90 days ago at our last earnings call, just before that. And now we're hot and heavy, I think we've got 25 or 30 customers that were actively in design wins. And there is some qualifications required of end customers, so that's what -- it's all leading to 100 gig demand so this is 4 times 25G, so it's big numbers, healthy ASPs, great gross margin, so it's all good stuff.

That's one of the contributors, but it's pretty much across the board. The Metro Long Haul stuff, that is insatiable. It's all capacity expansion there, that's a growth driver. We get some contribution from GaN, A&D from the previous comments, that's strong. It's pretty much everything. When you get into the third and fourth quarter everything is kind of clicking on all cylinders or that's the way it looks.

Okay, thanks, nice job.

Thanks.

Quinn Bolton, Needham & Company.

Hey guys. Just wanted to first ask on the AppliedMicro, should we be thinking about that quarter since you have a partial contribution this quarter, is that business fairly linear across the three months, meaning that we should take effectively two-thirds of whatever we forecast AMCC to do in a full March quarter, and then you'll pick up that third month in June? Or does it tend to be a little bit more back end loaded in February and March? That your guidance would actually include more than a two-thirds contribution for AMCC?

So as Bob said, we don't bifurcate the business between the two. But if you take two-thirds of the number, it's probably good math, not inconsistent with the previous expectations.

But it's not what they did two-thirds of what they did last quarter though. That's the caution here. Because of the end of life and the dynamics going around the embedded processor.

Yes -- well are you talking about for second quarter or third quarter?

For the forward quarter.

Yes, so when you go forward to the third quarter and so on, you have a very substantial tail off on that embedded business.

Right. Got it. And then sort a similar question on the expenses, I know when you announced the deal you said that the connectivity business carried about 49% of the OpEx. Will that other 51% from day one of the acquisition be included in those discontinued ops or could some of the AMCC expenses be a little bit higher here in the stub period for March that could weigh on OpEx?

Quinn, as we talk about it as we announced the deal, there are some imbalance in the first partial quarter of timing of expenses, so it's possible the expenses could be a little higher on this partial quarter that's mismatched against the more traditional linear revenue.

To put in perspective here, we're three days into this post closing, so we are always very cautious because every deal we have done there's always things that we learn, so let's just say we guide with caution.

Understood. And then just wanted to come back to the core business, Non-GAAP gross margin towards the lower end of your guidance and I think you said in the script that you have now fully integrated Metelics, and once you're done that I thought you were going to be tracking towards 60% gross margin on the Metelics business. Just wondering where we are on the gross margin ramp for both Metelics and FiBest. Are they still a distance away from that 60% gross margin target that you are aiming for or are they getting closer to that target? Especially on the Metelics side now that you've integrated the two manufacturing facilities into Lowell.

I would say both on the Metelics integration, we've closed Sunnyvale and Londonderry and moved that production into Lowell. That's now a tailwind in terms of gross margin expansion. Likewise on FiBest, we've restructured our supply chain as new product transitions where we have the majority, if not 100% semiconductor content. So that's a tailwind in gross margin expansion.

The issue with the last quarter, as bizarre as this sounds, is the weakness in PON. PON is actually one of our highest gross margin -- higher, not highest -- but higher gross margin areas for commodity. Those lasers, the Etched Facet Technology has just a fabulous economic position in that market. So with the weakness in PON being compensated by Metro Long Haul, part of that is actually compensation with the TOSA/ROSA portfolio that came over with FiBest. Which is, even on a good day, not nearly what we get from the Etched Facet lasers.

So it's really a mix issue that was this weakness in PON and strength in the Metro Long Haul. Which again is counterintuitive, you would think PON would be low margin, Metro Long Haul would be high margin, the modulator drivers are a great margin, the TOSAs/ROSAs are modest margin. So it's just a bunch of moving parts in the past quarter.

Got it, great, thank you.

You're welcome.

Mark Delaney, Goldman Sachs.

Yes, good afternoon, and thanks very much for taking the questions. First question is on some of the -radar opportunities around tiles with MPAR and the SPAR tiles. Can you give us an update on when you could maybe convert some of those opportunities for aerospace and defense and weather applications into revenue?

We try to avoid talking a lot about that because until we have landed the programs, we can't say that we've landed the programs. I can tell you our lead customer, Northop, has some very active focus within Northrop on specific programs that would be thoroughly inappropriate to talk about. But on the civil side, where we work with Northrop and everyone else, MPAR continues to move down. The bidding is this year in 2017 with RFPs that are going out. Our customers are all kind of scrambling to come up with their own competitive strategies on how they plan to bid. But that's still a ways off in terms of production.

The one thing I would say though is, if you actually look at even modest levels of initial production builds for some of these guys, for their own bidding process, it adds up to not immaterial revenue to us in terms of growth. So in the medium term, if MPAR gets traction in terms of through that RFP process, we can see material contribution next year.

That's helpful, and then follow up question, if you could just talk a bit more on the multi market business, just any sort of trends you're seeing in terms of distribution changes and changes in inventory patterns at the channel.

No. There wasn't anything really material in terms of inventory trends for our catalog portfolio. Again, catalog transcends multi market A&D and networks. So that was not a primary factor. Things were relatively flat, to be honest.

With the growth of the networks business, the reliance upon the contribution of distribution revenues continue to decline. As the networks business primarily direct OEMs or their contract manufacturers.

Big guys.

Got it. One clarification as you guys go to the new segment reporting for next quarter with AMCC. I think a piece of AMCC in the acquisition presentation with allocated out to be optical, so is the part of AMCC that you consider optical going to be in the optical line or is all of AMCC going to go into your data center segment?

There is a small piece, most of it though is going to go to the enterprise data center.

Yes, I don't think we're talking about reporting even our analog data center products as optical. We will pull it out of optical. And in the spirit, we want to provide greater visibility and granularity in terms of -- that data center business is really driven by a different set of economics than the service provider side. So now that we're going to have such a mass of revenue, it makes sense to report on that separately as it really behaves differently. But we've got to get to the point is actually slicing and dicing the AppliedMicro revenue to come up with definitive answers 90 days from now.

Understood, thank you very much.

You're welcome.

(Operator Instructions)

Tore Svanberg, Stifel.

Yes, thank you. Can you just clarify what exactly is going to be reported under data center revenue?

So we sell many products, clock data recovery, TIAs, the L-PIC would be a data center product; some of the framers, OTM MACsec at the data center primarily and the PAM4, when that kicks off, that would be more of an optical application.

Okay. I just got a bit confused, because you said some of the analog parts, you're actually not going to include in data center, or did I not hear that correctly?

No. So the products that we have that we started reporting as data center last quarter, these are VCSEL and laser drivers, TIA, CDRs and so on. We will report those separately as data center -- separate from optical. And then, a sizable chunk of the AppliedMicro portfolio, notably PAM4, but they sell a lot of product into enterprise data centers. So that's the part of their revenue that we will be reporting as data center. So it's not just cloud data centers, it's enterprise and cloud data centers.

That's very helpful. And you also talked about some competitors flushing out inventories in the March quarter and the PON area, I'm just wondering, are these same competitors going to be around or they are basically just older parts that they need to flush out? Just trying to understand the dynamics a little bit better there, which obviously gives you confidence that maybe PON is going to start growing again in the June quarter.

So basically what happened is, coming in Mitsubishi and CyOptics, Avago, Broadcom, or whatever they called now, were really the two incumbent big guys, and when there was a supply shortage, there were four Asian competitors that attempted to try to fill the void in addition to BinOptics. And what happened was when we got so aggressive in taking share a few quarters ago during the summer, we got up to about 70% share, we got a cost structure that is well below what any of these guys have. We could meet the market price targets and basically consolidate down to the three big guys. Three of the four guys basically decided, what we understand, is to exit the business and started liquidating inventories.

When that behavior starts, as you can imagine, there is some dumping that goes on they will sell at any price. So we assumed the posture of saying, okay, we've got to let that stuff flush, because our primary concern is preserving ASP such as that when that stuff flushes, we still have a healthy cash flow business, because the end market demand has not changed. Our customer is telling us the end market demand is the same.

There was some other dynamics when one of our customer is changing from an in sourcing to an outsourcing with five sub cons, so lots of kind of moving parts. But at the end of the day there's three definitive guys, second tier guys that are exiting the business. And the fourth one, they are on the ropes.

Okay.

So that's something that, frankly, we didn't fully anticipate that when guys exit that happens. But it is what it is.

Okay, very good. And then the last question is on GaN. So maybe you could talk a little bit about some of the milestones from your own manufacturing perspective and my understanding is that you're going to be manufacturing all these in-house. Is that the case, would you consider doing outsourcing? And again, what are some of the milestones for us to monitor as far as manufacturing on your side as you gear up for a bigger GaN ramps?

Yes, so the answer is really time dimensional. So when the Nitronex business came over it was outsourced, Nitronex was not manufacturing wafers, so we still have that source that supplies some of our GaN. We then brought it into Lowell, so we have Lowell as a source, as a qualified source now for our GeN4. And then we have another partner that I'm just chomping at the bit to announce, which is the game changer in terms of the cost structure. We are within spitting distance now of being able to announce that, and be off to the races. So in terms of wafer supply, it's going to be multisourced.

That's one of the things that, if you're going to supply proprietary product to base station guys, you cannot be supplying it from one factory. And you need to have surge capacity, so that supply chain is really being tuned with partners both on the front end as well as backend. The backend manufacturing is equally critical in terms of surge capacity. So it's not fully internally sourced. Partially, but not entirely.

That's helpful, thank you very much.

You're welcome.

Harsh Kumar, Stephens.

Hey Bob, a lot of us are trying to triangulate on the March guide and trying to figure what's running that, is there any way you could give us a range or point us in the direction of how much is switch and how much is compute business? Or give us some idea thereof?

So it was in the 20% to 25% range of total revenues last quarter for their December quarter.

Okay, that's helpful Bob. And that's together, right? Obviously the compute business was not very much. Okay that's very helpful. And then you're saying it falls off really, really fast from there?

Yes.

Okay. Also, second question, in terms of -- and this is for John and Bob, in terms of you have it now, it's a little early, couple days now, but obviously I would suspect there is some consolidation at least at some level that will happen. How do you view these, is there even an opportunity here?

I'm sorry, consolidation?

Cost structure.

Oh yes, people have already been informed. The people who are not staying on, many have already left. And then one of our goals, and we've achieved it this time, is at the time of closing, everyone knows definitively if they are staying, if they are going, if they are staying temporarily for 90 days, 180 days, transitional, we owe it to them to be very clear. And for those who are not necessarily in the short term, necessary in the short term, they are informed immediately and walk away with very generous packages. So there is a lot of cost savings going on right now.

Understood. And another one for Bob, Bob in terms of OpEx, would you be able to give us an idea of how the new OpEx for March, how that breaks down into R&D and SG&A considering is going to have a pretty big component in AMCC?

So I think you will see continued -- the way I will tell you is, you will see continued expansion of operating margin by 100 to 200 basis points, something like that. So I think on the guide you can kind of get to the number there.

Fair enough, that's helpful. And then, sorry back up to John, John you mentioned there is on the GaN side, there is a global requisite from a customer, one of your potential customers. And then you separately mentioned there is a 900 MHz bid request on the product side. Are these two from the same guy or customer or are they from the two separate customers?

The one I was referring to are both from the same guy, there were other 900 MHz requests that are not as far along. By the way, there other customers where we already have global purchase agreements. The reason why I called out the new one was, the fact that it's a new specifically for base station business is an indicator that they are looking to move forward and to bring us on as a mainstream supplier. I can't say, if we have a GPA the preexists, I can't make that statement. We are already covered by a GPA. But when I was trying to do is really provide our investors visibility into leading indicators that we're on the right track. And that to me, for that particular customer, which is a very substantial player, is a very big deal.

Understood. Thanks guys. This is all I have, thank you.

You're welcome.

Richard Shannon, Craig-Hallum.

Hi John and Bob, thanks for taking my questions. Maybe just a couple for me first on the topic of PON. Taking a couple of your prepared remarks, as well as one of the questions, John, curious what your expectations are for share, that you might have after three of the suppliers liquidate their inventory. Think you mentioned CyOptics and Mitsubishi as ones who have historically been there, do you expect them to maintain or could you have a share easily higher than the 70% number you talked about over the summer?

It's quite possible we can end up with a higher share. It's just when you get above 70%, it's kind of diminishing returns in terms of incremental share. I think when you get up to that level, you're going to be guided more by the end market health than anything else, and I can't predict those customers', those competitors' behaviors. We suspect that this is relatively poor margin business for them, so it's not something at all that they care to fight over. But it's not like we're looking to rule the universe with a monopolistic supply condition either. So at 70% we are happy, we accomplish what we want, which is a great cash flow business.

Okay fair enough. Question on your L-PIC products and if I could ask you to repeat the comments about the products you intend to come out with here. I thought I heard you say CWDM4 and PSM4, if you could just repeat which products you specifically anticipate for L-PIC that would be great.

So the product that we'll be showcasing at OFC is the first product, which is a quad L-PIC for CWDM4. So that is a very hot commodity for data center applications. Really showcases the benefits of that self aligning technology.

Okay. And just to verify, you also said PSM4 as well, John?

Yes. I don't think we've announced anything about product plans beyond that, but we have very ambitious plans taking advantage of that L-PIC capability.

Okay. And then on CWDM4, do you think you can give us a sense of timeframe you expect to be in the volume production for that?

Second half of the year unequivocally we will have production units at OFC. In fact, I believe we have production units today, we are just completing the qualifications. It's kind of like analogous to the GaN ramp. There's issues of getting the supply chain aligned to be able to scale to the volume required for these data centers. And we have complete alignment with our manufacturing partner on that stuff, and it's a matter of just locking down supply and securing the designs. We've actually got the same customers who we would anticipate to be the lead customers for the L-PICs with the previous generation where we are not supplying the L-PIC, we're providing all of the analog content at a higher level of solution with the right supply chain lined up. So the L-PIC really kind of slots in as the next generation that disrupts the cost structure that much more. But it's not like our revenue in data centers is waiting for the L-PIC.

Right of course. Understood. Last question for me, you mentioned you're still capacity constrained, any way can give us a sense of what product or products you are constrained on and how long those will remain?

We have insatiable demand for the modulator drivers where we have leadership share, as well as for the TOSAs and ROSAs. Every single product that we can manufacturer, we can sell for the foreseeable future.

Okay. Perfect, that's all the questions for me guys, thank you very much.

You're welcome.

I'd just like to -- Harsh, to your question on operating margin, the right range is about 50 basis points to 100 basis points, not 100 to 200. I want to make that clear.

Thank you, and that concludes our question and answer session for today. I would like to turn the floor back over to John Croteau for any closing comments.

Very good. Before closing out today's call, please note that we will be attending a number of upcoming investor events, including the Goldman Sachs conference on February 15 in San Francisco and the Raymond James Institutional Investors conference in Orlando on March 6. In addition, we'll be taking meetings that Mobile World Congress in Barcelona and OFC in Los Angeles, if any of you plan to attend. If you'd like to request a meeting at one of these upcoming events, please email us at IR@macom.com We look forward to reporting our fiscal second quarter results and continued progress on next quarter's call. That concludes today's remarks. Operator, you may now disconnect the call.

Thank you. Ladies and gentlemen, thank you for participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a great evening.