Earnings Call Transcript - MTSI Q3 2023

Operator, Operator

Welcome to MACOM's Third Fiscal Quarter 2023 Conference Call. This call is being recorded today, Thursday, August 3, 2023. I will now turn the call over to Mr. Steve Ferranti, MACOM's Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.

Steve Ferranti, Vice President of Strategic Initiatives and Investor Relations

Thank you, Olivia. Good morning, and welcome to our call to discuss MACOM's financial results for the third 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 discussions 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. With that, I'll turn over the call to Steve Daly, President and CEO of MACOM.

Steve Daly, President and CEO

Thank you, and good morning. I will begin today's call with a general update on our business. After that, Jack Kober, our Chief Financial Officer, will provide a more in-depth review of our results for the third quarter of fiscal 2023. I will then provide revenue and earnings guidance for our fourth fiscal quarter, and we will be happy to take some questions. Revenue for the third quarter of 2023 was $148.5 million and adjusted EPS was $0.54 per diluted share. Cash flow from operations was approximately $46 million, and we ended the quarter with $588 million in cash and short-term investments on our balance sheet. Our team did an excellent job in meeting our business and financial objectives, albeit in a challenging market environment. We are especially pleased with our cash flow as we manage our way through the down part of the cycle. Our book-to-bill ratio in Q3 was 0.9, which was a significant improvement over Q2. Our total company backlog decreased slightly quarter-over-quarter, although it remains at a healthy level. The bookings growth was driven primarily by our data center and defense customers. Our turns business, or revenue booked and shipped within the quarter, represented approximately 18% of our total revenue, which is approaching historical norms. While we are encouraged by the improvement in bookings, the broader demand environment remains weak in several of our served markets, and in particular with the telecom market. I'll note that customer cancellations and push-out requests have slowed, which is a positive indicator. However, I would still characterize overall industry inventory levels as high, with many customers still carrying excess inventory. Our external sales channel inventory did decrease in Q3, and we plan to manage our external sales channel inventories down again in Q4. Turning to our discussion of our end markets for fiscal Q3. Industrial and Defense revenue was $83.5 million, up sequentially, and it was a company record. Within the I&D market, demand for MACOM's products remains robust. We continue to see numerous secular drivers within both the industrial and defense markets, which have the potential to drive slow but steady growth for MACOM over the coming years. Applications include new satellite networks within the DoD, new AESA or active electronically steered antenna radar deployments, electronic warfare applications, secure communications, and new very high frequency electronic sensors. These applications require progressively higher frequency levels, more bandwidth, and higher power levels in smaller form factors, which plays directly to MACOM's competitive strength. Our goal is to expand our SAM within the I&D market and to establish differentiated products that span analog ICs, MMICs, and RF and microwave subsystems. Our portfolio has multiple growth initiatives, which were previously discussed, including our high frequency 0.14 GaN process, low frequency MACOM pure carbide power amplifier products, BAW filters, KV CAPS, ruggedized photonic subsystems, and RF amplifier palettes. Our recent acquisition of Linear Communications Group is an example of our SAM expansion initiatives. As previously highlighted, the Linearizer team brings MACOM new design and manufacturing capabilities in microwave predistortion products for SATCOM, and satellite payloads, as well as microwave photonic subsystem products for defense applications. Over the past three decades, the Linearizer team has developed an outstanding reputation in the SATCOM industry and forged strong relationships with many leading TWT manufacturers, Tier 1 U.S defense prime contractors, SATCOM ground station OEMs, and satellite manufacturers. This acquisition strengthens our market position within the defense industry and improves our ability to capitalize on the estimated incremental $250 million TAM. Since closing the acquisition in March, we have initiated new R&D activities to combine our proprietary semiconductor technologies with Linearizer's system design expertise to create more differentiated solutions for our combined customers. The industrial market continues to expand with new applications, including, by way of example, traffic monitoring radars, automotive sensors, such as LiDAR, industrial wireless IoT platforms, factory automation and robotics, and wireless and laser-based instruments for medical applications. In short, we continue to build a unique and differentiated product portfolio of RF and microwave and millimeter wave and optical capabilities for the I&D market. While programs in the I&D market take a long time to enter production, the programs typically have long life cycles and carry healthy margins, which ultimately create attractive financial returns. Revenue for the telecom end market was $38.3 million, down 29% sequentially. The global telecom markets remained very challenging with weakness in China, slowing 5G deployments in the U.S., and elevated inventory levels at CATV and Metro long-haul customers. Our telecom bookings have been weak for most of fiscal year '23. At current levels, we believe we are under shipping to end demand. In spite of the current market weakness, we continue to view telecom as an attractive market with large and diverse long-term growth opportunities. We believe this market has the potential to be one of our faster growth markets because design cycles are fast, volumes are high, and customers typically select products based on performance rather than price. MACOM has compelling products for the telecom market, from our diode and MMIC portfolio to our analog ICs and optical or optoelectric analog IC products. While this year's order demand has been weak, our sales team has been doing a great job finding new customers and applications which will drive our future growth. We believe our telecom revenues will improve in the near-term, when infrastructure deployments increase and as customers' and sales channel inventory is depleted. New product introductions remain a core aspect of our growth strategy in the telecom market. As an example, over the past few years, we have expanded our portfolio to include high power switch and LNA modules to serve 5G base stations, including macro cell, small cell, and massive MIMO active antenna systems and frequency bands up to 60 gigahertz. We've also developed a product line of high power transmit and receive front-end modules or FEMs that operate in the 5G FR2 microwave frequency bands, which consist of multistage PAs, LNAs, and TR switch and directional couplers. MACOM's RF and microwave IC design expertise is compelling. Our chip designers have the ability to utilize a wide range of GaAs, GaN, SOI, and CMOS processes from both internal and external fabs. As a result, we're able to select the process which achieves leading product performance. While this capability is ideal for 5G radios, our growth strategy is broader than the 5G infrastructure market. Our product line managers use the same technology to target other high-volume applications where we can differentiate. For this reason, we see a large telecom growth opportunity for MACOM in the next few years. Data Center revenue was $26.6 million in Q3, down 31% sequentially. We still see excess inventories impacting customer demand at lower 25G and 100G data rates. However, during the quarter, we were pleased to see customer demand for our 400G and 800G products start to accelerate, and this near-term trend will provide an opportunity for significant quarter-over-quarter growth. We have also seen an uptick in 200G short-reach PAM4 demand to address some new U.S cloud deployments. MACOM has a focused product portfolio for the data center to support high-speed analog connectivity and our products are used in optical transceivers, active optical cables, and active copper cable applications. MACOM has been a leader in supporting the analog linear drive architecture across InfiniBand and Ethernet protocols because we believe linear drive in certain applications can provide lower latency and reduced power consumption compared to DSP-based solutions. We believe our solutions are gaining traction in the market, especially at the higher data rates. As an example, our linear drive products can support new deployments in artificial intelligence, machine learning, and high-performance computing. Hyperscale operators are in the early stages of 400G and 800G deployments today, and these customers are actively looking for ways to reduce complexity, DC power, and cost. We believe we are well-positioned to capture a portion of the market with our analog solutions. I would now like to review a few key events during Q3. First, we continue to focus on developing cutting-edge semiconductor processes. In support of this effort, we were awarded a contract from the United States Air Force Research Labs, or AFRL, to develop advanced semiconductor process technology related to gallium nitride on silicon carbide. The contract will support MACOM's research and development on process technologies used in millimeter-wave MMIC products. We believe this contract underscores MACOM's technical leadership and commitment in high power millimeter wave, GaN on silicon carbide, and it will enable us to strengthen our competitive edge. This is a multiyear contract that has a total value of around $4 million. Our strategy is to provide customers with the industry's best-performing high-frequency GaAs and GaN MMIC products. Future MMIC products from advanced processes represent a large growth opportunity for MACOM over the next 2 to 5 years. Historically, MMICs have been among the most profitable products within our portfolio. Second, we are pleased to announce that during the quarter, we were awarded platinum supplier status by a U.S based Tier 1 defense contractor, and we were named as a global preferred supplier by a leading Japanese test and measurement company. Customer satisfaction is at the center of MACOM's business strategy. These awards are great recognition of our success in servicing these customers. I would like to congratulate the sales teams, application engineering, operations, and all of the other critical members of the MACOM team who helped make these awards possible. Third, we are pleased that during the quarter we formally established the MACOM European Semiconductor Center outside of Paris, France. The center bolsters our European presence and provides a manufacturing platform from which we can build upon to expand and better serve our European customers. The center also brings us an amazing team and a portfolio of high-performance MMIC products. And finally, I would like to note that the integration of Linear Communications Group is on schedule, and our teams have been excited to start collaborating to win new business. Before I turn the discussion over to Jack, I would like to review one more item. In mid-July, the management team updated its long-term strategic plan. As a reminder, in July of 2020, we initiated a long-term new planning process, and this year was our fourth revision of the plan. As you would expect, the strategic plan analyzes our capabilities, the markets in potential areas for SAM expansion, reviews our current technology portfolio, product roadmaps competitive landscape, SWOT analysis, and formulates a roadmap for growing revenue and profitability at a detailed product line level. We believe that in-depth long-term planning is essential for a semiconductor business, and this is a critical element of how we manage the company. We believe our strategy will strengthen and diversify our business and provide MACOM the ability to capture market share. We are excited to scale the business and achieve $1 billion in revenue. Jack will now provide a more detailed review of our financial results.

Jack Kober, CFO

Thank you, Steve, and good morning, everyone. Our results for the third quarter of fiscal 2023 were within our guidance for the period. Revenue for the third quarter was $148.5 million, down 12% quarter-over-quarter. The sequential decrease was driven by weakness in Telecom and Data Center markets with a slight sequential increase in Industrial and Defense. On a geographic basis, sales to domestic customers represented 49% of revenue, flat sequentially. Sales to China-based customers were 16% of revenue, down from 20% in our fiscal second quarter. Despite sales declines in China, we continue to see additional growth opportunities in Asia and Europe. Adjusted gross profit was $89.2 million, or 60.1% of revenue, down 200 basis points sequentially driven by lower absorption of some of our fixed costs with the lower Q3 revenue levels. MACOM utilizes a flexible manufacturing model, leveraging our internal wafer fabs as well as third-party foundries, which we believe will provide financial leverage as business cycles and revenue improve. Total adjusted operating expense was $52.2 million, consisting of R&D expense of $33.2 million, and SG&A expense of $19 million. As expected, our total operating expenses were sequentially up by $3.6 million, mostly due to the incremental expense from our acquisition of Linearizer and the establishment of our European Semiconductor Center in France. Adjusted operating income in fiscal Q3 was $37 million, down from $56.6 million in fiscal Q2. Adjusted operating margin was 24.9% for fiscal Q3, sequentially down from 33.4% in Q2. Going forward, we expect our operating margins to improve as revenue recovers. Depreciation expense for fiscal Q3 was $5.8 million, and adjusted EBITDA was $42.8 million. Trailing 12-month adjusted EBITDA was $233.1 million compared to $250.3 million in Q2 fiscal 2023. Adjusted net interest income for Q3 was $2.8 million, up roughly $700,000 from fiscal Q2 on higher investment portfolio returns, partially offset by higher interest expense on our term loan. Our adjusted non-GAAP income tax rate in fiscal Q3 remained at 3% and resulted in an expense of approximately $1.2 million. Our cash tax payments were $1.2 million, down from $1.4 million in the second quarter of fiscal 2023. We expect our adjusted income tax rate to remain at 3% for the fourth quarter of fiscal year 2023 and through fiscal year 2024. Fiscal Q3 adjusted net income was $38.5 million compared to $56.7 million in fiscal Q2. Adjusted earnings per fully diluted share was $0.54, utilizing a share count of 71.4 million shares, compared to $0.79 of adjusted earnings per share in fiscal Q2. Now moving on to balance sheet and cash flow items. Our Q3 accounts receivable balance was $105.9 million, down from $121.8 million in fiscal Q2, with our days sales outstanding remaining at 65 days. The decrease in our accounts receivable balance is primarily due to the timing of outstanding receivable collections, as well as lower sales in the quarter. Inventories were $139 million at quarter-end, up by $7.1 million sequentially, primarily due to inventory balances acquired through our European Semiconductor Center acquisition, as well as increases expected to support future data center revenues. Inventory turns were 1.7x in Q3, down slightly on a sequential basis from 2.0x in the prior quarter. We recognize that at this stage of the business cycle our inventory balance is at a multiyear high. However, the quality and mix of our inventory is strong and continues to support our strategic backlog. I would like to note that our turns business was the highest since our fiscal second quarter of 2022. Our book-to-bill also improved during the quarter, both of which we believe are positive indicators that will support improving inventory turns as we progress through fiscal 2024. Fiscal Q3 cash flow from operations was approximately $45.8 million, compared to $32.5 million in fiscal Q2. The increase was due in part to increased accounts receivable collections. Capital expenditures totaled $3.3 million for fiscal Q3, down from $6 million in the prior quarter. Our full year 2023 CapEx is now estimated to be $25 million based on the timing of payments, as we balance our capital spending with the growth and profitability of the business. Continued capital investments in our fabs, manufacturing capabilities, as well as process and product development initiatives remain strategic priorities for us. Cash generation continues to be an important priority for us as we manage through changing business cycles. Despite the challenging demand environment in Q3, we generated cash flow from operations of $45.8 million and approximately $117 million year-to-date. Cash, cash equivalents, and short-term investments for the fiscal third quarter were $587.6 million, up from $577.3 million in fiscal Q2 2023. During the third fiscal quarter, we utilized approximately $37 million of available cash to acquire the assets utilized to establish our European Semiconductor Center located in France. Today, our net debt remains less than $50 million, and our gross leverage is approximately 2.6x. Before turning the discussion back to Steve, I would like to note a few additional items. As Steve mentioned, we opened our new MACOM European Semiconductor Centre or MESC at the end of May, and look forward to integrating the differentiated technology and dedicated workforce. We do not expect that ESC will have a meaningful impact on our revenue in 2023, and its associated operating expenses will result in slight EPS dilution. However, we are excited that it brings us new products, technology, manufacturing, and customers. We are also pleased to announce today that we have paid off the $121 million that remained outstanding on our term loan. The term loan did not come due until May 2024. However, with increasing interest rates and our consistent quarterly cash generation, we felt it was appropriate to put this outstanding floating interest rate debt behind us and reduce our net interest expense by approximately $600,000 per quarter. And finally, as Steve mentioned, we completed our 5-year annual strategic planning process during the quarter, which we believe will result in increased stockholder value. I will now turn the discussion back over to Steve.

Steve Daly, President and CEO

Thank you, Jack. MACOM expects revenue in fiscal Q4 ending September 29, 2023, to be in the range of $148 million to $152 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 $0.53 and $0.57, based on 71.5 million fully diluted shares. Sequentially, in Q4, we expect revenue in I&D and Telecom to be down and Data Center up. And finally, as you may have seen in a press release issued yesterday, I am pleased to announce the appointment of Wayne Struble as Senior Vice President, Advanced Semiconductor Technology, a newly created position reporting to me. Wayne will be a key contributor to the development and management of our semiconductor technology roadmap. Wayne has over 40 years of experience in the RF and microwave engineering and has served as a MACOM distinguished fellow of technology since joining MACOM in 2010. I would like to congratulate Wayne on this well-deserved promotion and the entire management team, and I look forward to working more closely with him going forward. I would now like to ask the operator to take any questions.

Operator, Operator

And our first question coming from the line of Tom O’Malley with Barclays. Your line is open.

Tom O’Malley, Analyst

Good morning, guys. And thanks for taking my question. I guess my first question, it's something that you've highlighted since you took over the company, it's just a strategic review process in July. You mentioned the $1 billion again. Can you just give us any update on the timeline there? Could you talk about just the overarching growth drivers that get you to that $1 billion and just the framework that you put together over the last month that's going to guide you from this point over the next couple of years?

Steve Daly, President and CEO

Sure. Good morning, Tom. So the timing of that is in our fiscal '26 or early '27 timeframe, which is about a year to a year and a half behind what we had originally stated a year ago, primarily due to the softness in the market slowing things down this year. When we look at our growth trajectory, we want to achieve at least our 10-year historical CAGR, which is about 14%. When we look at what's going to be driving our growth, it's primarily new product driven, not necessarily acquisition driven. More importantly, when we start to look at the P&L at that $1 billion to $1.3 billion run rate, we see an EPS close to $5. Part of our strategy is to make sure that we are growing profitable revenue that's accretive to the business model. In terms of the specific product lines or segments that we're focused on, it's really the same markets that we've been speaking about over the past few years. Certainly, we believe telecom over the long term will drive growth, followed by Industrial and Defense, and then the Data Center. The framework that I talked about is really some of those details that I spoke of in my prepared remarks. It’s really an external review of market dynamics, looking at our capability to design, and positioning the company in a market where we know we can be successful.

Tom O’Malley, Analyst

Helpful. And then something I guess, more shorter term than the overarching question there. It looks like Data Center was a lot stronger, particularly well into the September quarter. You mentioned specifically higher speed connections at 400G and 800G. Is that the area of the Data Center business that you're seeing accelerate? And could you talk about different areas where you're seeing traction with those deployments? Thank you.

Steve Daly, President and CEO

You're correct that we are predicting strong growth in our fourth quarter for the Data Center business. In fact, we think it will be so strong that we'll have year-over-year growth within the segment. This would represent 5 years in a row where the Data Center end market is growing. We're happy about that. The growth is primarily coming from 400G and 800G short-reach applications. Typically, it's 100G per lane. We have a very strong position with some of our latest products that are ramping quite quickly. We have not seen a general recovery in the lower data rate applications, sort of the standard 4x50G or 8x50G type applications. We see the growth primarily in short reach 100G per lane. Some of these products are supporting linear drive applications. Most, if not all of the business is coming from PAM4 protocol. We do expect good things in the quarter.

Operator, Operator

Thank you. And our next question coming from the line of C.J. Muse with Evercore ISI. Your line is open.

C.J. Muse, Analyst

Yes. Good afternoon. Thank you for taking the question. To follow up on Tom's question about the Data Center, you mentioned year-over-year growth, which indicates approximately $10 million growth sequentially. Can you discuss the trends regarding AI data centers compared to the base case? Is there sufficient spending on high-speed connectivity linked to AI to maintain growth in the Data Center throughout the calendar year?

Steve Daly, President and CEO

Right. Our primary focus for product development within the data center is analog solutions as well as optical photo detectors and lasers. Those are really the three areas that we focus on. Wherever we can find an application, whether it's a pluggable transceiver, CPO, an active optical cable, or even an active electrical copper cable, we want to sell our products into those applications. We have definitely seen an increase in what we consider AI-related deployments and applications. We've seen many examples where customers are excited to perhaps reduce the diameter of a copper cable by electrifying it and running it at a higher data rate over a slightly longer reach than they could have otherwise. That's been a growth area for us. The linear drive, as we've talked about in the past, has many advantages over a DSP solution. We see a bit of a convergence around this type of architecture. This is typically in areas where you have a 100-gig switch and a 100-gig optical. MACOM can insert several products that go into these applications. The key for the customer is that there's no gearbox, lower power consumption, lower latency, and lower cost. The challenge is designing these optical channels with only equalization or an analog solution for signal integrity, which is very difficult. So the design process is complex, and we've been working with major OEMs to support the growth of this part of our business.

C.J. Muse, Analyst

Very helpful. I guess, maybe a broader cyclical question. You talked about book-to-bill almost to 1 versus 0.5 last quarter. Turns normalizing. It looks like backlog is somewhere close to $300 million, still strong. Are you suggesting that we're nearing the bottom for your totality of your business, or might it take a few more quarters for telecom to bottom?

Steve Daly, President and CEO

We try not to call the bottoms because we really don't know. What we can say based on where we are today is that for a year-over-year comparison, two of our three markets will be up, I&D will be up, Data Center will be up, and Telecom will be down somewhere between 20% and 25%. As I highlighted in my comments, the inbound new business has been quite weak this year for Telecom. We do expect at some point that will turn. We see certainly great opportunities in the SATCOM market with the deployment of various satellite platforms, which we believe can provide near-term growth opportunities. But it's very difficult for us to say where the bottom is and what might happen 3 or 6 months from now.

Operator, Operator

Thank you. And our next question coming from the line of Tore Svanberg with Stifel. Your line is open.

Tore Svanberg, Analyst

Yes. Thank you. Good morning, and congrats on the order turnaround here. Steve, you talked about being able to support InfiniBand and Ethernet. You also said that for next quarter, it sounds like most of the growth is going to come from PAM4. Does that mean InfiniBand is kind of further out? If you could just add any color, that'd be great.

Steve Daly, President and CEO

Yes, I would say that more than 50% of our Data Center revenue over the past few quarters has been PAM4 related. I expect that trend to continue as we move into our fiscal '24. Additionally, it's important to note that both InfiniBand and Ethernet are PAM4.

Tore Svanberg, Analyst

Perfect. Thank you. And as a follow-up, you mentioned China revenue at 16%. Is that predominantly down at this point? Or do you still have some base station business there? Just trying to understand regionally where the risks are and so on with that 16% revenue?

Steve Daly, President and CEO

There's been a broad decrease in our China-based business. It's primarily on the optical side and 5G related. That's the area that's the weakest. Areas where we see support would be in some parts of 5G networks we are supporting at a low level. There's no doubt that this year is going to be a down year for our China business. As it starts to come back, it will be primarily due to the recovery from our Data Center and Optical customers.

Operator, Operator

Thank you. And our next question coming from the line of Karl Ackerman with BNP Paribas. Your line is open.

Karl Ackerman, Analyst

Yes, thank you. Good morning. I wanted to follow-up on Data Center for a second. I just wanted to confirm, are you suggesting that Data Center is up year-over-year in the fiscal fourth quarter, or for fiscal 2023 as a whole? And I have a follow-up.

Steve Daly, President and CEO

Sure. From a Data Center point of view, going into Q4, it will certainly be up significantly, as well as year-over-year. I would say very strong double-digit quarter-over-quarter and high-single-digit year-over-year. Our Data Center revenue has shifted quite a bit this fiscal year. The first half strength predominantly came from shipping backlog that was constrained in fiscal '22 due to supply issues. We cleared out a lot of that backlog in the first half. Then in Q3, we hit an air gap with very little demand from what I consider a base business due to inventory issues. Now what we're starting to see is growth and demand for our higher data rate products, for 400G and 800G that is just starting to kick in. So when you add all that up, what you get is growth year-over-year and quarter-over-quarter for the fourth quarter.

Karl Ackerman, Analyst

Yes. Thanks for that. I guess, is there anything to read into your prepared remarks on slowing sales in China? Is the reduction due to general market malaise in 5G infrastructure as you just called it out? Or are you seeing competitive pressures there? Can you just clarify on that, that would be very helpful. Thank you.

Steve Daly, President and CEO

Yes. For our revenues in China, they've been trending down pretty much all year. We started in Q1 about 20% to 23% of our business was China-based, and now it's in the mid-teens. Most of that is due to 5G in front-haul weaknesses as well as mentioned regarding the Data Center. There's always been a competitive dynamic in China, and I would say that dynamic is increasing. There's certainly more focus on supplying locally to the local OEMs. That trend is increasing and some is due to geopolitical reasons. We've not been defocusing our efforts on China, as some of the major telecom suppliers into the optical networks and whatnot are based in China. We'll continue to service the market. We're not pulling back per se. However, we are focused on developing our revenues in other areas, including Europe, and that's one of the main reasons we established facilities and manufacturing inside the EU.

Operator, Operator

Thank you. And our next question coming from the line of Harlan Sur Jr. with J.P. Morgan. Your line is open.

Harlan Sur Jr., Analyst

Yes, good morning, and thanks for taking my question. Good to see the inflection or activity, but it can be quite noisy during this period of macro weakness, but it looks like the dynamics are stabilizing, which is reflected by the decline in orders and push-outs. So quarter-to-date here in September, are bookings continuing to rise sequentially? And what's the turns assumption embedded in your September quarter guide?

Steve Daly, President and CEO

We are very pleased with our 0.9 book-to-bill in the third quarter. I would say we've started the fourth quarter with strong bookings. It’s our expectation that we can be somewhere around the 0.9 to 1 book-to-bill this quarter. A lot of these programs that are coming in are also large program-related, so we have good line of sight. But I think your point about the choppiness is absolutely right. The telecom market is still very weak. We see that many of our major customers are still carrying excessive levels of inventory, including CATV customers. Regarding your question about the turns, I think we're going to have similar turns levels in Q4 as we had in Q3.

Harlan Sur Jr., Analyst

Thank you for that. And then congratulations on the close. It looks like their operations are going to become the hub of your European semiconductor sector. Is MACOM going to transfer some of its origin GaAs and GaN-based MMIC technology to the OMMIC fab including your 0.14 micron GaN technology, and what's the revenue potential out of their current 3 inch manufacturing line?

Steve Daly, President and CEO

Thanks for that comment and question. We've had operations in Europe. We have a large facility in Cork, Ireland, where we have a design center, quality and reliability testing. We have sales and finance supporting a lot of our international business. Cork is certainly today the main hub of MACOM in Europe. We've had a design center in Sofia, France for over 10 years, and they've done a superb job supporting a lot of our high-performance analog product development. Adding a wafer fab and a group that is expert at very high-frequency millimeter-wave process technology complements the portfolio. We do not have plans to transfer any of our technology that we're running here, including the 0.14 micron process to France. Instead, we will continue to build the technologies that they've been working on. We see tremendous growth opportunity. Our sales and business development teams are actively turning the business around, and we see that being a nice growth vector for us over the next 1 to 2 years.

Operator, Operator

Thank you. And our next question coming from the line of Blake Friedman with Bank of America. Your line is open.

Blake Friedman, Analyst

Hi. This is Blake Friedman on for Vivek. Thanks for taking my question. Just want to focus a little bit more on the Q4 guide. I know you gave color around Data center. If you could provide kind of the sequential commentary, maybe for the Industrial and Defense and Telecom business, the magnitude of the declines in each of those areas, that'd be helpful.

Steve Daly, President and CEO

Sure. I'll say a word on that. And then maybe Jack can add to it. As we've talked about, we do expect very strong Data Center growth. We expect I&D will be down in the mid-single digits and Telecom somewhere between 10% and 15% down sequentially. Jack, I don't know whether you want to add to that.

Jack Kober, CFO

Yes. I think I'd just add we've developed a strong backlog over the past couple of years. We've eaten into that a bit over the past couple of quarters. So I think with regard to some of the Q4 guide items that we have, with Industrial and Defense and Telecom being down, that's also coming on the back of lower than 1 to 1 book-to-bill. We need to work through some of those lower order patterns we’ve seen in the past couple of quarters. However, we have a strong backlog that supports the business going into Q4 and beyond.

Blake Friedman, Analyst

Got it. And then just kind of following up on that specifically on the Industrial and Defense side. I know that across the industry several vendors are observing some kind of digestion in the core industrial states. I was hoping you could provide more specifics on trends on the design side, and areas in core industrial markets that could be a little weaker or stronger versus others.

Steve Daly, President and CEO

In general, our industrial business is weak and will remain weak in the near-term. Most of the growth we’re getting in the I&D segment is from defense programs, primarily radar programs, radio communication programs. I think we mentioned on last quarter's calls, some heavy demand for international radios coming out of Europe, that we have content in. So AI — the AI part of I&D today is weak. I talked about in my prepared remarks some of the new applications we are going after within the AI portion. But generally speaking, it's weak. We're not a good bellwether of the industrial end market. It's one of the smaller parts of our portfolio.

Jack Kober, CFO

Blake, this is Jack. I would just add that the inherent business we have going through from a defense perspective can be lumpy at times. The other item to look at our Industrial and Defense in the market is that it's quite diverse. There's a number of different things that work their way into the industrial category, which helps us from a stability standpoint.

Operator, Operator

Thank you. And our next question coming from the line of Matt Ramsay with TD Cowen. Your line is open.

Matt Ramsay, Analyst

Thank you very much, guys. Good morning. Not to go back to the Data Center stuff, but you can't get through a call now without saying AI a few times. So we kind of got to go there. I wanted to ask about your 400 and 800 gig product portfolio, particularly you mentioned the linear drive differentiation versus DSPs. Maybe you could expand on that a little more from a technical perspective, and also how you're thinking about the penetration of linear drive into those data center markets where we are today, where that can go over time, and what it represents as a $1 TAM for your company. Thanks.

Steve Daly, President and CEO

Sure. So I'll try to provide a bit more detail. Where we see linear drive working is when you have a 100 gig electrical lane matching up with a 100 gig optical lane. That's the ideal application. You can run that at 400, you can run that at 800, you can run that at 1.6 terabits as well. By using a linear drive architecture, you're effectively removing the function of the DSP or a CDR from the module and having the switch effectively manage the interface within the module. Those benefits show in latency, cost, and power consumption. You can eliminate the DSP and still remain applicable. We can use this for active optical cables and pluggable cables. There are customers who like that option since they can use many vendors to support their deployments. What it requires is a switch ASIC that now the module manufacturer must work very closely with the switch vendor. We demonstrated at OFC a few months back three different module manufacturers with interoperability with the Tomahawk 5 switch. That's ideal for primarily short reach. MACOM has historically serviced the short reach market where we can thrive. We sell drivers, TIAs, and equalizers into that market. Where we stand right now is that we have production at 100G, and we're quite far along with 200G per lane as well.

Matt Ramsay, Analyst

Thank you for all that detail. I really do appreciate it. As my follow-up, I think it is encouraging to see book-to-bill up to 0.9 and you indicated close to 1 for the September quarter. Could you give a little bit of color if you could on the three segments and how book-to-bill is trending in each of those, or some well ahead of 1 at this point and what those products might be? Are there certain end markets where we're still coming off the 0.5 and working our way back up?

Steve Daly, President and CEO

As in Q3, we will see the same behaviors in Q4. It will be primarily Industrial and Defense and Data Center driving the bookings growth or recovery. We still see tremendous weakness across many of our telecom segments, cable test and measurement, and 5G. Do not expect recovery in the fourth quarter. Many of the products are MMIC products, high-end GaAs and GaN products for military applications. There's a wide range of those supporting the growth within the defense sector. For 2024, the growth drivers from a product set would certainly be GaN. We think 2024 will be a great year for us. We launched the 0.14 micron process six months ago into production. Our teams are in the process of getting their first design wins to turn into production next year. Of course, on the data center side, we'll see more high data rate applications coming to bear, potentially ramping up. In telecom, the only real bright spot is what we're doing in the SATCOM market, both on the ground and satellite side.

Operator, Operator

Thank you. And our next question coming from the line of Harsh Kumar with Piper Sandler. Your line is open.

Harsh Kumar, Analyst

Yes. Hey, Steve and Jack. I had a quick one. Steve, when you talked about your long-term drivers, you mentioned the order of Telecom, Industrial, and then Data Center. As you try to get to your $1 billion goal by FY '26 or early FY '27, is that how you're thinking about growth to that $1 billion number? Or was that just a random order? And if I can flip the question, if that's not the correct order, what is the correct order as we think about?

Steve Daly, President and CEO

Yes, so that is the correct order and that's how we think about it. We're often mistaken in our forecasts, take that with a grain of salt. When we look at our R&D spending and the projects in our pipeline and position the company, we see a lot of variability within telecom that is very attractive. We like the diversity and the long tail of customers we can approach. That plays to our strengths. We spend a fair amount of our R&D developing chips for telecom. The I&D market is another great one for us. Q3 was a record for our I&D segment, and we expect to have year-over-year growth. We’ll have good things happen next year with the new programs we designed into. The smallest piece of our business is Data Center, though I realize we get the most questions about it. We focus on analog solutions for short reach, where we can insert high-performance connectivity chips, lasers, and detectors. That is our strategic focus.

Harsh Kumar, Analyst

For us, we get things wrong all the time too, so I wouldn’t be too hard on yourself. For my follow-up, you're seeing some good pickup in the Data Center space. The trend you're talking about typically doesn't go away in a quarter or two. Is it a fair assumption to think that 400 and 100 will stick around for a few quarters as you look past the next quarter and a little bit more beyond?

Steve Daly, President and CEO

It is possible, and it's very difficult for us to say. In the past, we’ve seen examples where programs ramp up very quickly and then ramp down quickly. So we must be cognizant of that. While we're excited about the great things we're doing within Data Centers, we recognize it can be a very volatile business.

Operator, Operator

Thank you. And our next question coming from the line of David Williams with Benchmark. Your line is open.

David Williams, Analyst

Good morning. Thanks for taking the question. On the magnitude of the inventory depletion you still see needs to happen in the channel. You've mentioned tremendous a few times, so it sounds like there's a fairly heavy level of inventory digestion still needing to happen. What are your thoughts on that?

Steve Daly, President and CEO

Sure. I'll make a comment and then certainly, maybe Jack can add to it. The manufacturing cycle times for many of our products can be in the range of 6 months, maybe longer, depending on the fab and the technology. Just two quarters ago, we had a run rate of $180 million. So when you're looking at our inventory today and relating it to the $180 million run rate, we're carrying excess inventories at today's level, but not necessarily from a couple of quarters ago. We're going through a digestion period where we need to move that inventory out into the market. Part of what we want to do is ensure our channels are not carrying excess inventory. We manage that down; we want to see more depletion. Jack, maybe you can add to that.

Jack Kober, CFO

As we discussed in prepared remarks, we're working closely to monitor what's out in the channel, ensuring we understand where things are going. We've had positive trends over the past quarter that are encouraging. Some of the uptick is associated with some of the acquisitions we brought on board over the past year. We're also purchasing inventory to support our backlog, particularly for the data center backlog we have.

David Williams, Analyst

Great, thanks. And Jack, in the past, you've talked about the flexibility in the model on the extent side. Can you give us thoughts in terms of modeling what's appropriate? If you're restraining growth or development efforts here, just kind of through the softer demand environment?

Jack Kober, CFO

We've been pleased with the gross margin performance of the business despite the slowdown over the past few quarters. We've made a significant number of structural changes to manage improvements we've seen over the last couple of years from a gross margin standpoint. We have a flexible manufacturing model where some products are manufactured in-house and others go to third parties. That mitigates some of the costs we have as a portion of them is variable. Our internal manufacturing fabs are generally medium volume; we don’t carry the same large overheads as some megafabs do. That protects us during periods of slowdown. Looking forward, hopefully as we return to higher run rates, that will support improving gross margins.

Operator, Operator

Thank you. And our next question coming from the line of Quinn Bolton with Needham. Your line is open.

Quinn Bolton, Analyst

Hey, just a quick clarification on 400, 800 gig. Is that almost entirely optical, or are you starting to see copper applications, active copper cables starting to take off in that higher-speed PAM4 business?

Steve Daly, President and CEO

Obviously, both. Some of our chips are four lanes of 100 on a single chip. You can use two of those to achieve 800. The linear drive approach works with various architectures within a module, whether it's silicon photonic-based, DML, EML, and even thin film lithium-based. Any technology the module vendor wants to use, we can support, including indirect nanotechnology. Very flexible technology from MACOM's standpoint.

Quinn Bolton, Analyst

And a follow-up on the linear drive. It sounds like your comments say it's mostly in Ethernet around Tomahawk 5, but InfiniBand seems like it's much more close-channels with effectively one vendor that dominates that market. Where do you think we are in the adoption of linear drive in the InfiniBand market?

Steve Daly, President and CEO

I would agree that we can serve both protocols. We, in fact, demonstrated a solution using an InfiniBand application at OFC. So yes, we are supporting that as well.

Operator, Operator

Thank you. And our next question coming from the line of Richard Shannon with Craig-Hallum. Your line is open.

Richard Shannon, Analyst

Hi, guys. Thanks for taking my questions. Steve, I want to follow-up on the responses to an earlier question on GaN. You mentioned you're expecting a great year in fiscal '24. Could you help us understand those dynamics and maybe even quantify what you see as the opportunity in that year?

Steve Daly, President and CEO

Certainly. We'll define great as we develop the process, and now we're selling it. So we'll start selling that in 2024. We're getting design wins, and we expect to see growth in that fiscal year. We haven't put a fine number on our internal goals, and we haven't shared that externally. It’s premature to do that. However, we view that as a vehicle for growth. We have full support from major OEMs that want to use the technology. We're conducting novel R&D, including next-generation process steps to improve performance beyond our current offerings. We think next year will be a great year for GaN.

Richard Shannon, Analyst

Okay, perfect. Thanks for that detail. My last question for Data Center here. I just want to verify, I think you said, all the upside here you're seeing is on the analog side, or are you seeing any upside coming with lasers? Obviously, you've had great discussions in the last few quarters on your laser portfolio, but it seems like it's all analog oriented. Could you confirm that's what you're seeing?

Steve Daly, President and CEO

It’s true; the growth is coming from the analog side. I characterize our fiscal '23 as a building year for our optical products with many design ends and lower revenue than we expected. That’s been disappointing. However, the team is making progress winning those design wins at accounts here in the U.S., and in China. We're also working on new laser categories, including EMLs and arrays that are receiving a lot of interest. To your point, yes, the growth for this quarter in Data Center is driven by analog solutions.

Operator, Operator

Thank you. And I'm not showing any further questions in the queue at this time. I would now like to turn the call back over to Mr. Steve Daly for any closing remarks.

Steve Daly, President and CEO

Thank you. In closing, I would like to thank our team for their continued hard work and dedication. Have a nice day.

Operator, Operator

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