MACOM Technology Solutions Holdings Inc (MTSI) 2015 Q3 法說會逐字稿

Good afternoon, and welcome to the M/A-COM Technology Solutions fiscal third-quarter 2015 financial results conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded today, Tuesday, July 28, 2015. I will now turn the call over to Leanne Sievers of Shelton Group, the investor relations agency for MACOM. Leanne, please go ahead.

Good afternoon, and welcome to M/A-COM Technology Solutions' third-quarter 2015 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 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'd 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, and quarterly report on Form 10-Q filed on May 13, 2015. Any forward-looking statements represent management's views only as of today, July 28, 2015. MACOM assumes no obligation to update these statements in the future.

The Company's press release and the management statements during this conference call will include discussions of certain non-GAAP measures and financial information. These financial measures and a reconciliation of GAAP to non-GAAP results are provided in the Company's press release and related current report on Form 8-K, which was filed with the SEC today and can be found in 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 30 days in the Investor Relations section of MACOM's website.

And now I'll turn the call over to MACOM's President and CEO, John Croteau. John, please go ahead.

Thank you, Leanne. Welcome, everyone, and thanks for joining us today. I'll begin today's call with an overview of our third-quarter results for FY15, and then turn the call over to Bob McMullan, 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, followed by guidance for the fiscal fourth quarter of 2015.

Straight to the results. I'm pleased to report that for our fiscal third quarter, we delivered record revenue in EPS. Revenue for the third quarter was $130.7 million. Gross margin was 54%, with net income coming in at $23.1 million, or $0.42 earnings per diluted share, based on 55.2 million shares outstanding.

Looking at our end-markets, Networks grew quarter on quarter, on the back of strong demand in 100G for long haul and metro networks, as well as lasers in the access market. We successfully met our first goal following the BinOptics acquisition, doubling laser unit capacity in Ithaca by the end of June. During the quarter, we saw none of the currency effects and headwinds that concerned us in the prior quarter. That said, we did see headwinds in mobile infrastructure, both fiber and wireless backhaul, that resulted from management restructuring at the top three carriers in China. In total, growth in global 100G and share gains in access more than offset the weakness in China backhaul.

Our laser business remains capacity-constrained for the foreseeable future. We also saw weakness in Multi-Market, including industrial, similar to what others have reported. Once again, end-market demand across the full breadth of our catalogue portfolio, including Networks and A&D, more than offset this weakness, and actually grew sequentially. Automotive was down slightly quarter on quarter, within the normal fluctuations in demand that we see at Ford. In summary, we're very pleased with another solid quarter of execution by the team.

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

Thank you, John, and good afternoon, everyone. During the course of my comments, as well as those made by John, all income statement amounts and percentages will be discussed on a non-GAAP basis, and are provided to enhance the understanding of our core operating performance. A reconciliation of each figure to the most comparable GAAP measure is included in today's earnings press release.

Revenue was $130.7 million, representing a sequential increase of 4.6% compared to reported revenues of $124.9 million in the prior fiscal quarter and an increase of 16.3% compared to $112.4 million in the fiscal third quarter of 2014. The 2014 fiscal quarter included revenues for the CPE business, sold in May 2014, of $5.3 million. Adjusting for the CPE business, revenues grew 22% over the prior year's fiscal quarter. Networks was $74.1 million and 56.7% of revenue. Aerospace and Defense was $20.3 million and 15.5%. Automotive was $21.6 million and 16.5%. And Multi-Market was $14.7 million and 11.3% of revenue.

Gross profit in the fiscal quarter was $70.6 million or 54% of revenues compared to $66.3 million or 53.1% of revenues in the prior fiscal quarter. And $58.1 million or 51.7% in the fiscal third quarter of 2014. Gross margins increased by 90 basis points sequentially, and benefited from selling a higher gross-margin product mix than the fiscal second quarter, including lower Automotive revenue.

Total operating expenses were $38.3 million compared to $36 million in the prior fiscal quarter, and $34.2 million in the third quarter of the prior fiscal year's quarter. The increase in operating expenses in the fiscal third quarter included higher levels of variable compensation of almost 50%. Research and development expense for the fiscal third quarter was $20 million. This compares to R&D expense of $18.7 million in the prior fiscal quarter, and $18.8 million in the fiscal quarter of 2014. R&D as a percentage of revenue represented 15.2% in the fiscal third quarter compared to 15% in the previous fiscal quarter, and 16.7% in the prior year's quarter.

Selling, general and administrative expenses for the fiscal third quarter were $18.4 million. This compares to SG&A expense of $17.3 million in the prior fiscal quarter, and $15.4 million in the prior fiscal year's quarter. SG&A as a percentage of revenue represented 14.1% in the fiscal third quarter compared to 13.9% in the previous quarter, and 13.7% in the prior year's quarter.

Income from operations was $32.3 million or 24.7% of revenue. This compares to $30.3 million or 24.3% of revenue in the prior fiscal quarter, and $23.9 million or 21.3% of revenues in the prior fiscal year's quarter. Solid gross margins and reasonable investment drove the continued improvement in operating income and margin in the fiscal third quarter, driving us further towards our goal of 30% operating margins. EBITDA, or earnings before interest, taxes, and depreciation and amortization was $35.6 million, up from $34.1 million in the prior fiscal quarter, and $27.2 million in the prior year's fiscal third quarter. This represents growth of 4.4% sequentially, and 23.6% year over year. Interest expense of $4.1 million in the fiscal third quarter was down from $4.3 million in the fiscal second quarter on lower levels of outstanding debt.

Turning to income taxes, our effective income tax rate for the fiscal third and second quarters was 18%. This tax rate compares to 23.5% in the year-ago quarter. Our cash taxes paid in the fiscal third quarter were $96,000 or 2 basis points of pretax income, as compared to $724,000 or 2.8% in the fiscal second fiscal quarter. As current fiscal year taxable income was reduced by tax losses and in NOLs. Our fiscal quarter net income was $23.1 million or $0.42 per diluted share on slightly higher outstanding shares of 55.2 million shares. This compares to fiscal second-quarter net income of $21.3 million or $0.41 per diluted share on 52.5 million outstanding shares. And net income of $15.8 million or $0.33 per diluted share in the prior fiscal quarter. This represents EPS growth of 3.2% sequentially, and 27.2% year over year.

Cash flow from operations was $26.8 million in the fiscal third quarter, growing from $13.9 million in the fiscal second quarter. The fiscal third quarter cash flows includes an add-back for prepaid compensation related to the BinOptics transaction. At fiscal quarter-end, our cash and cash equivalents was approximately $80.7 million. Outstanding long-term debt was $340.8 million, and we have an available $130 million under our existing revolving credit agreement, for future use.

Accounts receivable of $89.7 million compares to $89.4 million at the end of the prior quarter. Day sales outstanding was 62.5 days compared to 65.1 days at the end of the prior fiscal quarter. Inventory was $84.4 million compared to $84.1 million in the prior quarter. Inventory turns were 2.9 times compared to 2.8 times in the prior fiscal quarter. Capital expenditures in the fiscal third quarter were $18.5 million or 14.2% of fiscal third-quarter revenue compared to $11.1 million or 8.5% of revenues in the fiscal second quarter.

We continue to spend CapEx with a planned expansion of laser capacity in the Ithaca and Lowell fabs. In addition, MACOM was presented with the opportunity to purchase our Lowell headquarters from the former landlord at an attractive price of $8.3 million in the fiscal third quarter. All CapEx was funded by internally generated cash flow. The building purchase, while not anticipated, is expected to be very advantageous to MACOM in the long term. As a US Department of Defense-trusted foundry, we were already, essentially, locked into our Lowell facility. And by buying the facility, we have eliminated the future risk of having to renew our lease on potentially unfavorable terms. Depreciation expense for the fiscal third quarter was approximately $3.3 million and $3.8 million for the fiscal second quarter, as certain equipment became fully depreciated in advance of new equipment being placed into service.

Before I turn the call back to John, I want to discuss the accounting for the divestiture of the auto business to Autoliv, and other important considerations. As announced, MACOM will receive $100 million, of which $18 million will be subject to an escrow for potential indemnification claims for 18 months following the closing, netting $82 million to MACOM at closing. In addition, MACOM has the potential to be paid an additional $30 million based upon the attainment of specific revenue and booking targets for the period from closing through FY19, or a lesser amount based upon partial achievement. Payment of this contingent amount will be no later than the attainment of the target or after the close of FY19, whichever comes sooner.

Autoliv has retained MACOM under a consulting agreement for advice and services, which may generate up to $1.9 million for each of the next eight full quarters following the closing. The fees that are earned will flow through other income as services are rendered by MACOM. Upon closing the sale, the Auto business will be treated, for accounting purposes, as a discontinued operations. At the closing of the transaction, MACOM will file an 8-K which will restate the current and past two fiscal years by quarter, with the auto business revenue and associating expenses, net of tax, included as a one-line income item under the classification: Discontinued Operations Net of Tax. Dual EPS disclosure for continuing and discontinued operations will be presented. With this reclassification, future quarters and past quarters will be comparable, and exclude the auto business.

From a tax perspective, the sale will generate taxable income in FY15, although a portion of the gain will be reduced by NOLs. The sale of the auto business also shifts a mix of taxable income between US and international. It is anticipated that international taxable income will be larger than domestic without the auto business, which may result in a lower tax rate than the present rate of 18%. Also at closing, MACOM will update its guidance for the fiscal fourth quarter, without the auto business. We expect the transaction to close in the upcoming quarter, but our guidance today will be inclusive of the auto business, as we are constituted today.

Under the terms of the MACOM credit agreement, MACOM will elect not to prepay a portion of the outstanding principal to the extent of the net proceeds, a defined term, received. MACOM will retain the cash, as we believe there will be opportunities to reinvest the cash in future acquisitions. As a disciplined, consolidated and a proven integrator, MACOM believes that potential reinvestment of the cash from the sale of the auto business in future acquisitions offer higher returns than the cost of capital.

On this point, I will turn the call back over to John.

Thanks, Bob. I'd like to begin by providing an update on our laser capacity expansion efforts. As I mentioned earlier, we successfully achieved our goal of doubling capacity in Ithaca, New York. To be specific, the good die per wafer improved to from 12,000 to over 24,000 at the end of June. Nevertheless, we remain capacity-constrained to meet laser market demands through fiscal Q4. In parallel, we are still on track to double unit capacity yet again in Lowell by the beginning of calendar 2016. This is key as we prepare to address the next secular growth driver in 100G in data centers.

Diving in a bit deeper, COGS reductions associated with that capacity expansion resulted in gross margin improvements that more than offset what otherwise historically would've been an unfavorable mix during the quarter. Due to the well-chronicled management restructuring in China, demand for lasers in the more lucrative fiber backhaul segment experienced significant headwinds.

In total, though, our market share gains in access more than made up for that shortfall in backhaul. As mobile infrastructure recovers in future quarters, we would expect to see substantial tailwinds further accelerating revenue growth and margin expansion. Perhaps more importantly, our laser position continues to be a strategic differentiator, notably across 100G long haul and metro networks which actually grew faster than access last quarter, allowing us to expand market share and share of wallet across our entire optical portfolio. This positions us ideally to take advantage of the explosive growth opportunities as 100G enters data centers. For these reasons, we remain bullish in terms of our laser and overall optical businesses' ability to continue to outperform for the foreseeable future.

Switching gears, as I've mentioned previously, disruption resulting from consolidation in our quarter of the industry continues to benefit MACOM, whether it be customer design wins or access to talent that was previously unavailable. I'm proud to say that during the quarter, we staffed the application support functions necessary to take GaN mainstream, thereby accelerating MACOM's credibility and access to revenue at major customers worldwide.

For the past few quarters, I've been talking about active antenna arrays beginning to turn on, as the third major secular growth driver for MACOM. As of today, we have purchase orders in-house for the initial ramp for the airborne defense radar program. In addition, we believe purchase orders are imminent for field trial units for the next-generation Multi-Function Phased Array Radar program, or MPAR. We'll begin to see positive impact to revenue from these active antenna array programs beginning in this, our fourth fiscal quarter 2015.

Now moving on to the more recent big news. Two weeks ago, we announced a definitive agreement to divest our Automotive business to Autoliv. Simply put, this is the right deal at the right time for MACOM. The divestment of our Automotive business is a watershed moment for MACOM, as it will allow us to realize our full potential as a pure play high-performance analog semiconductor Company.

As many of you are aware, our Automotive business operated on a different financial model than the rest of the business, with lower growth and a lower gross margin profile. MACOM's operating margins are expanding to the point that the Automotive business will no longer be accretive to our operating model, and therefore not consistent with our long-term strategic vision from both a growth and profitability perspective. Given our belief that other parts of our portfolio, such as optical, are poised to outperform, now is the perfect time for us to put the business in the capable hands of an auto industry player like Autoliv.

The focus of our investments going forward can now be exclusively in businesses that are aligned with our high-margin, high-growth model. We believe that the divestment of the Automotive business will significantly accelerate the achievement of our 60% gross margin/30% operating margin model. We believe that the expected growth in our other businesses will backfill the earnings contribution that would've otherwise come from Automotive within a few quarters following the divestment.

As a pure play, high-performance analog semiconductor Company, I'm confident that our strategic growth drivers optical, GaN, and active antenna arrays, will deliver a powerful combination of high growth and sustained profitability, squarely positioning MACOM in the highest-performing part of our industry.

Before I turn to guidance, I'd like to mention that we'll be hosting our second Analyst Day the week of March 6, 2016, in New York City. This will be a great opportunity for the folks to meet and get an in-depth briefing from my management team on how and why we expect to achieve such aspirational goals, in terms of both growth and profitability.

Now, moving over to the guidance, we'll guide this quarter including the Automotive business, and we'll update guidance upon closure of the transaction. For the fiscal fourth quarter ending October 2, 2015, MACOM expects revenue to be in the range of $133 million to $137 million. Non-GAAP gross margin between 53% and 55% and non-GAAP earnings per diluted share between $0.43 and $0.46, based on 55.5 million shares outstanding. I'd like to close today's scripted remarks by thanking the team for yet another quarter of solid execution.

Operator, you can now open the call to questions.

(Operator Instructions)

Gabriela Borges, Goldman Sachs.

Great. Thanks so much for taking my question. Congratulations on the strong results. I want to ask for a little more detail on the active antenna array programs that you have ramping. Just relative to the call that you provided at the Analyst Day, any more detail on the timing and the magnitude of the ramp of these programs? And is there any seasonality in the business that we should be aware of? Thank you.

Sure. Great questions. First of all, there's really two dimensions to the active antenna array programs. One is an airborne defense program, which will be very predictable once it begins ramping, with no seasonality whatsoever. The second relates to the Empire program. For those who listened in or attended our Analyst Day last year, Empire was a joint development, an advanced development with MIT Lincoln Labs. And that is actually on the cusp of transitioning over to commercial programs. There are actually active bids that could be awarded within the next 30 to 60 days. We are hopeful that our lead customer will win those awards. If so, those could begin ramping quite substantially next year. If not, there are still many other programs that are adopting the Empire architecture. And like the airborne defense program, there'll will be no seasonality. Very predictable, long-term programs.

Appreciate the color. And as a follow-up, if I may, on the competitive environment in 100-gig lasers, maybe you can give us a sense of what you're hearing from the competition, in terms of their willingness to bring capacity online, any change in pricing environment that you're seeing? And any threat from optical margin-makers potentially trying to delay the technology in-house? Thanks very much.

Sure. Again, a series of great questions. I don't think there's been any meaningful change in the competitive environment. We are still what I would call severely capacity-constrained. That is, our customers are still beating us on a daily, weekly basis to get capacity allocation. We anticipate that will continue at least through this quarter. We anticipate that perhaps in the first fiscal quarter, fourth calendar quarter, supply may catch up with demand. There's no indication that any of our -- the traditional incumbents have expanded capacity. We don't see any challenges of indigenous Chinese or otherwise programs, suppliers coming online. And I think what has happened is, people see with our ability to expand the capacity, and especially as we bring Lowell onboard, that there really isn't the necessity from both a cost structure and reliability/continuity of supply standpoint. My interpretation is, customers see us as solid, going to rock-solid.

And the last thing I'll add is, there's a time dimension to the demand profile. Right now, the PON market access is driving the overall market growth -- at least, the part of the industry we operate in. That will transition beginning next year. Not transition, but will get the added benefit as data centers rampat 100 gig in data centers. We are told that overall demand, as that turns on, will be at least an order of magnitude even greater than PON. So it's the reason why we're so manically fixated on getting Lowell up and running. Not just for the existing market, and expand market share, but it's really for the next phase, as I said, the next secular growth driver in data centers.

Great. Appreciate all the color. Thanks very much.

You're welcome. Thank you.

Blayne Curtis, Barclays.

Maybe just from a high level, in terms of your segments, given your commentary, I'm assuming Networks is up again in September. Is there any other segment that's up? And then just drilling down on networks, just following on the prior question, you talked about a doubling of capacity. And I think last quarter, you said, don't think of revenue doubling. Obviously, the access would have lower ASPs. But clearly you're booked out through another quarter here. How much does Lowell add? What does that do to your cost structure? And what is the trajectory of revenue here? Obviously, if you're doubling capacity and sold out, you should have quite a steep ramp with this BinOptics business.

Yes, exactly. A series of great questions. You're asking great questions. So Networks for the next quarter -- Networks was a strong driver on the back of optical. The backhaul stuff was a very significant headwind, so that mix effect in lasers that I had mentioned last quarter was actually even further aggravated. Because the higher ASP part of the market, the fiber backhaul, was extraordinarily weak. I mean, we saw exactly the kind of softening that other people are reporting over in China there.

The good news is, we could sell every laser we made, so we just shifted the mix over to the access market. But again, you've got that less-than-linear ramp. As that turns back on -- by the way, our guidance for next quarter assume no recovery in mobile infrastructure -- so both wireless and fiber backhaul -- as well as no recovery in the industrial Multi-Market side of our business. So slight growth in Networks associated with further laser capacity expansion. But A&D actually starts contributing growth with the programs that I mentioned -- the airborne defense program and the Empire program. Did I address all of the questions?

Sorry, I piled on a lot for you there. Maybe just a follow-up on the Multi-Market business. Obviously, everybody across the board is seeing weakness. Just curious your thoughts on the general trend in the industry? Obviously a couple quarters down here. What is your sense of inventory levels and customer demand behavior?

It's interesting. We switched from the selling model, and last quarter, POS actually held up very strong, the end-market across our catalog business. What we are told is that our leading disti, that June actually finished up pretty strong. So I don't think things are, at least for us, don't look to be the unmitigated disaster that some of the other people are reporting. But again, we're very cautious, in terms of guidance, that it's not going to turn back on and contribute to growth.

Great, thanks, nice job.

Thank you.

Harlan Sur, JPMorgan.

Hey, guys. Thanks for taking my question, and nice job on the quarterly execution. On the Ford Sync business, which you're selling to Autoliv, my understanding is that this segment generates low-30% gross margins and low-20% operating margins. Is that the right way to think about this business as we try to model the core MACOM business, ex-auto?

That's correct, Harlan. But as I said, we'll be coming out with some information that will guide you very specifically, post-close, at the close, from the filings with the 8-K, to give the right information on the business and the new business model going forward.

But am I in the ballpark?

Yes, definitely.

Okay, great. And then in Multi-Markets, obviously you guys saw a weakness in the June quarter. You mentioned industrial. Any other end-markets you saw weakness in? I know you've got a good footprint in test and measurement, and medical. Any commentary on demand by the different geographies? And for the September quarter, what's your sense on the direction of your Multi-Market segment for the September?

Again, I consider the best indicator at POS, and POS in June ended up turning on and making somewhat of a recovery. Now whether that ends up sustained through July and the summer months, remains to be seen. Again, our working assumption is no recovery. In terms of color at the sub-segment level, our business is just so diffuse, it's impossible to draw any kind of trends between test and measurement versus industrial and other. So it's just -- our business is very hard to predict that way.

Okay. Thanks, guys.

Thank you.

Harsh Kumar, Stephens Inc.

Hey, guys, congratulations. Great results, great guide. Question on your radar upgrade program. Could you, John, give us some idea of the length of these programs? Are these just a couple of quarters once they start, or is it just a multi-year program, global program? Anything would be helpful.

I think in all cases, the airborne defense program, as well as the ground-based Empire stuff, the time period is actually measured in decades rather than quarters or years. So once they turn on, it turns into a very stable, predictable long-term business. I would describe airborne defense program as the first program at that particular customer that we would expect to proliferate. But Empire is even much more significant. That is a profound shift in the way people build radar programs. And we've actually got pull from the Department of Defense and the US government to be able to -- with programs that are driving aggressive price targets, to help customers -- to pull customers over to actually adopt the architecture. So that is something that will be step-and-repeat, and we believe can scale -- I best describe it as, it has the juice for growth and gross margin expansion equal to our optical business, as well as our GaN business. It's really that large and lucrative.

Great. That was actually very helpful. And the other question I had was, could you comment on the Chinese wireless backhaul? Are they just globally in the wireless backhaul market? I know that it's been an area that didn't work out for you. But based on what you're hearing out there in the marketplace, what would you speculate is the best time for recovery for this business?

Okay, so my crystal ball and I'll qualify it � is no better or worse than anybody else's. What we've heard is, perhaps in the December quarter, and most definitely in the subsequent quarter, that the management restructuring among the three major carriers would be completed, and we would see a distinct recovery. In my experience, however, that is a very unpredictable part of the world.

Got it. Thank you. Thanks, guys.

Thank you.

Mark Lipacis, Jefferies.

Hi. Thanks for taking my questions. First question, John -- I had an issue with my line, so I didn't hear this. Could you repeat what you said about what you felt was going to be able to backfill the Automotive business and the timing on that?

Yes. I mean, I'll oversimplify and say it's lasers and optical. Exactly what you would predict it. And it's 100G, as well as access.

And how many quarters?

You know, we don't give forward guidance. But let me just say, given the -- as mobile infrastructure recovers, that was a very substantial headwind. So as that turns around and turns into a tailwind, I think within a couple quarters we could be back to what people have been predicting our EPS to be.

Okay, that's helpful. And then one other question, on the BinOptics side of the business. It sounds like you were taking share and that was able to help you with some of the headwinds. Could you give us a sense of what you believe your share is in the market? Did you just pick off the low-hanging fruit? Do you think you have more to go?

There's no question we have more to go. I would say picking up low-hanging fruit is probably not a bad term, when customers can't get enough product. Our biggest problem has been dealing with customers who are irate about how many lasers we allocate them. Not a bad problem to have, but a problem, nonetheless. So definitely, as supply catches up to demand, the dynamics change. We feel we have done such a outstanding job of actually meeting that upside demand in the short term -- we really were the guys coming in, saving a lot of people's businesses -- that we have not just the goodwill, but the long-term contracts that are being put in place through 2016 to progressively take additional share. That is unquestionably part of the out-performance in our comments about backfilling for the Automotive business.

Great. If I could just sneak one more in on GaN-on-silicon. Where are you in the process of qualifying your foundries? And could you discuss the competitive environment? Because there's some news that has been coming out recently about GaN becoming more popular in the market, and even some GaN-on-silicon players. If you could talk about that, that would be great. Thank you.

Sure. We remain on track. We continue to progress with our qualifications of our production foundries. Again, the critical path here is entirely reducing -- we announced our Gen 4 GaN, which was a spectacular hit at the NPT IMS Show, which matched the performance of GaN-on-silicon carbide, and with a cost structure that ends up below that of the incumbent LDMOS. That was, as you can imagine, a big hit.

But I don't want to understate the task here of getting that ramped, yielding and qualified in the high-volume production foundries that can supply things like base stations. Supply chain is everything to the base station guys. I mean, you can see the gyrations that the industry has gone through from last year to now what's happening. Supply chain flexibility is a big deal. I would say technically, our big progress last quarter was, with the disruption that's going on in the marketplace, there was access to some talent that previously never would've been available. We staffed the support teams in both China and the US to support Europe, the US and in China. So all the major guys, with now guys who have proven -- who understand the customers and the applications, which was a critical piece of the puzzle that had to be put in place.

And I would say, I think the customers are keenly aware that we are really the only path to GaN, in my opinion, being capable of supporting those supply chain demands. When we actually come out public with our supply chain partners, it'll be obvious why that is the case. But again, there's a lot of work to get that supply chain qualified and yielding. We are still on track, as far as we are concerned, for first-quarter 2016 being in that position. But it's not done until it's done, and I should say our assumptions -- when we talk about replacing the earnings of the Automotive business, that assumes zero revenue in 2016. Not that we believe zero revenue, but we're not counting those chickens until they hatch.

Thank you. That's very helpful.

You're welcome.

Steve Smigie, Raymond James.

Great, thanks a lot, guys. I'll say: congrats for great performance in an awful environment. Just wanted to follow-up on the GaN. It sounds like you said that your GaN-on-silicon can match the GaN-on-silicon carbide performance. It seems pretty -- like a pretty big deal. I know they've been fairly close, but to match it at your cost structure seems like it should be a pretty deal. So I'm just curious in terms of customer reaction to that, if you've been able to get that, that far. I know you probably don't have your engineers there, but can you talk a little bit about what the performance metrics were that you were able to match?

Yes. The two metrics were efficiency -- so we demonstrated -- we had live demos at NPT IMS of 70% efficiency. And power gain was -- I think it was 18 dB or 19 dB, was our power gain spec. Which is -- that's actually best-in-class for LDMOS. So we get the power gate of LDMOS, with the efficiency of GaN. I actually don't consider GaN, to the first approximation in those commercial applications, to be our natural target, because it's just not that well-penetrated. There's some good revenues that people have posted, but it's relatively esoteric programs, so that's really easy pickings. The real issue is being able to expand that penetration of GaN against the incumbent LDMOS. With that, I mean, our cost structure is now, I think, very well-understood.

The one thing that I failed to mention on the previous question was, there is reference to other people with GaN-on-silicon. The thing I can say unequivocally is, our patent base that we acquired from Itronics is multi-dimensional in a minefield that people simply cannot navigate. Anybody who tries to bring GaN-on-silicon into RF applications will be met with a pretty firm legal situation. We think this is a highly defensible market that, as we drive and lead the conversion, it will very high barriers to entry over time.

Okay, great. And when you spoke about getting the supply chain up here, it seems like you had originally been talking about Q1, some production shipments. And then more the back half of the year, more significant volumes. Is the supply chain just part of making that happen, or is this tracking a little bit ahead of schedule?

I wouldn't say anything is ahead of schedule. And I'm trying to very carefully avoid commitments of production volumes any time in 2016, for the following reason. What we hope to have is the process qualified and have production units, and be able to begin production as early as the first quarter. That said, until we pass qualification and we're yielding, we haven't passed qualification and we're not yielding. That is like doing a crossword puzzle on a schedule. You don't really want to commit to that, right?

But once we have those production units, then customers start turning programs on. And it is completely impossible to predict how many programs and how fast customers will award programs, how quickly they will ramp. I can tell you in general, the base station industry cycles programs at a pretty good churn, especially with the Chinese manufacturers, less so with the Europeans. Specifically, Ericsson tends to be more diligent in taking longer. People like Huawei and ZTE tend to be far more aggressive. But again, cautious optimism is probably the best approach.

Thanks. If I could just sneak one more in, just a follow-up here on BinOptics. Can you talk about six months out, or call it intermediate-term, whatever, what you might see the mix being of the, say, 100G stuff versus more of the axis point stuff? And at this point on the 100G for metro, et cetera, any one customer, Huawei, et cetera, emerging as a lead customer in that area?

I'd say our success is across the board. If you take proportionate shares across the board, I mean, Huawei is a major player, so obviously, they're a major customer. But I don't think disproportionate to others.

Regarding the first part of your question, our long haul -- our 100G business and long haul and now metro networks grew actually at twice the rate of even our access, our laser business. And if you believe what they're saying about metro networks only beginning to deploy and being a very strong growth driver starting in 2016, it's quite possible that 100 gig and the long haul metro stuff could be in excess of our laser business within a few quarters. So that -- there's a halo effect from a vendor standpoint. The laser unquestionably became a strategic differentiator. Obviously, there are different applications and markets. But both optical and then separately the laser stuff, are both poised to outperform.

Okay, great. Thanks a lot, guys. Appreciate it.

Thank you. Great questions.

Vivec Arya, Bank of America Merrill Lynch.

Thank you for taking my question. A few quick questions. First, John, I was wondering if there's a way to quantify how much impact you're having from the slow wireless activity in China? And whenever it turns back up, will there be some benefit from pent-up demand?

Yes, great question. We try to avoid reporting down at a product-line level, and that's actually sub product line. Let me put it this way. In our fiber backhaul, the drop sequentially was over 66%. It was a very substantial headwind in our laser business. That said, we took advantage and just shipped more PON. But the ASPs are substantially higher for the higher-rate backhaul stuff, such that, when that turns back on -- I mean, if that turns on in the December quarter in a meaningful way, we're going to have a quarter that we're probably going to surprise even ourselves. But it's just unpredictable if it comes back quickly or if it comes back slowly. Again, it's backhaul, not access -- meaning base stations. Again, I am loath to predict the behavior of that market and recoveries. Things always come upon you in both directions far faster than you could ever imagine, both on the upside and on the downside.

Got it. And then the second question related to that. Maybe if, Bob, you could give us some puts and takes of the gross margin guidance for Q4? I think you're expecting trends to be somewhat flattish, even though sales are expected to be up. I would imagine it has to do with the mix of more access versus backhaul. Any color around gross margins?

The mix is an important driver to overall gross margins. To confirm, the prediction -- the guidance is inclusive of the auto business, which is quite low, as we talked about earlier in the call. But overall, we are still trending up. I think we had a good quarter at the 54%, even with the puts and takes in the laser business. And I think even our guidance shows that we have more confidence in stepping that up here over the next quarter.

Got it. And then lastly, I know you'll provide more information when the autos business is divested. But if I just take the numbers that have been given on the call, is it fair to assume that it's about a $0.05, $0.06 a quarter type hit? And the assumption is that, let's say, towards the end of FY16, that the growth in your core businesses is able to get you back onto the quarterly EPS trajectory?

I'm going to defer til we close the business to answer the first question, with a general statement, it's really in the range. But to reiterate John's commentary, we are poised to accelerate the top-line growth to recover from the sale of that business.

I'd say, there is both a short-term dip, but it'll be very interesting when we come out with the restated financials and you look at the intrinsic growth rate of our business, excluding automotive. And you look at, with the larger proportion of optical and laser, and now the contribution of even the A&D programs, in a few quarters, I think we'll be back to what people are expecting. For the most part, people hadn't cooked in that upside, so we're arguably taking down some of the upside and replacing the Automotive business. But again, we are confident it will be a very similar expectation for EPS for next year compared to what people's models are at this stage.

Got it, very helpful. Thank you.

You're welcome.

Quinn Bolton, Needham & Company.

Hey, guys, congratulations. Just wanted to come back to the laser business. You talk about China, both in optical backhaul and access. Just wondering if you could give us some sense how much of the laser business today is derived from OEMs or customers in China? And then as you look forward to the data center opportunity, I assume that, that's probably going to be more geographically diverse and probably help reduce some of your current exposure to China. But wondering if you could shed some light on that?

Yes, if the access PON market -- global demand is serviced out of China, the Chinese ODMs supply everybody, not just the local indigenous demand, which is very strong growth this year in China. There's a strategic program in China for fiber-to-the-home and home deployment. But that's actually global. But yes, as we talk about some of the other segments, the fiber backhaul absolutely, not just the Chinese business.

And then secondly, data center is a very highly diversified business. I'd be putting my money that when that stuff is in volume, it's going to be manufactured in China. So where the transactional sales is one thing, far more important to me is where the design decisions and the architectural and technology and vendor selections are. In that there's no question, data centers is driven by cloud service providers and system OEMs rather than an ODM-driven segment, like PON.

Yes, I would just add the point that in this allocation situation, direction to ship to the contract manufacturers are coming from the system manufacturers, which is very critical to have real clear visibility moving forward here.

Yes, so that's a -- I think we mentioned it before, defining the color. What happened when we announced the acquisition of BinOptics, the behavior switched almost instantly over in China. The System OEM stepped up to negotiate their own capacity allocation, bypassing the intermediary transceiver guys, the ODMs. Because they were simply not getting the allocation that they wanted, their unfair share. So the supply agreements that we have are with the power brokers over there, not just the ODM partners. Which are still nice customers, supplying the global world. But the dynamic was almost literally overnight, China-time. Next day we came in, and there were meetings set up, and negotiations began in earnest.

Great. And then just looking at the combination of BinOptics, the core Optomai, your core long haul metro optical business, and then the portion of the Mindspeed business that serves as the PON modules. Is it fair to say that the optical business in aggregate is probably now more than half of your total Networks division?

I'd have to add it up. But I think it's likely to be the case.

Great. And then --

A big chunk of the high-performance analog business, the previous Mindspeed business was already strong in PON, and already strong in opticals. So add that to the growth that we had in the long haul metro with the G stuff, and now lasers. You're right. I mean, it's a significant chunk.

Got it, great, thanks. And then just any updates on the CFP2 design win position you had? I think you had mentioned you thought you might be as high as 70% share in CFP2. And it certainly sounds like CFP2 modules really start to ramp for metro applications next year. Can you just talk about that competitive landscape, if there have been any changes?

No changes. What tends to happen in those type of programs is, once you're established -- both good and bad. Once a competitor gets entrenched or we get entrenched, it takes almost an act of God for things to transition, until CFP4, for instance. So we feel we've actually had a situation where competitors have actually publicly admitted our position, which is minimally 70% design win share. I think we are very well-positioned to benefit from that growth in metro networks next year. Quantifying that is difficult, but there's no question it is a significant contributor to those -- replacing the earnings of the Automotive sale.

Great, thank you.

You're welcome. Thank you.

Tore Svanberg, Stifel.

Hey, Tore.

Yes, sorry about that. Just to clarify, the guidance you gave, does that assume the automotive business to stay at the same level it was here in Q2?

Exactly.

Okay, very good. And just to follow up on Quinn's question on CFP2, the design wins you have there, are those for TIAs and drivers? Or is there other things going on there?

No. The strongest position we have is in drivers, and that ends up about 80% of the relevant analog PON content. So we do not have the same strength from the position of TIAs. We're the challenger rather than the leader. But again, the ASP difference between the TIA and the modulator driver is very substantial.

Very good. And on the BinOptics business, as it ramps into data center next year, is there a chance that data center could be as much as half of the revenue? Or is that a bit aggressive?

Well, it all depends upon the crystal ball you use for predicting ramp in data centers. I tend to find that markets turn on a little more slowly than people predict. But when they turn on, they turn on in a big way. I would describe it that, our assumption about data center business is extremely modest for next year. We want to be positioned with the right products and the right solutions and the right channels and sales and support structure to position ourselves in data centers like we have done in metro networks. But counting on the revenue ramp being anything substantial, anywhere close to half, is a dangerous prediction.

Okay.

And we don't -- again, even though we have aspirational goals for next year, it's not about data centers. It's not about base station GaN. It's not things that are high risk in terms of early ramp.

That's helpful. Just one last one for Bob. There's a lot of things moving around right now obviously, with divestitures and acquisitions and so on. Your inventory days came in at 128 this quarter. Is that the level that we should expect going forward? Or would you say that's probably a bit at the lower end of where you want to be?

So without the Ford business, that we do have some inventory to meet their demand, I think it's, from a days perspective, at a high level.

Okay.

And I think it may come down slightly. But again, if you look at the details of our inventory, we're substantially almost 50% in finished goods that are staged for shipment in the next quarter. And another 45% is in raw materials. We have very little in work in processes. It's a major driver to our manufacturing objectives here.

Very good, helpful. Thank you, guys.

You're welcome.

I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Croteau for closing remarks.

Very good, thank you, operator. Before closing out today's call, please note that we'll be attending the Jefferies Semiconductor, Hardware and Communications Infrastructure Summit in Chicago on August 25. The Barrington Research Conference, also in Chicago, on September 1. And the Drexel Hamilton Conference in New York, September 10. We welcome the opportunity to meet with investors planning to attend these events. To request a meeting with management at a future event or be notified of the next time that we plan to be in your area, please e-mail us at ir@MACOM.com. Very good. You may now close the call.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.