Earnings Call Transcript - CRDO Q3 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Credo Fiscal 2024 Q3 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Dan O'Neil. Please go ahead.

Dan O'Neil, Moderator

Good afternoon. Thank you for joining us on our Fiscal 2024 third quarter earnings call. Today, I'm joined by Bill Brennan, Credo's Chief Executive Officer, and Dan Fleming, our Chief Financial Officer. As a reminder, during the call, we will make certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties that are discussed in detail in documents filed with the SEC, which can be found in the Investor relations section of the Company's website. It's not possible for the Company's management to predict all risks, nor can the Company assess the impact of all factors on its business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement. Given these risks, uncertainties, and assumptions, the forward-looking events discussed during this call may not occur and actual results could differ materially and adversely from those anticipated or implied. The Company undertakes no obligation to publicly update forward-looking statements for any reason after the date of this call to conform these statements to actual results or to changes in the Company's expectations, except as required by law. Also, during this call, we will refer to certain non-GAAP financial measures which we consider to be important measures of the Company's performance. These non-GAAP financial measures are provided in addition to, and not as a substitute for or superior to, financial performance prepared in accordance with U.S. GAAP. A discussion of why we use non-GAAP financial measures and reconciliations between our GAAP and non-GAAP financial measures is available in the earnings release we issued today, which can be accessed using the investor relations portion of our website. I will now turn the call over to our CEO. Bill?

Bill Brennan, CEO

Thank you, Dan. I'll begin by providing an overview of our fiscal Q3 results and our outlook for the future. Our CFO, Dan Fleming, will then provide a detailed review of our Q3 financial results and share our expectations for fiscal Q4. For Q3, Credo reported revenue of $53.1 million and non-GAAP gross margin of 62.2%. These results and our future growth expectations continue to be driven by the accelerating opportunity for high speed and energy efficient connectivity solutions throughout the data infrastructure market. Our connectivity solutions include Active Electrical Cables or AECs, Optical DSPs, laser drivers, and TIAs, Line Card PHYs, SerDes chiplets, and SerDes IP licensing, each leveraging our SerDes technology. Core to Credo's success is our SerDes technology, which is the fundamental connectivity building block of all of our solutions. Credo continues to invest deeply in SerDes architectures that enable application-specific solutions, optimized for speed, reach performance, energy efficiency, and cost. Our 100 gig per lane SerDes portfolio spans process geometries from 12 nanometer to 3 nanometers, with optimized reach performance from the longest reach links to the most power sensitive die-to-die links for chiplets. Credo will continue our innovation for 200 gig per lane SerDes as the opportunity to differentiate increases, specifically related to the optimization of trade-offs between process geometry, DSP architecture, performance, and energy efficiency. Credo SerDes technology expertise, combined with our system-level, customer-focused design approach has led to our success with a diverse and growing set of industry-leading customers. In 2023, the technology industry experienced an inflection point driven by Generative AI applications. The acceleration in the deployment of AI clusters has put high-speed connectivity at center stage, given the fundamental need for higher bandwidth. For Credo, this need for higher bandwidth translates to the demand for higher speed, higher density, and more energy-efficient connectivity solutions. This plays directly to Credo's strength and underpins our growth expectations. I'll now provide more detail on our overall business. First, I'll discuss our AEC business, where Credo continued to build momentum during the third quarter. We believe our AEC leadership derives from our comprehensive systems level approach to the AEC market. We've built this from the ground up over many years, and as a result, we now have the ability to quickly innovate to support the diverse AEC needs of our customers. Given increasing single lane speeds, and the shortcomings of both passive copper cables and active optical cables and transceivers, we foresee continuing adoption of AECs for in-rack connectivity. We expect U.S. hyperscalers to remain the majority portion of AEC demand in the foreseeable future. Many of these customers have distinct architectural requirements that demand innovation and tight collaboration between the engineering teams at Credo and the customer. We're engaged at different stages with the five U.S. hyperscalers as well as other global hyperscalers and Tier 2 data center operators. We've delivered a range of products with non-standard optimized hardware and firmware features to meet our customers' needs for port speeds from 100 gig to 800 gig, depending on the customer application. Credo continues to work closely with our first two hyperscale customers, delivering AEC solutions for both front-end and back-end Ethernet networks, as each publicly highlighted during their conferences last quarter. We're gaining better visibility with these customers into their near-term product ramps, and we're also engaged in a range of AEC solutions to address longer term roadmaps. While advanced programs of this nature take time to achieve material deployment rates, we continue to expect an inflection point in the second half of our fiscal '25. Credo is also working with additional U.S. and global hyperscalers to develop 400-gig and 800-gig AEC solutions that we expect will yield significant revenue for Credo in the future as next generation network architectures transition to AEC solutions. Additionally, we see broader acceptance of AEC solutions among service providers and Tier 2 data centers. As a group, these customers represent a meaningful and growing revenue opportunity. Last quarter, we discussed the introduction of our P3 - Pluggable Patch Panel solution, developed in collaboration with a lead service provider. Over the past quarter, we've been encouraged by customer feedback that the combination of the P3 and the AECs can help overcome multiple networking challenges related to power and thermal distribution, lane speed disparities, and the trade-offs of operational efficiency, latency, and power. We expect to generate meaningful future revenue as the P3 enables AECs to be easily utilized in a broader set of operational opportunities, thereby expanding our addressable market. In summary, we were very pleased with our AEC progress in Q3, and due to our expanding customer base and focus on innovation, we expect further progress in Q4, fiscal '25, and beyond. Now, regarding our optical solutions, Credo continues to gain traction in the optical DSP market. During the third quarter, we continued production shipments of optical DSPs to multiple global hyperscale end customers for a variety of applications across numerous port speeds. We closely target the combination of optical module partners and hyperscale end customers, and we're making progress on optical DSPs for 400-gig and 800-gig optical transceiver and AOC opportunities. Enabled by our SerDes design approach, Credo wins by delivering a compelling combination of performance, energy, efficiency, and value, as well as focusing on innovative ways to solve complex customer needs. Last quarter, we talked extensively about the industry call for action for better power efficiency for 800-gig and 1.6T optical solutions. As we discussed, we believe eliminating the DSP with the Linear Pluggable Optics or LPO architecture is simply too far a leap, especially for 1.6T. Credo quickly responded with our innovative Linear Receive Optics or LRO DSP architecture that directly addresses the power challenge while delivering better signal integrity, maintaining industry standards, IEEE compliance, and interoperability, and extending to 1.6T solutions. Since our discussion last quarter, we've made meaningful progress. Our first 800-gig LRO DSP partner has built and tested 800-gig optical modules, and the results are exactly as expected, successfully delivering on the promise of much reduced power and great signal integrity while overcoming the shortfalls of the aspirational LPO architecture. Next month at OFC in San Diego, we'll be demonstrating both 800-gig LRO DSP and full DSP solutions, highlighting our progress. We'll be demonstrating 800-gig solutions with five different optical module partners. Our 1.6T roadmap includes both LRO DSP and full DSP solutions with 200-gig per lane speeds, with our top priorities being energy efficiency and signal integrity, which are both critical to achieve robust 1.6T optical solutions. We believe the growth in our optical business will be primarily driven by U.S. hyperscaler end customers, with further contributions from global hyperscalers. I'll now discuss our Line Card PHY business, which delivered another solid quarter in Q3. In this segment, our customers include networking OEMs and hyperscalers, and our products include Retimers, Gearboxes, and MACsec PHYs for data encryption. Our customers are the leaders in the space. We have close working relationships, and our design wins typically have long lifecycles once they ramp to production, contributing nicely to our overall results. In the upcoming months, we'll tape out our customer sponsored 5-nanometer 1.6T MACsec PHY, and our power optimized 1.6T Retimers and Gearboxes. Credo is among the industry leaders for 50-gig and 100-gig per lane Line Card PHY applications. We have many customers that have deployed our 50-gig per lane solutions in production, and we count more than ten customers designing in our 100-gig per lane Screaming Eagle Line Card PHYs. And now turning to our IP and Chiplet business. Our SerDes IP and SerDes Chiplet businesses continue to be a strategic component of our overall business. These solutions enable our partners to address the ASIC market for next generation solutions. Due to revenue recognition rules, our SerDes IP revenue can vary meaningfully from quarter to quarter, which is what we saw in Q3, and we will likely see in the upcoming quarters. Our funnel for SerDes licensing opportunities remains strong, bolstered by the increased opportunity on ASICs with high-speed SerDes for data center applications. We have a comprehensive portfolio of SerDes IP for our ASIC customers, including 100-gig per lane SerDes across the broadest range of process geometries from 12 nanometers to 3 nanometers, and the broadest range of reach performance from long reach to die-to-die reach. Our SerDes IP offering enables our ASIC partners to optimize their solutions for process geometry, reach, and power. Last quarter, our chiplet business was highlighted by a win with significant NRE at one of our leading customers for a next-generation, five nanometer chiplet solution, which speaks loudly regarding our differentiated SerDes portfolio. When complete, Credo will be able to market and sell this chiplet to the broad market. Overall, we remain optimistic about the prospects of the chiplet category, given our results to date and due to our belief that chiplets will be a key enabler in the most advanced system solutions. In summary, we're pleased with our results for fiscal Q3, and we're optimistic about the increasing market demand for high-speed connectivity. Credo's competitive advantage is driven by our focus and execution on our core SerDes technology, which leads Credo to being one of the few companies capable of delivering the necessary breadth of connectivity solutions at the highest speeds while optimizing for energy efficiency and system cost. For these reasons, we expect continued long-term growth across a diversified customer base and a diversified set of connectivity applications. I'll now turn the call over to our CFO, Dan Fleming. Dan will provide additional financial details, and then we'll be happy to take questions. Thank you.

Dan Fleming, CFO

Thank you, Bill, and good afternoon. I'll first review our Q3 results and then discuss our outlook for Q4 of fiscal '24. In Q3, we reported revenue of $53.1 million, up 20% sequentially, and down 2% year-over-year. Our IP business generated $1.3 million of revenue in Q3, down 83% sequentially, and down 90% year-over-year. IP remains a strategic part of our business, but as a reminder, our IP results may vary from quarter-to-quarter, driven largely by specific deliverables to pre-existing or new contracts. While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q3 was 2% IP, below our long-term expectations for IP, which is 10% to 15% of the revenue. We expect IP, as a percentage of revenue to be within our long term expectations for fiscal '24 and near the high-end of the range. Our product business generated $51.8 million of revenue in Q3, up 41% sequentially and up 24% year-over-year. Our top three end customers were each greater than 10% of our revenue in Q3. Our team delivered Q3 non-GAAP gross margin of 62.2%, above the high-end of our guidance range and up 235 basis points sequentially. Our IP non-GAAP gross margin generally hovers near 100%, and was 92.7% in Q3. Our product non-GAAP gross margin was 61.5% in the quarter, up 877 basis points sequentially, due to a large increase in product NRE revenue, and up 1,420 basis points year-over-year. Total non-GAAP operating expenses in the third quarter were $30.6 million, above the high-end of our guidance range, up 13% sequentially and up 19% year-over-year. Our OpEx increase was a result of a 24% year-over-year increase in R&D as we continue to invest in the resources to deliver innovative solutions. Our SG&A was up 12% year-over-year. Our non-GAAP operating income was $2.4 million in Q3, compared to a non-GAAP operating loss of $0.7 million last quarter, due to increased topline leverage. Our non-GAAP operating margin was 4.6% in the quarter compared to a non-GAAP operating margin of negative 1.7% last quarter, a sequential increase of 622 basis points. We reported non-GAAP net income of $6.3 million in Q3, compared to non-GAAP net income of $1.2 million last quarter. Cash flow used in operations in the third quarter was $1 million. CapEx was $5.1 million in the quarter driven by R&D equipment and production mask spending. Free cash flow was negative $6.1 million, an increase of $3.1 million year-over-year. We ended the quarter with cash and equivalents of $409.1 million, an increase of $168.6 million from the second quarter. This increase in cash came from the net proceeds of our successful follow-on offering of shares completed in December of 2023. We remain well capitalized to continue investing in our growth opportunities while maintaining a substantial cash buffer. Our accounts receivable balance increased 36.8% sequentially to $44.8 million, while day sales outstanding increased to 77 days up from 68 days in Q2. Our Q3 ending inventory was $31.5 million, down $4.3 million sequentially. Now, turning to our guidance, we currently expect revenue in Q4 of fiscal '24 to be between $59 million and $62 million, up 14% sequentially at the midpoint. We expect Q4 non-GAAP gross margin to be within a range of 64% to 66%. We expect Q4 non-GAAP operating expenses to be between $33 million and $35 million, and we expect Q4 diluted weighted average share count to be approximately 180 million shares. We are pleased to see fiscal year '24 playing out as expected. The rapid shift to AI workloads has driven new and broad-based customer engagement, which has continued to enable us to diversify our revenue through fiscal year '24 and beyond. As a result, we look forward to driving operating leverage in the coming quarters. And with that, I will open it up for questions.

Operator, Operator

Our first question comes from Toshiya Hari with Goldman Sachs. Your line is now open.

Toshiya Hari, Analyst

Hi, good afternoon. Thank you so much for taking the question. Bill, I wanted to ask you how you're thinking about your business over the next year or so. I thought the way you framed the AEC opportunity and the optical DSP opportunity, both in the near-term and the medium term, was pretty consistent with how you framed it three months ago. But I'm curious, just given the significant increase in AI spending infrastructure broadly, have you seen any of your customer projects either get pulled in or the sizing increase over the past 90 days, or the way you're thinking about the additional customer in AEC, the engagements on the DSP side, are they pretty consistent with 90 days ago? And then I have a follow-up.

Bill Brennan, CEO

Sure. I would say that, generally speaking, it's pretty consistent with what we've communicated in the past. We're really in the early innings of many of the opportunities, and we're going to see some variability as each one of these things ramp. And I can say that we feel great about the fact that we've got more irons in the fire than ever before. But I think from a revenue profile standpoint, we've been pretty consistent in saying that we see an inflection point in the second half of fiscal '25. So really, really no change.

Toshiya Hari, Analyst

Got it. Okay, thank you. And then a follow-up on gross margins for Dan. In the quarter, I guess even if you exclude the increase in NRE revenue, your product gross margins I thought were pretty good on a sequential basis, they improved quite nicely. What were the drivers there? And if you can provide a bridge from 62.2% last quarter to, I guess, 65% at the midpoint for this quarter, that would be helpful. And is there anything kind of one-time in nature embedded in the 65% for this quarter? Thank you.

Dan Fleming, CFO

Yes. That's a great pickup on your part because as we look at things, we thought kind of the hidden story is really that due to increasing scale and product mix, if you exclude NRE from our product gross margin, it was up 328 basis points sequentially, as you say, from 50% to 53%. And that's in line with our messaging that we've given historically. We think we're well on track for attaining our long-term gross margin expectation, which is again 63% to 65% within the next two years. And this is kind of a key part of that story, is increasing product margins. Now, when it comes to Q4, the other thing I mentioned or alluded to, IP in Q3 was only 2% of our overall revenue mix. Yet we said in our prepared remarks that we expect for the full year that IP as a percentage of the overall revenue mix will be at the high end of our long-term range of 10% to 15%. So if you look year to date, IP has only been 9% of our overall revenue mix. So you could expect Q4 to be very strong in terms of IP deliverables, which again, we recognize revenue upon those deliverables of IP databases under ASC 606. So, IP has been quite variable, quarter-to-quarter. Throughout FY'24, it's been highly variable. It's been very illustrative of that pattern. So, in a sense, you might say the IP portion contributing to the gross margin being 65% at the midpoint can be attributed to that variable part. But having said that, the underlying focus is really product gross margin exclusive of NRE. And the trend there has been very favorable to us due to product mix and increasing scale.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Karl Ackerman with BNP Paribas. Your line's now open.

Karl Ackerman, Analyst

Yes. Thank you, gentlemen. You tend to not be dictated by the seasonal variations of market each quarter. But since you happen to sell primarily into front end traditional server market applications, I'm curious to hear whether you are seeing a cyclical recovery in traditional servers as new data centers are being built to really ameliorate the power limitation of installing GPUs, and therefore you are seeing that happen in ramp now.

Bill Brennan, CEO

So, I think that the way that we view our AEC business is really broken out into two parts, front-end networks and back-end networks. And so the front-end connections that we're making for general compute as well as AI, they look very similar in a sense. I can tell you that the most history that we've got on the front end network connections is really with our first AEC customer, Microsoft. And if we think back on history, the number of front end connections associated with AI clusters is fewer, it's fewer in an overall volume sense because you've got one front end network connection for maybe six to eight GPUs, whereas there's one connection for every general compute server in comparison. And so, we saw a big reduction in the forecast, which would clearly imply that they made a huge pivot towards AI. I can say that we've always expected a rebalancing, and I think based on forecasts, I think we see that coming within the next 12 months, probably back-end weighted on the 12-month forecast. So I do think that we're seeing some of that movement. But again, we don't really get super specific visibility on that.

Karl Ackerman, Analyst

I see. Thanks for that. For my follow-up, I was hoping you could address how large is your chiplet business today? And is that broadening into multiple customers or is it still dominated by a single customer at this point? Thank you.

Bill Brennan, CEO

We've got two customers in production now. One is Tesla and one is Intel, and both have been publicly discussed. The expectation that we've had, we've been working on chiplets for several years, and we've been bullish on the space, probably before the industry at large was talking about it. I think that the discussion that we've had about this recently is that it has become a nice portion of our business. But if I think about long term, and I think about how the different businesses will break down, this is not going to probably rival the AEC business that we've got or the optical DSP business long term. So, it'll be a smaller component of our business, but still very meaningful. And to answer your - the second part of your question, we've got a handful of customers that are engaging with us for chiplet designs. Understand that chiplets we design will be generally available to the market, even though typically we have an initial sponsor that moves us in a direction on a given spec.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Tore Svanberg with Stifel. Your line's now open.

Tore Svanberg, Analyst

Yes, thank you. Bill, I was hoping you could update us on the AEC market, perhaps just more in sort of form factor, right, so I mean, it's very clear that the AEC market is heating up. We're starting to see more competitors in the market, but everybody seems to take a different approach on the form factor, system versus chip. So, I was hoping you could update us on where you see the market evolving over the next 18 months to 24 months. And again, filling the entire system is still the way to go?

Bill Brennan, CEO

Yes, I think that the key for us is that we see the work required to bring an AEC to production with great performance, high quality, and high reliability. It's really the same whether one company is taking responsibility like we are, or if many companies are trying to work together and sharing responsibility. Our feeling has always been that the most effective approach to bringing these products to market quickly is to take full ownership of all aspects of the hardware and firmware design, the entire process to qualify and bring a product to production. And then ultimately, be the responsible party for directly servicing and supporting during production. And so, there's no lack of clarity for us and our customers as to who owns the responsibility during any stage. As a result, we've been first to samples several times and first to qualification now with several different customers. There are different approaches, but I think there's always going to be some signal loss as it relates to multiple parties trying to respond to urgent needs within the customer base. And so, we're feeling quite good about the efforts that we've made over the last several years in developing customer relationships and also just developing a core capability. I estimate that we have more than 100 people dedicated to our AEC business at a system level. We can also talk about if we want to make a direct apples-to-apples comparison. I think it's important to point out that our core SerDes, which is a key point that I want to emphasize, if we're head-to-head, apples-to-apples, we're always going to have the most energy-efficient solutions, just given the advantages that we bring with our SerDes technology.

Tore Svanberg, Analyst

Yes, that's really helpful. And as my follow-up and on PAM4 DSP, and not to sort of steal away thunder from OFC, but you've had the LPO DSP out now for a few months, and I'm just wondering what the early reaction has been from customers, assuming you've been able to discuss this in more detail with your customer base.

Bill Brennan, CEO

I think the reaction has been as expected. We've seen certain customers really become very interested in this approach, especially for the 800-gig market. There's quite a broad spectrum in the way that customers are thinking about the market. We can go back to OFC a year ago when this whole concept of linear pluggable optics or an optical module without a DSP was really introduced. Although the call to action during OFC last year was really talking about 1.6T modules, the fact that the curve was almost unsustainable from a power standpoint was evident, necessitating alternative options. Some participants in the market are investing resources in trying to play out the LPO architecture in the 800-gig space. But I think, in a sense, the 800-gig approach is already out there, with full DSP being present in every 800-gig module currently being built. There remains a desire to lower power and potentially cost. Our solution, which is really deploying DSP on half of the connection within the module versus what we refer to as a full DSP, gives a path to maintain industry standards and signal integrity while overcoming the obstacles that people face by eliminating the DSP. We're offering a path to significantly reduce power and potentially cost. We're excited about our demonstrations with two optical module partners at OFC and expect our first sample units to be shipped to a hyperscaler in the next fiscal quarter. We're pleased with the efforts that have been made over the last quarter in collaboration with our module partners. Looking to the future, we aim to deliver great solutions offering both LRO and full DSP optical DSPs, while still focusing on power efficiency with our 3-nanometer design, compatible with established connector specs and maintained power ceilings.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Matt Ramsay with TD Cowen. Your line's now open.

Matt Ramsay, Analyst

Thank you very much, guys. Good afternoon. I guess, Bill, I wanted to follow-up on kind of the tenor of the conversation you were just having in your last answer. With OFC coming up, my observation has been there's developed in the networking and optic space two or three polarizing technical debates over the last 12 months with InfiniBand and Ethernet with Linear Drive versus DSP, or whether to do whole system solutions or just chips. When you're engaging with your customer base and talking about solutions going forward, are you noticing that hyperscale companies are making bets in all areas here, and there's sort of room and area under the curve for companies like yourselves and your competitors that may take different approaches to all succeed because the pie is big enough? Or are customers making more binary decisions that might influence opportunities for your company? I'm just trying to get a sense of the current market dynamics.

Bill Brennan, CEO

Sure. From our perspective, it's a bit clearer. The churn and polarization you see in the market are really from observers or participants trying to create momentum. The real decision-making happens in ongoing conversations directly with hyperscalers. We view each of them as a separate market, each with a different architectural strategy and timeline. Ultimately, they all have an end objective they strive for. However, this market does not have a singular cadence or roadmap among hyperscalers. Our focus is on having the right conversations and identifying the appropriate connectivity solutions for our customers. We aim to be agnostic, supporting customers' desired directions and delivering the value they're seeking. Yes, we see hyperscalers investing in various technologies, but we seek to accommodate every customer need.

Matt Ramsay, Analyst

Thanks for the thoughts there. As my follow-up question, Dan, I just wanted to reflect on the last year or so and compare where things were. Obviously, the AI pivot was unexpectedly severe in magnitude and timing, but I believe your customer base has broadened. Could you spend a few minutes discussing your sense of quarterly revenue visibility? I've observed that certain components in data center builds are tight, and large hyperscalers want to ensure components like yours are not bottlenecks in system deployment. What is your confidence in quarter-to-quarter revenue visibility considering customer concentration, and how does that compare to 12 months ago?

Dan Fleming, CFO

Yes. Some key observations: If we go back just about a year to the Microsoft reset, we've executed well following that point. What drives our comfort level is product and customer diversification, as you mentioned. Now, as we approach the close of fiscal year '24, revenue is up modestly compared to FY23. Excluding Microsoft from that comparison, however, it’s significantly increased, primarily driven by AI-related programs we've benefited from this year. This diversification of customers and products enhances our confidence, so we're in a much stronger position today than we were a year ago in terms of visibility.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Vijay Rakesh with Mizuho. Your line is now open.

Vijay Rakesh, Analyst

Yes. Hi. Thanks, Bill and Dan. Just a quick question on the AEC side. Just wondering, I think you mentioned working with five hyperscalers now. As you go to the back half, do you see the AEC ramp broadening out to others like Google or OpenAI or Dell? How do you see other partner ramps starting in the back half?

Bill Brennan, CEO

I think we've been pretty consistent in talking about new ramps with two of our existing customers, both in front-end and back-end networks for future deployments. These companies demonstrated this in their respective conferences last quarter. Looking at fiscal '25 and this expected inflection point in the second half, it's related specifically to these first two customers. As for the balance of the U.S. hyperscalers, we have qualified a potential third customer, but we don't have visibility on their exact deployment timeline or volume yet. The other two hyperscalers are still in earlier stages, focusing on architecture discussions, spec definition, product development, and early samples. Notably, in terms of revenue integration, I anticipate this third customer contributing as early as fiscal year '26. Hopefully, that provides some clarity.

Vijay Rakesh, Analyst

Yes. And quickly on the LRO side, it’s encouraging to see how fast you came to market with that receiver-side DSP. Are you seeing a ramp with a hyperscale customer into the next quarter? How big do you think that business could be? Do you see the optical DSP ramping substantially faster, and presumably with better margins as well?

Bill Brennan, CEO

Yes, I'm not sure if I communicated this clearly. Generally, an optical DSP design has a lengthy development cycle, as the first step involves building a module with a partner. A qualification cycle follows this before hyperscaler qualification. Looking at the timeline from start to production, it could be significantly longer than our AEC experience. For optical DSP business, we're just beginning to ramp our first U.S. hyperscale customer through our module partner. We're observing a comeback in spending with qualified customers in China and are competing for the next-generation ramp with a second U.S. hyperscaler that could impact fiscal '25. Beyond that, we continue pursuing other opportunities, but significant volume ramp may not occur until fiscal '26.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Thomas O'Malley with Barclays. Your line is now open.

Thomas O'Malley, Analyst

Hi, guys. Thanks for taking my question. My first one is a bit of a multi-parter, so forgive me. In the quarter you saw a big engineering services contribution. Dan, you mentioned product NRE. Historically, those have kind of come in on a quarterly basis of about $2 million to $3 million. Could you give us some color on why this quarter's was so significant? Is it one customer, multiple customers? Is it volume-related? Any color on whether it’s AEC or DSP would be helpful, just given how substantial it was in the January quarter. Thank you.

Dan Fleming, CFO

Yes, certainly. As you correctly identified, our product NREs historically range from $2 million to $4 million per quarter. So Q3 being higher is notable. This increase is largely for a single customer in the development process of our next-generation chiplet. Additionally, given the move down in process node geometries, this particular five-nanometer development called for more engineering resources than prior generations like seven nanometer. However, I don't believe this sets a new level for NRE services; I expect it to trend back to historical averages.

Thomas O'Malley, Analyst

Got it. Super helpful. And just on the guidance, you've indicated that full-year IP is at the high end of your range, and you also indicated services will revert to historical levels at $2 million to $3 million. You've spoken positively about the AEC business, but when considering all these pieces, I sense other products might trend down a little. Can you provide color on where you may see some sequential weakness? That would be super helpful.

Dan Fleming, CFO

I wouldn't characterize anything as sequential weakness. If you look at all those pieces together and exclude NRE from product, it's flat to up quarter over quarter, based on a very strong Q3 performance. As programs ramp up, they become significant, and pauses might occur generically. So I wouldn't point to any seasonal weakness.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Vivek Arya with Bank of America Securities. Your line is now open.

Vivek Arya, Analyst

Thank you for taking my questions. The quarterly product revenues are running in the $40 million to $45 million range. Could you give us a sense of how much of that is AEC run-rate currently, and how do you envision that quarterly trend over the next few quarters?

Dan Fleming, CFO

We don't break it out specifically by product line. However, one of our 10% customers is in the initial stages of a production ramp of AECs, which has driven much of the sequential growth from Q2 to Q3. In upcoming quarters, as these programs ramp, it's challenging to predict linear trends, producing variability until we reach the expected fiscal '25 inflection point.

Vivek Arya, Analyst

Thank you, Dan. My broader question is how we should build confidence that AEC will become a preferred choice for your customers? Many deployed GPUs last year and are continuing to deploy optical transceivers, but AEC has not yet seen widespread deployment. What changes do you expect in the second half for AEC to be viewed as a mainstream choice rather than a niche option?

Bill Brennan, CEO

Yes. The question relates to architectures for back-end networks, whether top-of-rack switches are utilized in AI-appliance racks. The long-term preference seems to be deploying Ethernet networks, a consensus among the five U.S. hyperscalers. Each will have different timelines for high volume Ethernet networks. Some may deploy InfiniBand today. Notably, if top-of-rack switching is omitted, building known-good racks and forklift installations would be hampered, and on-site assembly of clusters would present operational efficiency challenges. Nonetheless, our discussions are closely aligned with customer feedback, and nothing we're talking about is a real one-off. As customers implement long-term strategies, AEC's relevance will become clearer.

Vivek Arya, Analyst

Thank you both.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Quinn Bolton with Needham. Your line is now open.

Quinn Bolton, Analyst

Hi, guys. Thanks for taking my question. I guess, following up on Vivek's question, last quarter you had four top customers each in different product lines. This quarter, you've talked about three 10%-plus customers. Can you disclose what percent of revenues they represented, and did they all align with different product lines, or is AEC starting to represent a majority of revenue among two of the three customers?

Dan Fleming, CFO

Yes. We had three 10% end customers this quarter. When we file our Q in the next day or so, you'll find our end customer disclosures in the MD&A. To summarize, our largest customer was our first AEC hyperscale customer at 28%, followed by a lead chiplet customer, primarily NRE driven, at 23%. The final top three customer is our second AEC hyperscaler at 19%. Therefore, two of the three customers are primarily AEC driven, while one is chiplet driven. This contrasts with last quarter, which had four different product lines among the top customers.

Quinn Bolton, Analyst

Got it. Thanks for that detail, Dan. Bill, you've mentioned U.S. hyperscalers leaning towards Ethernet-based back-end networks instead of relying on InfiniBand. Most GPUs deployed thus far have been NVIDIA-based, making InfiniBand logical. However, with AMD ramping meaningful volumes, could you provide insights into what you're observing across the hyperscale customer base regarding backend connections in AMD GPU networks? Are they deploying Ethernet, InfiniBand, or another fabric? Considering the opportunities presented by AMD MI300 deployments, what’s your outlook?

Bill Brennan, CEO

Generally speaking, you're correct. However, the visibility we have into utilized GPUs is somewhat obscured by the NIC. We observe a certain number of Ethernet lanes at a given speed, and our solutions remain consistent regardless of whether they're connecting to NVIDIA, AMD, or internally developed GPUs. We might not be the best equipped to comment on decisions between Ethernet and InfiniBand; however, it appears that the U.S. hyperscalers are keen to deploy Ethernet. While Microsoft leads with InfiniBand, the list of others deploying InfiniBand is quite short, suggesting Ethernet is the preferred option going forward.

Operator, Operator

Thank you. I'm showing no further questions at this time. Now I'd like to turn it back to Bill Brennan, CEO, for closing remarks.

Bill Brennan, CEO

Thank you very much for the questions. We really appreciate the participation and look forward to following up on the callbacks. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.