Welcome to MACOM’s Second Fiscal Quarter 2023 Conference Call. This call is being recorded today, Thursday, May 4, 2023. I will now turn the call to Mr. Steve Ferranti, MACOM’s Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.

Thank you, Olivia. Good morning, and welcome to our call to discuss MACOM’s financial results for the second fiscal quarter of 2023. I would like to remind everyone that our discussion today will contain forward-looking statements, which are subject to certain risks and uncertainties as defined in the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those discussed today. For more detailed discussions of the risks and uncertainties that could result in those differences, we refer you to MACOM’s filings with the SEC. Management’s statements during this call will also include discussion of certain adjusted non-GAAP financial information. A reconciliation of GAAP to adjusted non-GAAP results is provided in the company’s press release and related Form 8-K, which was filed with the SEC today. And with that, I’ll turn over the call to Steve Daly, President and CEO of MACOM.

Thank you, and good morning. I will begin today’s call with a general update. After that, Jack Kober, our Chief Financial Officer, will provide a more in-depth review of our results for the second quarter of fiscal 2023. When Jack is finished, I will provide revenue and earnings guidance for our third fiscal quarter, and then we will be happy to take some questions. Revenue for our second quarter of fiscal 2023 was $169.4 million and adjusted EPS was $0.79 per diluted share. Cash flow from operations was approximately $33 million, and we ended the quarter with $577 million in cash and short-term investments on our balance sheet. Overall, our team did an excellent job on execution to meet our business and financial targets. Our book-to-bill ratio for Q2 was 0.5, which was well below our expectations. Our turns business, or revenue booked and shipped within the quarter, was approximately 9% of our total revenue, also lower than expected. Despite the weak Q2 bookings, our backlog remains strong as 7 of the last 9 quarters had greater than 1 book-to-bill ratios and our book-to-bill ratio for the full fiscal year 2022 was 1.1. Given the extraordinarily weak Q2 bookings, I thought it would be helpful to discuss the current order trends and address a series of important questions. First, were we surprised by the weak Q2 bookings? As discussed on our last earnings call, we had anticipated that bookings would be weak in Q2. However, our actual bookings were approximately $40 million below our internal forecast. So while we expected some softness, we did not anticipate the magnitude of weakness in the number of cancellations that occurred during the quarter. What caused the weak bookings? We believe it was a combination of excess customer and channel inventory as well as pockets of short-term end demand weakness. What markets have the most inventory? We believe our data center, networking, and 5G infrastructure customers and the associated sales channels continue to have high levels of inventory. Additionally, some of our cable broadband customers have significant levels of inventory, and they will not be ordering more products for at least a couple of quarters. Most of these customers placed large orders in fiscal year 2021 and 2022 to lock in capacity and to minimize the risk of supply chain interruption. As supply constraints have been resolved, many of these customers find themselves with excess inventory and therefore, are delaying new orders or asking to push out or cancel certain backlog. Are any of our target end markets slowing down? We believe there is end demand slowdown in certain parts of the data center and telecommunication markets. For example, our customers that manufacture optical transceivers for the U.S.-based cloud ISPs are telling us they expect to receive new volume production orders but only at 60% to 70% of the prior year’s levels. We also believe that China PON market demand is currently weak compared to last year, somewhat offset by moderate support for XGS-PON for the U.S. and European markets. We do not see any slowdowns in defense opportunities or end demand. Are there any notable MACOM-specific issues causing the weak bookings? With the exception of the timing of DoD orders, we believe the weakness is excess inventory and/or short-term end demand related. Are we losing market share? We do not believe we have lost market share or have lost any major customers or programs. Most of our design wins are sole-source sockets based on our products’ performance. Additionally, our design-in activity is strong, and the interest in our newest products is very high. Given the weakness in Q2 bookings, what is our outlook for Q3 and Q4? We have identified which major programs and associated orders are delayed, reduced in scale, or canceled. We believe it will take time for customer and channel inventory to return to normal levels. Therefore, we expect bookings to remain relatively weak in the next 1 or 2 quarters. That said, we do expect booking trends to begin to improve in Q3. Where is end demand strong for MACOM? Defense, medical, avionics, satellite communications, and high-performance computing remain strong. Further, we are confident that our growth potential continues to improve. We have been expanding our SAM and our latest products are compelling. The near-term weakness should not be confused with the long-term secular growth potential in our three core end markets. In summary, the Q2 bookings do not reflect the strength and the depth of MACOM’s portfolio and our long-term growth potential. I hope this extra detail on bookings helps investors understand the current market environment. Turning to our end markets for fiscal Q2: Industrial and defense revenue was $77.2 million, flat sequentially. Telecom was $53.9 million, down 12.3% sequentially, and data center was $38.3 million, down 7.6% sequentially. I’ll note that both industrial and data center revenues are up year-over-year, and telecom is down year-over-year. Within telecom, North America, China, and Korea have led in 5G deployments thus far. As the number of 5G subscribers increases, additional network densification and capacity expansion will be required to support the associated increase in traffic. Based on these factors, we do believe 5G will remain a growth opportunity over the next few years, and we will continue to invest in penetrating this market. Additionally, within our telecom market, fiber-based broadband access networks continue to increase globally, displacing copper and coax-based networks. Fiber-to-the-home deployments create a very large high-volume market, with the total unit shipments of 2.5G and 10G PON approaching 100 million units annually, representing a sizable opportunity for MACOM over the next few years. Satellite-based broadband networks are seeing a resurgence as a viable alternative or supplement to terrestrial-based systems. Lower Earth Orbit, or LEO, satellites configured with mesh network architectures are making global broadband coverage a reality. Constellations announced by SpaceX, OneWeb, Amazon, Kuiper, and Telesat will drive demand for thousands of new LEO satellites over the next few years. To support these systems, new ground station infrastructure is being built along with the associated backhaul fiber network. All these RF and microwave platforms play directly to MACOM’s strengths. Turning to the data center. We see new trends emerging fueled by growing bandwidth demand. Today, hyperscale operators are in the early stages of 400G and 800G deployments, and 1.6T is following closely behind. The technical challenges for high-speed mixed-signal ICs in systems designed associated with these higher-speed nodes grow more complex with each successive generation. This has a number of positive implications for our business; artificial intelligence and machine learning are just beginning to be deployed, which will drive the next wave of growth within the data center. Finally, we see the defense market as a growth opportunity for MACOM in many areas. Radar, communication systems, and electronic warfare requirements across space, airborne, shipborne, and ground-based platforms can drive significant growth for our types of semiconductor products. In summary, our target markets contain significant growth drivers, and we believe our differentiated technology will provide MACOM a competitive advantage to capture market share. I’d like to review some major accomplishments across the business during Q2. As previously announced, we released our 0.14 GaN on silicon carbide semiconductor process. Today, we have approximately 20 new mimic designs being processed in the Fab. Initially, the target applications will be high-volume shipborne and airborne radar programs and various SATCOM and telecommunication systems. On a related note, our Fab equipment team has recently completed the installation of a new backside via ETCH tool and an Atomic Layer Deposition or ALD tool to support this and other next-generation GaN processes. During the quarter, we made our first production shipments from our new Bulk Acoustic Wave, or BAW, filter product line. Our BAW growth strategy is to focus on high-performance applications in industrial telecommunications and defense applications. In March, our technical team successfully demonstrated the performance of a newly designed high-power transmitter subarray panel. This was an important contract milestone, and we will now begin work on the full array. We expect this program will lead to similar opportunities in the next 12 to 24 months. Notably, this transmitter is designed with almost 100% MACOM RF content. A few trends in the data center market include we are seeing a demand decline for NRZ products as new systems are moving to more PAM4. Covering product demand for 100G AOCs as well as 100G CWDM4 and LR4 is weak. We expect this to continue for 1 or 2 more quarters. We are seeing strengthening production demand and growth in 100G DR1, 400G, and 800G. Most of this demand is supporting AI and high-performance computing applications. During the past few months, we have secured numerous design wins for laser drivers and TIAs for 400G-ZR and ZR light to support coherent systems for data center campus applications. A few notable items on the RF power products: We have been selected by a Tier 1 defense prime to support an L-band radar program with a custom-designed amplifier subassembly. We expect this large program will begin to ramp production within the next 6 months. We expanded our pure carbide portfolio to include products specifically designed for industrial, RF power cooking, and heating applications, and STMicroelectronics delivered FET devices from its newly qualified GaN on silicon process. This material will enable us to design our next-generation GaN silicon amplifier products to support low power and lower-cost RF amplifier applications. During Q2, we received numerous initial orders that have significant long-term revenue potential, including an IC design contract to support a long-range automotive FMCW, LiDAR application, a pilot order from a Tier 1 base station OEM for a new 5G massive MIMO front-end module, and initial diode orders from both Japanese and German customers to support their new tactical radio production programs. In March, we attended the Optical Fiber Conference, or OFC, where we highlighted our newest products and hosted 8 live product demonstrations at our booth. One demonstration, which gained a lot of attention, was our linear drive products that support single-mode and multimode PAM4 architectures at 800G. The linear drive architecture enables power savings compared to retime solutions and a significant cost reduction due to the elimination of the DSP chip from the optical module. Our demonstration showcased 800G link performance and interoperability with Broadcom’s Tomahawk 5 switch using OSFP modules designed by Eoptolink, Hisense, and Cloud Light. The demonstrations confirmed post FEC error-free operation with multiple orders of magnitude margin over the standards requirements. Additionally, we demonstrated NVIDIA’s 800G modules, which we believe will be ideal for applications like artificial intelligence, machine learning, and high-performance computing. The linear drive architecture is protocol-independent and can support InfiniBand, Ethernet, as well as other low-latency interconnects. We believe our first-to-market linear drive products and associated intellectual property position us for growth as this new architecture is adopted. Before I turn the discussion over to Jack, I would like to review 2 recent acquisitions. In early March, we completed the acquisition of Linearizer Communications Group, a private company located in Hamilton, New Jersey. Linearizer is an expert in microwave pre-distortion linearization, microwave electronics for satellite payloads, and microwave photonic subsystems, or RF over fiber for defense applications. Linearizer designs and manufactures custom products for space, SATCOM, and defense customers. Their customers are primarily U.S.-based, and the revenues will be reported as part of our industrial and defense and telecommunication market segments. I’m excited to welcome the entire Linearizer team to MACOM. Linearizer is a well-run, profitable business with great management, great employees, great technology and customers, and a 31-year track record of success. By combining our proprietary semiconductor technology with their component and subsystem design expertise, we can create even more differentiated solutions for our combined customers and further penetrate the relevant markets. Together, we make a powerful combination. And in January, we announced a definitive agreement to acquire the assets of OMMIC, a semiconductor manufacturer located outside of Paris, France. The transaction has a few more hurdles to clear. Currently, we expect to close in our fiscal third quarter. This acquisition of key manufacturing capabilities and technologies will expand our millimeter wave frequency GaAs and GaN portfolio, increase our wafer manufacturing capacity with an operational 3-inch and idle 6-inch production line, add epitaxial growth expertise, bolster our European presence, and strengthen our Mimics semiconductor process and IC design teams. This acquisition supports our strategic goal to establish a leadership position in very high frequency semiconductor mimic processes and products. Jack will now provide a more detailed review of our financial results.

Thanks, Steve, and good morning, everyone. Our results for the second quarter of fiscal 2023 were consistent with our guidance for the period. Revenue for the second quarter was $169.4 million, a decrease of 6% from the previous quarter. This decline was primarily due to the telecom and data center markets. In terms of geography, sales to domestic customers made up about 49% of revenue, remaining flat from the previous quarter. Sales to customers in China represented around 20%, down from 23% in the first quarter. Sales to customers in Europe accounted for approximately 7% of revenue over the last four quarters, and we are focused on increasing sales in that region. Adjusted gross profit was $105.2 million, or 62.1% of revenue, a decline of 50 basis points from the previous quarter. Adjusted operating expenses totaled $48.6 million, which included R&D costs of $31.3 million and SG&A expenses of $17.3 million. Total operating expenses decreased sequentially by $5.3 million due to lower variable compensation, professional fees, and discretionary spending. Adjusted operating income in the second quarter was $56.6 million, down from $58.8 million in the first quarter. The adjusted operating margin for the second quarter was 33.4%, an improvement from 32.7% in the first quarter. This higher adjusted operating margin compared to the first quarter reflects the flexibility of our operating model as we manage internal investments in response to changing business cycles. Depreciation expense for the second quarter was $5.8 million, with adjusted EBITDA at $62.3 million. The trailing twelve months' adjusted EBITDA was $250.3 million, compared to $244.7 million in the first quarter of fiscal 2023. Adjusted net interest income for the second quarter was $2 million, an increase of about $1 million from the first quarter due to higher returns from our investment portfolio. Our adjusted non-GAAP income tax rate for the second quarter remained at 3%, resulting in an expense of about $1.8 million. Cash tax payments were $1.4 million, up from $300,000 in the first quarter. We anticipate that our adjusted income tax rate will stay at 3% for the rest of fiscal year 2023 and into fiscal year 2024. Adjusted net income for the second quarter was $56.7 million, compared to $58 million in the first quarter. Adjusted earnings per fully diluted share were $0.79, based on a share count of 71.4 million shares, compared to $0.81 in the first quarter. Turning to balance sheet and cash flow items, our accounts receivable balance was $121.8 million, up from $112 million in the first quarter, resulting in days sales outstanding of 65 days, compared to 57 days in the prior quarter. The increase in accounts receivable is mainly attributed to shipment timing, with most shipments occurring later in the quarter, as well as accounts receivable from the Linearizer acquisition. Inventories were at $131.9 million at the end of the quarter, an increase of $10.5 million sequentially, primarily due to inventory related to the Linearizer acquisition. Inventory turns were 2x in the second quarter, slightly down from 2.2x in the previous quarter. We believe the quality of our inventory remains robust and despite lower customer orders and shorter lead times, we expect to reduce our net inventory balance as we move through fiscal year 2023 and into fiscal year 2024. Cash flow from operations for the second quarter was approximately $32.5 million, down from $38.3 million in the first quarter, largely due to the timing of accounts receivable and accounts payable payments. Generating cash continues to be a priority as we navigate changing business cycles. Capital expenditures for the second quarter totaled $6 million, down from $9.6 million in the previous quarter. Our total capital expenditures for fiscal year 2023 is now projected to be $35 million. We are carefully balancing capital spending with the profitability and cash generation of the business and plan to make essential investments in our fabrication capabilities and processes during fiscal 2023. Moving on to other balance sheet items, during the second quarter, we used approximately $51 million of available cash to complete the Linearizer acquisition. Consequently, cash, cash equivalents, and short-term investments for the second quarter amounted to $577.3 million, down from $594.7 million in the first quarter of fiscal 2023. Our gross leverage for the second quarter remains under 2.5x, with net debt being less than $50 million. Before returning the discussion to Steve, I would like to highlight a few additional points. We are pleased to have finalized the Linearizer acquisition in March and are working on integrating their team with MACOM. We expect Linearizer to have a minimal short-term impact on our revenue but anticipate it will be modestly beneficial to our bottom line. Over the long term, we believe that combining Linearizer with MACOM’s brand and infrastructure will provide growth opportunities. We are excited to welcome the Linearizer team to MACOM. Furthermore, we are working towards finalizing the OMMIC acquisition, which has unique technology and a dedicated workforce. As previously mentioned, we do not expect OMMIC to significantly impact our revenue immediately after the transaction closes, although it may be slightly dilutive to our earnings per share initially. However, in the long run, we foresee that investing in OMMIC will lead to growth, profitability, and increased shareholder value. Additionally, we are making strides with new product introductions and plan to release 30% more products this fiscal year compared to last year, which we believe will aid in long-term revenue growth. Furthermore, during the June quarter, we look forward to updating our 5-year strategic plan, which historically has included a thorough framework for expanding our serviceable available market, enhancing our technical skills, and growing our product offerings. We regard this process as essential in developing a detailed plan and setting objectives across the entire organization to build on our solid financial base, establishing growth, profitability, and investment targets for the next five years. Lastly, considering the current business landscape, we will strategically manage our expenses in the second half of the fiscal year. I will now turn the discussion back to Steve.

Thank you, Jack. MACOM expects revenue in fiscal Q3 to be in the range of $145 million to $150 million. Adjusted gross margin is expected to be in the range of 59% to 61%, and adjusted earnings per share is expected to be between $0.52 and $0.56 based on 71.5 million fully diluted shares. This guidance does not include any revenue contributions or financial impact from the planned OMMIC acquisition. In Q3, we expect industrial and defense revenues to be up and data center and telecom revenues to be down for the reasons we’ve previously discussed. As I’ve noted, we maintain a long-term perspective on executing our strategy. Our product portfolio is stronger than it was a year ago, and we are confident we can meet or exceed our targets. Finally, as we model our second half financials, we expect our full year fiscal year 2023 revenues and earnings to be down approximately 4% to 5%, and gross margins to be over 60%. I would now like to ask the operator to take any questions.

And our first question comes from Matt Ramsay with Cowen.

Yes. Steve, could you elaborate on the near-term trends? We appreciate the detailed information in the script. Given the current macro environment, it's not surprising that you've experienced some order pushouts. What I'm particularly interested in is whether there have been any full cancellations of orders that caught you off guard, aside from just inventory adjustments. Considering that many of your products are single source and carry a low risk of obsolescence, I want to understand whether we should interpret this situation as merely a temporary delay in multiple programs, or if there have been actual program cancellations we need to be aware of. If there are, in which segment did they occur?

Thanks for the question, Matt. So first, I would say that the cancellations that we’ve had probably fall into 2 categories. The first would be customers managing their inventory and exposure, which we would put in the category of normal business operations given the climate today. And then the second category would be more along the lines that customers have decided to cancel the programs or they lost business. And so they were truly eliminating the demand for those products, for those programs. We saw most of that in older networking programs that we’ve been supporting. I would say where typically, those products also would be in the category of non-cancelable and not returnable. So oftentimes when we see those kinds of cancellations, there are associated cancellation fees. So those are really the two categories that I would call out regarding the cancellations. I think the total dollar value is in the range of about $10 million, a little over $10 million in the period, which is abnormally high. It should be close to 0 on a regular basis. So yes, we were surprised by those cancellations. And we think over time, that number will drive to 0.

Thank you for the information, Steve. I have a follow-up question. You mentioned at the end of the script that you expect revenue for the year to be down by 4%. This suggests a slight recovery, but not significant, in the September quarter, perhaps moving from around $147.5 million to $150 million. Is that the correct understanding? Additionally, how do you view the recovery from this point back to a normal business run rate? If you have any insights on the timing of recovery by segment, that would be helpful. I realize things are changing rapidly and that some factors affecting orders last quarter were unexpected, but we are trying to gauge the timing of recovery.

Thanks, Matt. So I think I’d just like to highlight first that it’s very important that we do talk about bookings. Jack and I have been reporting the book-to-bill ratios for now about 4 years. We think that’s probably one of the most important metrics to discuss on these quarterly calls. What we’ve seen over the past 4 years is certainly a lot of strength in the bookings. Back in fiscal 2020, our book-to-bill ratio was about 1.1, close to 1.2. In fiscal '21, it was about 1.2. And then last year, last fiscal year, it was 1.1. So all of that suggests that there is growing demand, growing interest in MACOM’s products. It also allowed us to build a very strong backlog for times like this when things start to slow down. There was a period, towards the end of we had a backlog over $400 million. And what we’ve seen in the first quarter was a 0.9 book-to-bill and then the second quarter of 0.5. We’ve seen our backlog come down, but it’s still around $300 million. So we still have a significant amount of backlog. This is high-quality backlog within 12 months delivery. When we talk about this quarter and even next quarter in light of the weak bookings, we still have a lot of confidence in our ability to execute and deliver and hit our targets. And so we did think it would be helpful to provide some directional information about the fourth quarter to give investors comfort that we are still in a very strong position. So I just wanted to highlight that. And by the way, the factors that drive bookings are certainly manufacturing cycle times. We’ve seen those coming down. Inventory levels at customers are high, so they’re ordering less. And then, of course, the risk buys for new programs. We are seeing a lot of smaller orders coming in that are really targeting new programs that will ramp not only towards the end of our fiscal year but the beginning of next. So when we add all of that up and then we look at our sales forecast, we do think things will slowly improve. We don’t think it’s going to be a rapid return to, let’s say, strong bookings because we do have to work through the inventory situation that we’re currently facing. So I think the comments that I made in my prepared remarks about the trends improving is probably as far as I want to go. We don’t know what Q4 bookings will be. We’ll have to wait and see. There is certainly a lot of uncertainty around the markets. But I think what’s very important for today is investors understand that we’re sitting on a very strong backlog. When we apply a conservative book-to-bill on top of that, we think year-over-year, we should be able to achieve between a 4% and 5% decline in revenue, which is not ideal, but I think it’s a reasonable outcome given the market environment.

And our next question is coming from the line of Tom O’Malley from Barclays.

I also appreciate the script where you guys took all the good ones earlier. So thanks for making us think a little bit today. But I just wanted to ask, I think Matt just covered the revenue side. But if you do the math on the earnings, down 5% implies a pretty good step up in the gross margin for September as well. Could you just address, one, do you think that the June 60% is the bottom from a gross margin perspective? And then just given the fact that that revenue is kind of flattish at that midpoint of 4% to 5%, how do you get that leverage of a couple of hundred basis points going into September from a gross margin perspective?

Tom, this is Jack. So just as we looked out over Q3, I think the midpoint of the guide is that 60% number and going into Q4, we haven’t gotten down to that granular level, but it would probably be somewhat consistent with that at that lower revenue volume. Obviously, we’ve seen a bit of a step down here in the June quarter versus the March quarter that we just completed from an overall gross margin point of view. I think a majority of that is volume related. We’ve been very pleased with the gross margins that we’ve had, which have exceeded 60%. I think going back over the past 9 or 10 quarters. I would also highlight with the revenue levels that we’ve put out there for the upcoming June quarter, if you look back to a comparable period from MACOM, it probably goes back to the end of 2020 or early 2021. Our gross margins were probably in the mid-50s at that point in time. So there’s been quite a bit of things that we’ve done structurally to improve the gross margins over the past couple of years, which we’ve obviously seen in the incremental increases that we saw in the past. So if we can get that top line volume back, that will help support improvements in gross margins. And then one of the other items that we’ve talked about is the new product introductions that we’ve had over the past number of years. That has also helped. Obviously, new product introductions will continue as we go forward, and that will further support improvements in the gross margins as we get into fiscal year '24 and beyond.

Helpful. And then I kind of have one out of left field here. But you guys, I’m not sure intentionally or not, didn’t mention the chips act in the script, and that’s something that you brought up in the past. Obviously, it seems that things are moving a little sideways there. Can you just talk about your current efforts there? What you’re hearing from the government? And if you still view that as something that you would like to participate in terms of receiving the funds?

Thank you for the question about the Chips Act. As we have mentioned before, we are actively engaged. In earlier calls, we detailed our strategy and what we are looking for. We have interacted with the government and submitted various documents; however, we are somewhat restricted in what we can share moving forward. We cannot disclose the specifics of our strategy now that we are in communication with the government. Other investors should be aware that we are seeking opportunities, but we cannot provide any further details at this time.

And our next question coming from the line of Harsh Kumar with Piper Sandler.

Thank you for the information. It’s very helpful. I have a quick question, Steve. Regarding the projected revenues of $145 million to $150 million for the June and September quarters, would you say that you are significantly under shipping, or is it more about selling off excess inventory? Do you believe this revenue level will be sufficient to reduce excess inventory by the end of the September quarter, or will there still be excess inventory as you move into the next fiscal year?

So Harsh, I think we are under shipping in certain areas. So generally, yes. But it’s also very difficult for us to get a sense of what might happen in the September quarter. I can tell you that we are being more aggressive looking at what we call the point-of-sale report and the sell-through within all of our sales channels. So we’re becoming very, very focused on looking at that data on a more regular basis. I would also add, which is sort of aligns to your question that we want to bring our channel inventory down, and that is part of our strategy in the back half as well. And so that is factored into our guidance. So on the first part of your question regarding cable infrastructure and broadband as well as China PON, I think in the case of cable, that is going to have a slower recovery than the PON market. So we would expect going into next year to be at higher volumes or healthier environment for PON. We think cable will be stretched out a little bit more, mainly because we know our lead customers, and there are multiple customers, are sitting on significant inventory. So they have to burn that through. We think we will be seeing orders in about 2 quarters to help us set up for fiscal year 2024. Regarding your question on compute and specifically high-performance compute, that is a very active area for MACOM, as I talked about in the script, especially our chips supporting 800G applications. These are typically less than 100 meters, less than 500 meters, and inside the data center where our customers want to move high volumes of high-speed data. So that’s an area where we are seeing some strength. But unfortunately, that strength is muted by the slowdown with CWDM4, a lot of the SR programs, and a lot of the NRZ programs that we’ve been involved with in the past. So the weakness outside of, let’s say, the higher speed PAM4 area is causing our data center revenues to, in aggregate, be down significantly in Q3 and in Q4. But that doesn’t speak to what we think will be a really nice setup for next year as our customers are pushing us to ship and ramping up on those higher speed programs. As I mentioned in the script, we feel like we are in a leadership position there. These are products that were not just developed within the last 12 months. These are products that we’ve been working on for over 2 years. For us to be able to demonstrate operating modules at OFC with the Tomahawk 5 switch suggests that we have been working deeply with not only module manufacturers, but also switch manufacturers, and to your point, companies like NVIDIA.

And our next question coming from the line of Quinn Bolton from Needham & Company.

I’ll echo the thanks for the color on the bookings trends by end market. I guess, Steve, maybe just if you could help us, what is the normal backlog position for the company? If you’re $300 million today, that looks like it’s about 1.5 quarters of forward revenue. Is that a more normal position as backlog, normal backlog, perhaps even lower than that?

That’s a great question. The answer is that you can never have enough backlog. Over the past four years, we’ve been increasing that number nearly every quarter and fiscal year. We expect that, over the long term, backlog will always be on the rise. When that doesn’t happen, it’s disappointing. Jack has mentioned that we have consistently hit record backlog numbers over the past year. About 20% of our revenue is coming from new products, which is clearly driven by the excellent work our engineers are doing to deliver compelling products in the market. There really isn’t a typical level; that number should always be increasing. When it isn’t, we work harder to ensure it does. Our sales teams, business units, and leadership are actively engaging with customers and getting involved early. A couple of quarters ago, I outlined our priorities for this fiscal year, one of which was to gain market share. We plan to achieve this by collaborating with our customers at their locations and having our app teams and designers create custom designs for them. All these positive developments are occurring, and we expect that, over the long term, that number will always increase.

Understood. And then a more specific question on data center. You’ve talked now for several quarters about weakness in the NRZ, the CWDM4 for the short reach. It sounds like that business will offset some of the strength in 800 gig or the PAM4 side of the business. As you get into the June and September quarters, with that business continuing to decline, can you give us any sense of what percentage of the data center business would still be represented by those NRZ or kind of more legacy products exiting this fiscal year? Is that still something you would expect to be an overhang or a headwind in fiscal 2024? Or is it down to pretty inconsequential levels by the end of fiscal 2023 that you really set up for growth in the 400, 800 gig PAM, the direct drive, the equalizers, and some of the newer data center products?

Yes. So certainly, the NRZ is becoming a smaller percentage of the total. A lot of that business is China-centric as they’re building out and deploying modules at our 25G short-reach type either AOCs or pluggables. It’s not clear to us when that eventually goes to 0, let’s say. We would expect at some point it becomes a de minimis amount. That might happen over the next 12 months, it may take 2 or 3 years; we just don’t know. When we think about deploying R&D resources, we want to always be working on the highest-speed applications as we talked about earlier and also taking some of those same resources and getting them engaged in other markets, including telecom and defense. Over the long term, we believe that industrial and defense and telecom will outgrow the data center end market primarily because there are so many differentiated opportunities in those other markets.

And our next question coming from the line of Tore Svanberg from Stifel.

I have a question regarding the consumption levels, particularly in the data center and telecom sectors. From my analysis and how I see the business evolving in the June quarter, it appears both sectors will experience a decline of about 20% to 30% sequentially. Can you identify areas that may currently operate below consumption? Additionally, which segments do you believe will still have excess inventory as we exit the June quarter?

Right. So Tore, thanks for the question. You’re right. As we move from Q2 to Q3, as I highlighted, we believe industrial and defense will be up sequentially, perhaps 9% to 10% and certainly over 10% year-over-year. So we’re happy about that. Telecom and data center will be down, data center probably more down than telecom. As we’ve talked about, a lot of the legacy NRZ programs are dragging the aggregate number down. In telecom, the areas that are weaker, certainly 5G pretty much across the board, whether it’s on the optical side or on the RF side. Metro/Long-haul, where we have a very strong position, is also going to be weak in the current quarter. I would say cable TV is also an area of weakness. When we think about what’s going to happen in the September quarter and when inventories sort of level off, it’s very difficult for us to say. That’s why we’ve sort of highlighted that we do expect our Q3 bookings to begin to improve, and that is a leading indicator of inventories coming down across all the markets, but I think it’s too early to be specific on what actually might happen this quarter. As you saw in Q2, there was a significant reduction in bookings, so we have to let things play through here.

No, that’s great color. And then on your own internal inventories, I think you said you intend to bring that down throughout the year. The inventory days stand at 187 right now. So do you have a target either by days or by dollars that we should track?

Yes, Tore, this is Jack. We’re targeting to bring that down. Obviously, it’s going to depend on order flow to some extent as we work our way through this. We’ve looked at it from a target standpoint, we’re targeting to try and get our inventory turns up above that 2 number that we had for the current quarter, targeting something probably closer to 3 over the long term. We know we’ve got some work to do to get there. We were obviously building some strategic supplies over the past year or so. We still have those. We do an analysis of our inventory. We feel our inventory is very healthy. As we work through things over the next couple of quarters, we expect to see some overall reductions. During the quarter, the linearizer acquisition drove a majority of that increase that we had seen quarter-over-quarter.

And our next question coming from Vivek Arya with Bank of America.

This is Blake Freeman on for Vivek. Just the first one, kind of going back to gross margin. If I look at the last time sales were down double digits sequentially, gross margins fell much more than 200 basis points that you’re guiding for the June quarter. So the portfolio has certainly changed since then, but just kind of curious if you can elaborate on what gives you confidence that gross margins won’t see further declines kind of amid the second half challenges.

Sure. Thanks, Blake, for the question. Maybe I’ll make a few comments, and then Jack can add to those comments. So as we talked about, we do have a significant portion of our current quarter in backlog. So that gives us some visibility into the range. As Jack also highlighted, when we were down at these revenue levels back in fiscal 2021, our gross margins were lower, but we know that the mix is favorable. Our cost structure is favorable. Our ability to execute and the efficiencies within our operations are all favorable. Even at those same revenue levels, we’re seeing a significant improvement in the gross margins. The strength of the portfolio is providing a nice tailwind. With that, maybe, Jack, you could be more specific.

I think that was a helpful summary that you had gone through, Steve. Once again, we’re in a much better position than we were a number of years ago in terms of how we manage our costs. Our flexible manufacturing model, where certain of our products are fabbed outside, has less of an impact on our overall gross margin. Even the mix that we have through products that are fab, we’re not a mega fab where a slight dip in revenue can have a more significant impact on the gross margin. We are somewhat insulated from that perspective versus some of our peers that may be out there that are higher volume operators.

Got it. I have a quick follow-up regarding operational expenses. As we navigate the headwinds in the second half while also focusing on investments in new product lines, can you provide insights on how you anticipate operational expenses will trend over the next few quarters?

I think if you look to the midpoint of our guide, we’re probably in the $50-ish million range, which is a bit of a step-up from where we ended this current quarter, which was around $47 million of total OpEx. Some of that is near acquisition coming online for a full quarter, but we will continue to make investments. We’ve talked about our new product introductions as being an important area for us. We will continue to focus on making some of those R&D investments where they make sense. But one thing that we stated many times before, we’ll keep a close eye on our operating expenses as we go forward and make sure we manage those expenses in an appropriate manner.

And our next question coming from the line of David Williams with Benchmark.

So quickly, I wanted to see if maybe you had any color around maybe the CapEx spending plans that you’re seeing within maybe carriers and service providers. Are you seeing major changes in the CapEx or just maybe some programs that are being shelved here in the near term?

Right. Thanks for the question. I’m probably not the best person to ask that question regarding what the industries are doing with their capital spending. We have seen directionally that there is increased spending with 5G. It depends on the country, of course. We see that the data centers are continuing to invest. I mean, they’re having massive layoffs on one side of their business, but they’re investing heavily in equipment on the other side of their business. So that capital investment will certainly flow down to companies like MACOM. It’s very difficult for us to sort of talk about those higher level of capital spending because we’re so far removed from how those dollars flow. But I would highlight that there are secular growth trends that favor MACOM. For example, the defense industry is growing, not only here in the U.S. but also internationally. Many, if not most, of the NATO countries are increasing their spending on defense equipment, and they want to build that equipment locally. Companies like MACOM can support European defense contractors. I talked about participating in some tactical radios for German customers, for example. There’s a tremendous opportunity for us in the defense industry with the technology that we have. When we think about telecom, most systems deployed today are moving to higher frequencies. You can count the number of companies that can support those platforms with high-frequency semiconductors on one hand. We are one of those companies. Our strategy is to be stronger and be a leader with high-frequency semiconductor technology. When you layer on top of that our gallium arsenide and GaN, gallium nitride, and GaN on silicon carbide capabilities at those higher frequencies, it really starts to look differentiated. The telecom market is, we believe, going to continue to grow. There are lots of exciting growth opportunities. We talked about some of the LEO constellations in the script. Last, the data center, we want to participate at the highest data rates. As things become commoditized or move to lower data rates, that’s when we will step out and put our R&D resources in other areas. While we’re not focused on capital spending of the end-user community, I would highlight that our three core markets will have secular growth over the next decade, and we’re in a great position to take advantage of that.

It was good information there. Additionally, could you provide an update on the situation in China and the demand you are experiencing there? I know you mentioned this earlier, but I’m curious about any demand trends or inventory issues related to that market.

Sure. China is a very important market for us. In the first quarter, about 23% of our revenue, or about $40 million, was coming from Chinese customers. This past quarter, it was – the percentage dropped. So now in absolute dollars, that’s around $33 million. It’s certainly come down. I don’t think these numbers represent the potential of that market. I would say right now it’s a very muted market in the sense that 5G deployments or a lot of optical module build-outs. There’s a lot of uncertainty around the volumes and sort of what’s going to happen next. General speaking, things are improving as COVID is sort of behind the local economy, and now things are opening up. That’s a positive trend for companies like MACOM. The last thing I’ll add is that there’s certainly a risk against U.S. semiconductor manufacturers selling products into China, and we recognize that, and we will make sure that our strategy addresses that.

And our next question coming from the line of Karl Ackerman with BNP Paribas.

Steve and Jack, in your prepared remarks, you noted that your optical transceiver partners have said that new orders would be down 30% to 40% from the prior year. Is that just specific to your own NRZ products? And is that weighted more toward telecom? Or is it more weighted toward data center? Any color on that would be helpful.

I would say that was a broad statement covering all data rates in NRZ and PAM4, excluding the higher-end PAM4 products, which are more focused on data centers. We believe that when telecom operations begin to ramp up, we will have a very strong position in front haul with our electrical products like drivers, TIAs, and CDRs, as well as our optical products, including lasers and photo detectors. Currently, we see that the Metro/long-haul business is relatively weak, but we anticipate it will start to recover in about one to two quarters.

That’s very helpful. Maybe to dovetail on that last part. You noted growing design wins for 400-gig ZR. Could you discuss your opportunity on ZR products over the next maybe even a year or two as you’re starting to win some of these designs?

Yes. I mean, it’s certainly very early, but we are seeing customers developing coherent products that will be used in and around the data center. With our Metro/long-haul technology, these are generally high-end semiconductor processes for long-distance applications. We are seeing sort of a reset on that technology to apply it to things like 400 ZR light. It’s primarily in two product areas: it's drivers and TIAs, generally used for applications around 20 to 40 kilometers.

Thank you. I’m showing no further questions in the queue at this time. I will now turn the call back over to Mr. Daly for any closing remarks.

Thank you. In closing, I would like to thank all our employees for their hard work and dedication, which made all these results possible. Have a nice day.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.