CRDO - NASDAQ

Ladies and gentlemen, thank you for standing by. [Operator Instructions] I would now like to turn the conference over to Mr. Dan O'Neil. Please go ahead, sir.

Good afternoon, everyone. Thank you for joining our earnings call for the third quarter of fiscal 2026. Today, I'm joined by Bill Brennan, Credo's Chief Executive Officer; and Dan Fleming, our Chief Financial Officer. During this call, we will make certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties discussed in detail in our documents filed with the SEC, which can be found in the Investor Relations portion of the company's website. It is not possible for the company's management to correct all risks nor can the company assess the impact of all factors on its business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks, uncertainties and assumptions, the forward-looking events discussed during this call may not occur, and actual results could differ adversely and materially from those anticipated, implied or inferred. The company undertakes no obligation to publicly update forward-looking statements for any reason after the date of this call to conform these statements to actual results order changes in the company's expectations except as required by law. Also, during this call, we will refer to certain non-GAAP financial measures, which we consider to be important measures of the company's performance. These non-GAAP financial measures are provided in addition to and not as a substitute for or superior to financial performance prepared in accordance with U.S. GAAP. A discussion of why we use non-GAAP financial measures and reconciliations between our GAAP and non-GAAP financial measures is available in the earnings release we issued today, which can be accessed using the Investor Relations portion of our website. I will now turn the call over to our CEO. Bill?

Thanks, Dan, and thank you all for joining our third quarter fiscal '26 earnings call. I'll start by walking through our Q3 results, give an update on our business and share our view on our long-term opportunities. After my remarks, Dan Fleming, our Chief Financial Officer, will provide a detailed financial review of the third quarter and our guidance for the fourth quarter. We will then open the call for questions. In the third quarter, we delivered record revenue of $407 million, a sequential increase of 52% and more than 200% from Q3 last year. We delivered non-GAAP gross margin of 68.6% and generated approximately $209 million of non-GAAP net income. Over the past 18 to 24 months, maximizing network reliability and energy efficiency have been our core mandates as we built our road map and brought new products to market. In AI infrastructure, performance without reliability stalls clusters and scale without efficiency, strains both economics and power envelopes. The strategy is clear, accelerate cluster bring up, maximize XPU utilization and reduce total cost of ownership, all while providing our customers the highest reliability in the industry. Our recent performance reflects the most accelerated growth phase in Credo's history. From fiscal '24 to fiscal '25, we more than doubled revenue. And for fiscal '25 to current year fiscal '26, we expect to triple revenue on top of that. That represents greater than 6x growth in just 2 years. Few companies, particularly in semiconductors have scaled at that pace while maintaining consistent execution, healthy margins and product leadership. Our purpose-built SerDes MICs vertically integrated system model and deep hyperscaler partnerships win at scale. We established leadership in high reliability copper connectivity and built strong position in optical DSPs and retimers. Now our strategy is to lead in reliability, power efficiency and signal integrity across the full spectrum of AI and data center connectivity from die-to-die links to chip-to-chip and board-level links to rack and [indiscernible] scale copper to mid-reach optical and to resilient facility-wide optical solutions. By extending both inward towards the silicon and outward across the data center, we're positioning Credo to encompass the entire connectivity fabric of AI infrastructure. Each layer of connectivity is being fundamentally reshaped by demand for higher bandwidth and faster data rates. AI workloads continue to grow in parameter size, model complexity and cluster scale, driving sustained transitions from 100 gig to 200 gig per lane and the 400 gig per lane in the upcoming years. At the same time, architectures are becoming more complex, power envelopes are tightening and reliability requirements are rising. We believe the industry's persistent push towards higher speed and larger clusters continues to expand our long-term opportunity and our ability to win. I'll now discuss our business in more detail. Our AEC product line once again delivered strong growth, driven by existing customers and new wins, including our fifth hyperscaler. Demand is accelerating across both hyperscalers and emerging Neocloud providers. We continue to believe the industry is early in its AEC adoption. As AI clusters scale, reliability and power efficiency have become the primary design constraints. AECs are now the de facto standard for intra-rack and rack-to-rack connectivity up to 7 meters, increasingly displacing laser-based optical modules. Their reliability and power advantages are driving broad adoption. Our

Thank you, Bill, and good afternoon. I will first review our Q3 results and then discuss our outlook for Q4 of fiscal year '26. In Q3, we reported revenue of $407 million, up 52% sequentially and more than tripling year-over-year and at the high end of our revised guidance range. Notably, our revenue again grew healthy double digits sequentially and RECONNECT to achieve new record revenue levels once again a substantial year-over-year growth across 4 domestic hyperscale customers. Our top 3 end customers were each greater than 10% of revenue in Q3. As a reminder, customer mix will vary from quarter-to-quarter. We continue to expect that 3 to 4 customers will be greater than 10% of revenue in the coming quarters and fiscal year. And we continue to make progress in diversifying our customer base across hyperscalers, Neoclouds and other customers. Note that with product revenue representing the vast majority of total revenue, we will no longer break out product and IP as separate line items in our income statement. Our team delivered Q3 non-GAAP gross margin of 68.6%, above the high end of our guidance range and up 92 basis points sequentially. Total non-GAAP operating expenses in the third quarter were $77.4 million, above the high end of our guidance range due to our strong R&D investment and up 35% sequentially. Our non-GAAP operating income was $201.8 million in Q3 compared to non-GAAP operating income of $124.1 million in Q2, up demonstrably due to the leverage attained by achieving more than 50% sequential top line growth, while OpEx growth was in the mid-30s. Our non-GAAP operating margin was 49.6% in the quarter compared to a non-GAAP operating margin of 46.3% in the prior quarter, a sequential increase of 327 basis points. Our bottom line once again demonstrated the substantial leverage we are delivering in the business. Our non-GAAP net income was $208.8 million in the quarter, a record high and a 63% sequential increase compared to non-GAAP net income of $127.8 million in Q2. Our Q3 non-GAAP net income quadrupled from Q3 of last year, which clearly demonstrates the magnitude of our top line growth, strong gross margins and our disciplined approach to scaling operating expenses. Our non-GAAP net margin was 51.3% in the quarter. Cash flow from operations in the third quarter was a record $166.2 million, up $104.6 million sequentially. CapEx was $26.5 million in the quarter, driven largely by purchases of production mask sets. And free cash flow was $139.7 million, up more than $100 million from the second quarter. We ended the quarter with cash and equivalents of $1.3 billion, an increase of $487.9 million from the second quarter, driven by the proceeds of our ATM offering, which began in October and ended in December and our strong free cash flow. We remain well capitalized to continue investing in our growth opportunities while maintaining a substantial cash buffer. Our Q3 ending inventory was $208 million, up $57.8 million sequentially. Now turning to our guidance. We currently expect revenue in Q4 of fiscal '26 to be between $425 million and $435 million. We expect Q4 non-GAAP gross margin to be within a range of 64% to 66%. We expect Q4 non-GAAP operating expenses to be between $76 million and $80 million, and we expect Q4 diluted weighted average share count to be approximately 197 million shares. These expectations are based on the current tariff regime, which remains fluid. As we look ahead to fiscal '27, we expect sequential revenue growth in the mid-single digits, leading to more than 50% year-over-year growth. And with that, I will open it up for questions.

[Operator Instructions] Our first question comes from Tom O'Malley, Barclays.

Bill, you mentioned that you saw a

Yes. I think the -- comparing the customer activity with AECs, I think it's a good way to look at it. Now I understand that we've been in development on

Your next question comes from Tore Svanberg from Stifel.

Congratulations on the record results. Bill, maybe you could just level set us a little bit here. You mentioned we're still in very early stages of AECs. Obviously, there's a lot of excitement around CPO. So maybe you could just help us on what's driving some of the use cases for AECs right now. How should we think about those developing, especially in fiscal '27 and fiscal '28?

Yes. So I think the narrative on AECs is very similar to what has been played out up to this point. There are several areas within the data center network, where AECs make a really compelling solution and really almost becoming de facto in an intra-rack as well as now more than ever, we're seeing rack-to-rack solutions that are within the reach of 7 meters. What's driving it is it's network reliability and power efficiency. And so I would only say one of our customers were really fully penetrated on all the swim lanes and those being GPU to host connections in the scale-out network, front-end connections within those same racks and then this aggregate in switch rack. Those are really the swim lanes that we've talked about. And so we see there's really great growth opportunity, not only for 100-gig per lane deployments as we see those increasing, but also as we see a shift to 200 gig per lane, it's even a stronger value proposition at those speeds. And so that's going to help us drive more volume as well as there's an uplift in ASPs. And so you mentioned the narrative on CPO. And look, this narrative has been one that's existed in different forms for the last decade, started with MBOM, mid-board, optical modules that have moved on to onboard optics, it's moved on to many different acronyms over time. And the bottom line is, just recently, I think there's been a bit of a signal-to-noise ratio issue in the market. And the noise right now is dominating the signal. So it's not an either/or type of situation. It's about deploying the right technology at the right reach and the right power head below. And we see the industry is evolving even more so to a heterogeneous mix of short-reach copper, pluggable optics, near package optics and eventually CPO. And so the strong interest we've seen in

Joseph Cardoso from JPMorgan has the next question.

Congrats on the results. Maybe just wanted to get an update on how you're thinking about the composition of the 50%-plus growth heading into next year, as we think about the AEC opportunity continuing to ramp, but also confluencing with the material ramps of other areas of the portfolio like the PCIe solutions, optical products, et cetera. Can this be a year where we start to see a more material contribution from the non-AEC offerings in the portfolio and where they can drive a more material portion of the mix as early as fiscal '27? Or is the expectation really that's more of a fiscal '28 story and beyond?

I think that it's fair to say that we'll see a different composition between copper and optical in fiscal '27, specifically as

Your next question comes from Vivek Arya from Bank of America.

Just a clarification to Dan first on what drove the upside? Almost $60 million plus upside was there a one-off or anything else right in your projects in the reported quarter? And then, Bill, I wanted to get back to this question of how complementary versus competitive is AEC versus optical solutions because over the last 3 months, we have seen this massive divergence in the performance of stocks of your optical peers and this morning, we saw NVIDIA invest in 2 of your optical peers. So why isn't that a very important right incredible pushback that the market for AEC might be limited? So I just wanted to get your views on where copper versus optical is competitive and where they are more complementary?

Vivek, so let me address your first question regarding what drove that strength. And I'll answer a question that wasn't asked as part of my answer. If you look at our top customers for the quarter, we've just continued to see strength across all of our hyperscale customers. In fact, our top 3 customers all grew sequentially from Q2 to Q3. So that really drove that growth. And our largest 3 customers in Q3 were also our largest in Q2, as you would expect but in a different order. Let me just talk briefly about our largest customer. They were 39% of revenue, and they were also the same customer that was our largest customer in Q1. So that was quite a large increase quarter-to-quarter for them. The second largest customer was 32% and they were our largest customer last quarter. And then finally, our third 10% customer was 17% of revenue, and that was the first hyperscaler that we had to ramp.

And related to the question about the AECs versus optical or actually how they complement each other. Really nothing has changed in the narrative. I think you mentioned NVIDIA, I think they've been really outspoken that where you can use copper, you will use copper. And so it's -- the reason is very basic why somebody would choose an AEC over, say, a laser-based optical module. And that's really reliability, number one. Power efficiency, number two. And ultimately, total cost of ownership, number three, that equation is not going to change. As we go towards 200 gig per lane 1.6T deployments, there is an effect that as you go faster, the length of connection is going to decrease slightly, we believe, from 7 meters to 5 meters. And so if you look at our investments over the last couple of years, it's been heavily weighted towards optical as we've talked about. There is a tremendous demand in the optical space. And that's in addition to the demand in the AEC space as well. Our approach is fundamentally different, and we think suits us well, which is to focus on delivering bullet-proof reliability, again, by going up the stack with real-time continuous telemetry on each link to be able to identify links that are degrading in single integrity and being able to mitigate by taking those links down in a proactive manner, in an orderly manner. I'll also say that the work that we're doing on active LED cables, ALC -- we're talking about delivering a different class of optical product, one that is at a base technology level as reliable as copper. You get the same reliability profile, the same energy efficiency profile, the same cost profile. But you get reach initially up to 10 meters, and then next step will be 30 meters. And so that's going to be a really unique new product category as we talk about the heterogeneous world between copper and different forms of optical.

The next question comes from Quinn Bolton, Needham & Company.

I guess given all the noise in the market around CPO and optical, I was wondering if you could kind of just discuss some further detailed two products: One, your Blue Heron DSP for scale up AEC connections, are you seeing interest in that? And then sort of a similar question on -- Bill, I think in the prepared comments you talked about in OmniConnect gearbox with an ALC-CPO solution somewhere down the road. Can you give us any sense on timing when you would have a ALC-CPO solution potentially coming to market?

Sure. So I want to note, first of all, that the bulk of our revenue from AI is really in scale out now. We don't have any revenue for scale up. And in fact, that market is relatively small in comparison today. There's great promise that the scale-up market is growth, especially if it goes from rack scale to [indiscernible] scale, and that's driving a lot of these conversations. The Blue Heron product that we introduced -- announced our first customer, upscale AI. This is a 200 gig per lane retire that supports UALink, ESUN, Ethernet. We will build AECs with this product as well. And so as that scale-out opportunity takes shape, we're going to have a full portfolio of products that we can offer. As it relates to my comments about OmniConnect, yes, it is a very straightforward path to basically extend the OmniConnect architecture to add a gearbox that converts from VSR to micro LED. And so the work we're doing with ALC, that's going to be the proof point. And ultimately, there's going to be a direct line of sight on doing a gearbox that takes that VSR conversion to, say, a pigtail that you can connect micro LED with. And so that is going to give a relatively straightforward lower-risk path to a near package optics solution. And again, that solution is going to be delivered with bulletproof reliability and it's going to be done at a power that's much less than laser-based CPO.

The next question is from Sean O'Loughlin, TD Cowen.

I will add my congrats on a really incredible set of results. I had a quick clarification. I think last quarter, you mentioned that you expected the fourth hyperscale customer to represent greater than 10% of revenues for the full fiscal '26. Obviously, you mentioned 3% to 10% customers this quarter. Is that still your expectation for the full fiscal year? And then on the OpEx guide, I was a little bit surprised to see that it was almost flat quarter-over-quarter, obviously after a pretty big step up last quarter. But with all the irons in the fire, including the acquisition this morning. Is there just some constraints around I don't know whether it's hiring qualified mixed-signal engineers? Or is there something else going on in OpEx? Or am I just overthinking all of this and you're just executing to your road map?

Yes. So let me address the first question first. With regard to our fourth hyperscaler that we talked about, we made those comments last quarter, we've obviously experienced a lot of upside really driven by our largest customer this quarter in the current time frame. So that may make the math, while they're still in line with our expectations from 90 days ago, they may not be a 10% customer for the full quarter, if that makes sense or for the full year. With regard to OpEx, a couple of dynamics there to note. One is there was a large step up this quarter for R&D spend. And one thing to note is that it was off a relatively light spend in Q2. And in addition, I highlighted two things: project-related spend and hiring. The project-related spend was higher than has been typical related to a lot of these things that we're working on. So if that were to come down, you might have some incremental hiring to -- they just happen to kind of offset for the year or for the quarter. So that's kind of the underlying dynamics in our Q3 to Q4 R&D spend if that helps you out.

Vijay Rakesh from Mizuho is up next.

Just a question on the 1.6T ramp. I think as you go to 1.6T, most of the big hyperscalers still seem -- have not talked much about CPO. So is your assumption that as 1.6T ramps into calendar '27, '28 that it will be predominantly copper? And as you mentioned, the ASP bump that should drive a pretty nice upside there between the adoption of copper and ASP?

Yes. For the 200-gig lane per market, we very much see that, that market is going to be addressed by AECs. And then a combination of laser-based models, we'll have the ALCs that ramp into that market as well. But that would be what I would consider the new product category. I think CPO is still sometime in the future beyond that. We see our customers ramping 200-gig programs really at very different schedules. Of course, NVIDIA is going to lead the charge with Vera Rubin, but many other customers will follow on a slower time line. So we do expect to see very strong business in all 3 categories that I just mentioned. So we'll have

Your next question is from Quinn Bolton, Needham & Company.

The follow-up, I just wanted to ask you guys announced the Chimera acquisition this morning. It looks like that's kind of more layer 2 stuff, right, Mac, TCS, Mastek security, are you buying that just to kind of enhance the IC product that you've done historically? Or is this a move to try to get into more Layer 2 solutions down the road?

Yes, I appreciate the question. We didn't have a chance to get it in the prepared remarks, given the fact that it's closed basically right at the same time. But we feel great about the combination of bringing Chimera into Credo. We've been collaborating with Chimera as an IP partner since 2022. And Chimera has a really strong reputation in protocol IP, error correction as well as security IP technologies. So we view this as a strengthening of our ability to deliver complete system level connectivity solutions. And you alluded to maybe going up, yes, absolutely, that's part of the opportunity. And so we're -- we feel great strategically about this and the fact that they'll be dedicated to Credo projects now, it will accelerate our end-to-end connectivity road map and expanding the overall platform.

The next question is from Sebastien Naji from William Blair.

There's been a lot of focus lately on supply chain constraints, including the high cost of memory. I guess what type of supply chain risks are you seeing for Credo, if any? And is there anything in the supply chain that can emerge as maybe a gating factor to your growth in some of the coming quarters?

Yes. So I think we got a little bit out in front on this topic last quarter. I feel great about our supply chain for Credo, and that includes wafers in all of the different product categories that we've talked about. And that encompasses 12-nanometer, 7, 5 and 3. So we did a lot of work over the last quarter to make sure that we are aligned with our supply chain partners, not only on the wafer level but also the packaging level. So I think it's clear that we're going to be able to support our plan as well as upside that we expect. In the market, we are absolutely in kind of uncharted territory where I think supply chain is going to become more and more of a differentiator. And as it relates to the supply chain issues that are outside of our normal IC builds, I would say, from a system level, there's no issues from a supply chain standpoint there. I will say at an industry-wide level, memory, as all of a sudden, been a concern. And if anything, we can look at the first OmniConnect product Weaver as almost a solution to some of the pain points where we enable the use of DDR over HBM, which I think is probably the tightest area within the memory market right now. Outside of that, there's been a lot of conversation about lasers. But from a

The next question today comes from Jim Schneider, Goldman Sachs.

Bill, it was helpful to hear sort of the -- you lay out the progression of your various product lines, especially the optical products over the next couple of years. I was wondering if you could maybe just give us a sense of how we should be modeling the strength of those optical products, a sense of where we might end fiscal '27 in terms of their contribution, are these something that could be kind of sort of 15% to 20% of total revenues of the company at an exit rate? Or should we be modeling something a lot less than that?

Yes, we haven't been too specific in that. But if you just look at where we are this year based on how we've guided Q4, we're just -- you'll end up just north of $1.3 billion. The 50% growth gets you to nearly $2 billion for next year. Bill did kind of mention that we expect AEC to continue to grow fiscal '26 to fiscal '27. So there will be a significant -- we think it will be a material component of our fiscal '27 for specifically

Your next question is from Suji Desilva, ROTH Capital.

Congrats on the progress here. Just quickly, how many customers do you expect to be ramping

Sure. Sure. Absolutely. You got to be confused with the second question. What was the first again?

My expectation is throughout fiscal '27, we're a bit early talking about fiscal '27. But my strong expectation is that we'll run more than 4. We've got 4 in now. And so I expect to add to that list. And I should reiterate that it's a combination of hyperscalers as well as Neoclouds. And the second part of your question was on OmniConnect. And so if you can imagine, the key enabler for OmniConnect is really our VSR SerDes that sits on the XPU side of the connection. And gearboxes are put together that mirror that VSR SerDes and then gearbox it to something else. And so I think it's pretty clear for memory that a first DDR gearbox would be for 5. And you can imagine as the market shifts to LPDDR 6, that all you have to do, you wouldn't have to retake out an XPU. You could just simply change the gearbox. And then you have that inference capability with that next-generation memory. And so you can also imagine, say, building a scale-up gearbox. And at first -- the first gearbox might be a Gen7 and Gen6 combo to where that XPU has got that same VSR SerDes and the gearbox would take those 100 gig lanes and Gearbox to either Gen7 or Gen6 PCIe. You can imagine when 200 gig per lane is really ready for that given customer you could just simply drop in a new gearbox that would support 200 gig per lane with any of the protocols we've talked about being Ethernet or UAL or ESUN. And you can extend that case to scale out as well. You could have a gearbox that would, say, improve, say, the first one that might be 200 gig per lane. As soon as 400-gig per lane was ready, you could simply drop in a new gearbox, that would gearbox lanes of 100 up to 400 gig per lane. So you're talking about having the ability to build an XPU that becomes composable based on different markets and it becomes composable based on the future enabled aspect of just being able to upgrade the gearbox to either the next speed or different protocol.

The next question comes from Christopher Rolland, Susquehanna.

I guess the first one is probably to you, Bill. Just about AEC applications and kind of where this may be moving around, if you could talk about where you think you're being used in terms of front end versus scale out, scale up or like traditional cloud where you're being used today? And what this looks like over the next couple of years in terms of changes?

Yes. So I'd say the part of the network that's probably where we're strongest is on scale-out. And so this is where we really see the full benefit of AECs, as we're talking about leading edge speeds, and we're talking about in the part of the network where reliability really means faster time to cluster stability as well as continuous uptime. And so we do very, very well scale out. Front end kind of comes along with it. And then we're also seeing a couple of customers now that are deploying in switch racks or disaggregated chassis. So it's really across the board, but I would say our real strength is in scale-out.

Next up is Karl Ackerman, BNP Paribas.

Bill, perhaps a follow-on to that question earlier. You indicated much of your AI revenue for AC products is for scale-out networks, how should we think about the $5 billion TAM for AECs split between front-end versus back-end links between the server NIC networking switches? And Dan, could you speak to why gross margins are guided down roughly 360 basis points at midpoint of your outlook? Is it just conservatism? Is it near-term product mix? Anything around that would be helpful.

Yes. Let me address the gross margin question first. So overall, as you mentioned in Q3, gross margin at 68.6%, up 92 basis points sequentially. We've really, over the last, say, 7 to 8 quarters, really seeing a significant benefit to increasing scale. But we've also been very persistent in saying that the gross margin expansion will always be linear as we continue to increase scale. There will always be differences from quarter-to-quarter in product mix and we are conservative in the way we forecast. We believe that we have not changed our long-term expectation in the 63% to 65% range for gross margin. And we've clearly entered this phase where we're at or above that high end of that long-term expectation. So it's really just a function of how we view the world and how we forecast our gross margin, and it's a very conservative forecast.

Right. On the -- you asked about the AEC TAM and the $5 billion number. So we're not the group that really focuses too much on the top-down forecast. We leave that to the market forecasters. And -- but I can give you my perspective on the market opportunity. And I think largely, the market opportunity that we see is scale-out networks, I think that will transition into some share of the scale up networks as they become deployed. And then, of course, front end is going to be smaller than scale out probably on the order of -- it will probably be 20% to 25% of the total scale-out market as we see it. And then this aggregate and switch market, that one is yet to be seen, but that could be a significant TAM if we see that kind of architecture deployed broadly, which there's a good case to be made for.

Tore Svanberg from Stifel.

I just had a follow-up. So this pull in of the optics business, Bill, I mean is that just mainly because of certain technical milestones that [indiscernible] or are there market dynamics? And the reason I'm asking the question because obviously, there's concerns about the availability of commodity lasers. So just trying to understand exactly what's driving that pull in by a few quarters?

Well, the pull-in is being driven by customers pulling it. I mean, this is a real indicator that as we've said many times regarding AECs, that reliability is really critical, again, from the standpoint of the time to bring up a cluster and the uptime that you can expect after that point of stability. And so it's a direct improvement in productivity. And so as AECs have been much more popular as a result of people getting it, right? The minute that we talked to our customers about

And everyone, there are no further questions at this time. Mr. Brennan, I'll hand the call back to you for any additional or closing remarks.

Yes. Thank you. I really appreciate the ongoing interest and support in Credo. We'll talk to you all very soon. So again, thank you very much.