Good afternoon and welcome to M/A-COM Technology Solutions' Fiscal Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of today's conference call, instructions will be given for the question-and-answer session.

As a reminder, this call is being recorded today, Tuesday, April 26, 2016. I will now turn the call to Leanne Sievers of Shelton Group, the Investor Relations agency for M/A-COM. Leanne, please go ahead..

Good afternoon and welcome to M/A-COM Technology Solutions' second quarter 2016 earnings conference call. I'm Leanne Sievers, Executive Vice President of Shelton Group, M/A-COM's Investor Relations firm. With us today are M/A-COM's President and Chief Executive Officer, John Croteau; and Senior Vice President and Chief Financial Officer, Bob McMullan.

If you've not yet received a copy of the press release, you can obtain a copy on M/A-COM's website at www.macom.com under the Investor Relations section. Before I turn the call over to Mr.

Croteau, I'd like to remind our listeners that management's prepared remarks and answers to your questions contain forward-looking statements, which are subject to risks and uncertainties.

Because actual results may differ materially from those discussed today, M/A-COM claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and refers you to a more detailed discussion of risks and uncertainties that could result in those differences in M/A-COM's filings with the Securities and Exchange Commission, including its current report on Form 8-K filed today and Annual Report on Form 10-K filed on November 24, 2015 and quarterly report on Form 10-Q filed on January 27, 2016.

Any forward looking statements represent management's views only as of today, April 26, 2016, and M/A-COM assumes no obligation to update these statements in the future.

The company's press release and management's statements during this conference call will include discussions of certain non-GAAP measures and financial information, including all income statement amounts and percentages other than revenue referred to on today's call unless otherwise noted.

These financial measures and the reconciliation of GAAP to non-GAAP results are provided in the company's press release and related current report on Form 8K, which was filed with the SEC today and can be found at the Investor Relations section of M/A-COM's website.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 30 days in the Investor Relations section of M/A-COM's website. And now, I'll turn the call over to M/A-COM's President and CEO, John Croteau. John, please go ahead..

Thank you, Leanne. Welcome everyone and thanks for joining us today. I will begin today's call with an overview of our second quarter results for fiscal 2016, and then turn the call over to Bob McMullan, our CFO, who will review our financial performance in further detail.

I'll then conclude today's prepared comments by providing a summary of our execution during the quarter, followed by guidance for the fiscal third quarter of 2016. Straight to the results.

I'm pleased to report that for our fiscal second quarter of 2016, revenue was $133.6 million, exceeding the top end of our guidance with gross margin coming in at 58.1%. Net income was $25.7 million with earnings per diluted share beating the top end of our guidance at $0.46 per share.

Networks was up strong sequentially, with continued growth across all optical markets spanning PON, long haul metro and datacenter applications. Our catalog business performed as expected with A&D flat and multi-market up sequentially.

All in all, strong demand across our end markets enabled us to beat the top end of our guidance on revenue and EPS, another quarter of solid execution by the team. Now let me turn it over to Bob to review our fiscal second quarter financials in more detail..

Thank you, John, and good afternoon, everyone. During the course of my comments as well as those made by John, all income statement amounts and percentages will be discussed on an adjusted non-GAAP basis, and are provided to enhance the understanding of our core operating performance.

A reconciliation of each amount to the most comparable GAAP measure is included in today's earnings press release.

Revenue was $133.6 million during the second quarter, representing a sequential increase of 15.4% compared to revenues of $115.8 million in the prior quarter and an increase of 30.4% compared to $102.4 million in the fiscal second quarter of 2015. Revenue by end markets.

Networks $96.3 million and 72.1% of total revenue; multi-market $19.2 million and 14.4%; and A&D $18.1 million and 13.5%. Networks' revenue contribution was up 0.5 percentage point compared to fiscal first quarter's contribution.

Gross profit in the fiscal second quarter was $77.6 million or 58.1% of revenue compared to $68 million or 58.7% of revenues in the prior quarter, $59 million or 57.6% in the fiscal second quarter of 2015. Gross margin was essentially flat sequentially.

Short-term contribution from lower gross margin products from fabs we are in the process of consolidating into our Lowell facility are reducing gross margin from our target operating model of 60%.

In terms of operating expenses for the second fiscal quarter, total operating expenses were $45.2 million compared to $40.3 million in the prior quarter and $35.3 million in the prior year's quarter. Operating expenses were up for full quarter expenses from our recent acquisition and higher variable compensation expense.

Research and development expense for the fiscal second quarter was $23.1 million. This compares to R&D expense of $21.5 million in the prior quarter and $18.2 million in the fiscal second quarter of 2015.

R&D as a percent of revenue represented 17.3% in the fiscal second quarter compared to 18.6% in the previous quarter and 17.7% in the prior year's quarter. Selling, general and administrative expenses for the fiscal second quarter was $22.1 million.

This compared to SG&A expense of $18.8 million in the prior quarter and $17.1 million in the prior year's quarter. SG&A as a percentage of revenue represented 16.5% in the fiscal second quarter compared to 16.2% in the previous quarter and 16.7% in the prior year's quarter. Income from operation was $32.4 million or 24.3% of revenue.

This compares to $27.7 million or 23.9% of revenue in the prior quarter, $23.7 million or 23.2% of revenues in the prior year's quarter. Operating margin increased 40 basis points, realizing greater operating leverage.

Interest expense of $4.1 million in the second quarter was flat compared to the prior fiscal quarter and down from $4.3 million in the prior year's quarter. The year-over-year decrease was due to lower outstanding debt.

Other income of $1.9 million represents revenue from a consulting contract from our automotive divestment that continues through fiscal 2017. Turning to income taxes, our effective income tax rate for the fiscal second quarter was 15%, which is also our normalized rate for fiscal 2016.

This tax rate was consistent with the prior fiscal quarter and down from 18% in the fiscal second quarter of 2015. We paid cash taxes of $100,000 in the second fiscal quarter.

Our fiscal second quarter net income was $25.7 million or $0.46 per diluted share compared to fiscal first quarter net income of $21.8 million or $0.40 per diluted share and net income of $16.5 million or $0.31 per diluted share in the prior year's quarter.

EPS grew sequentially 15% and 48.4% over the same quarter in the prior year as we continued to leverage operating expense leading to net income expansion.

The share count used to compute fully diluted EPS was 55.4 million shares for the second fiscal quarter, 55 million shares in the fiscal first quarter of 2016 and 52.5 million shares in the fiscal second quarter of 2015.

EBITDA, or earnings before interest, taxes, depreciation and amortization, was $39 million, up from $33.5 million in the prior fiscal quarter and up from $27.4 million in the prior year's quarter.

GAAP cash flow from operations was $19.5 million in the fiscal second quarter as compared to $15.5 million in the fiscal first quarter or 75.9% and 71.1%, respectively, of non-GAAP net income.

After deducting capital expenditures in each fiscal quarter, free cash flow was $8.4 million and $8.8 million, respectively, or 32.7% and 40.4%, respectively, of non-GAAP net income. Turning to the balance sheet.

At fiscal quarter's end, our cash, cash equivalents and short-term investments were approximately $81.8 million, up $4.2 million over the prior fiscal quarter. Accounts receivable of $91.6 million compared to $84 million at the end of the prior quarter. Day sales outstanding were 62 days compared to 63 days.

Inventory was $107 million compared to $101 million in the prior quarter. Inventory turns were 2.1 times compared to 1.9 times in the prior fiscal quarter.

We are building inventory in line with our future revenue expectations and specifically to allow for buffer stock for customers affected by the closing and consolidation of fabs into our Lowell facility. Long term debt was $341.4 million inclusive of acquired capital leases and we had $130 million of availability in an undrawn credit line.

Capital expenditures in the fiscal second quarter were $11.1 million or 8% of revenues compared to $6.7 million or 5.4% of revenue in the fiscal first quarter.

Capital expenditures are necessary as we continue to grow our engineering resources and design centers globally for emerging initiatives such as base stations, silicon photonics, 5G, high speed lasers, also expanding our process technologies such as GaN on silicon, silicon germanium and indium phosphide and from multiple customer support locations, as well as our manufacturing, test and packaging capabilities to expand capacity, reduce process times and meet customer expectations.

Related depreciation expense for the fiscal second quarter was approximately $4.8 million as compared to $3.9 million in the prior quarter, and $3.7 million in the prior year's quarter. Our investments in capital expenditures exceed our current level of depreciation expense.

This reduces the percentage of free cash flow as compared to non-GAAP net income. Specifically, fiscal year-to-date we generated positive free cash flow of $17.2 million after capital expenditures of $17.8 million. Back to you, John..

Thanks, Bob. I'd like to start by providing some color on optical. We had another quarter of strong sequential growth in optical, fueled by modulator drivers for long haul-Metro and lasers for access and backhaul applications.

Last quarter long haul and Metro growth was driven by several major customers servicing the (12:39-12:43) demand for our CFP2 ACO drivers continues to grow with very strong backlog that will drive growth through the second half of 2016.

Our laser capacity continues to ramp in Lowell and we saw double-digit sequential growth in PON and exceptionally strong growth in backhaul. Our share continues to expand unabated. In datacenter, we saw initial revenue and strong backlog for our high performance analog products to support demand at Facebook and Amazon.

We also began volume production ramp of 25 gig lasers in support of 100G and datacenters. The strong results we achieved this quarter were further underscored at OFC last month.

Coming out of the show, it's clear from the level of interest and deep customer engagement that M/A-COM has established a truly preeminent position in the optical space across a diverse set of products, technologies, applications and market segments. Now, let me share some of the learnings from OFC.

Word at the show was very bullish on long haul-Metro as deployments expand at 100G this year and quickly move onto 200G and 400G. M/A-COM was the only company at OFC who was shipping in production six different flavors of modulator drivers to cover the various classes of CFP2 ACO.

We announced the industry's first 64-gigabaud linear modulator driver that supports data rates up to 400G and beyond. This product is one of the key building blocks to enable the next generation of single wavelength 400G systems.

A positive surprise and another key learning was that the growth we've seen in backhaul to-date is only in the early stages of market ramp. Forward-looking growth prospects now exceed our previous expectations and we expect to see continued growth in backhaul moving into the second half of 2016.

Likewise in PON, where we thought the market might saturate by 2017, we heard at the show that there is a push to drive higher bandwidth for enterprises as well as residences, driven by the advent of 4K set-top boxes. This leads to an entirely new build out of 10 gig access for fiber to the home.

Where we thought that part of our business would possibly flatten and decline in the longer term, we now believe it too will grow for the foreseeable future. In datacenters, the big takeaway from the show was the resounding validation of our LPEC (15:23) and safety strategy from all major cloud service providers.

They acknowledged and clearly understood our intention and ability to drive the economics of 100G optical connectivity within datacenters. We are confident that this opportunity will be everything we had hoped for as articulated during our Analyst Day.

Overall, coming out of the show, customer response across all optical markets and sub-segments reaffirmed our belief that we've established a preeminent position as the pure play supplier of high speed analog and photonic components in the optical world. Touching briefly on Active Antennas, A&D performed as expected.

We see continued progress in the MMIC programs and tile-based opportunities, with nothing new to report on the customer order front since our Analyst Day last month. Moving to GaN, we continue to execute on our GaN vision and are 100% on track with process qualification as articulated at Analyst Day. Our confidence grows daily.

On the customer engagement front, we're rapidly converging on program wins, executing to clear schedules and customer requirements for certain 4G LTE regional deployment.

These programs address mainstream LTE deployments, where our GaN value proposition shines, delivering a degree of efficiency, integration, size and performance that could never be realized by incumbent LDMOS technology, making our solution a clear and winning choice.

Underscoring our belief that we're at the tipping point, as you saw in our announcement earlier today, we have initiated legal action against Infineon in Federal Court Los Angeles, to defend our rights to use certain GaN technology in M/A-COM's core RF markets.

This technology was originally developed and patented by Nitronex, which M/A-COM acquired in 2014. Since its acquisition of International Rectifier in 2015, Infineon has failed to honor the letter and spirit of certain IP agreements between Nitronex and International Rectifier relating to the Nitronex GaN technology.

These agreements functioned effectively for many years between IR and Nitronex and later between IR and M/A-COM. However, almost immediately after it closed on its acquisition of IR, Infineon began to try to unilaterally renegotiate the agreements to usurp our rights.

When we declined to reach Infineon's unreasonable demands, they responded by concocting claims that interfere with our rights. We believe that Infineon's conduct is a breach of the Nitronex-IR agreements and we've asked the court to confirm our position.

Infineon's actions are an opportunistic attempt to gain access to our burgeoning market for GaN RF products by improper means. It's regrettable that Infineon has attempted to engage in such strong arm tactics, but we intend to vigorously protect our rights and we expect to be fully vindicated in court.

We've built a highly successful business that has benefited both the electronics industry and our shareholders through the acquisition and integration of companies, and intellectual property that are supportive of our strategic plan. Defending those intellectual property rights is core to that success.

To some extent it's to be expected that we'll have to defend our rights as we begin to dislocate markets and drive major share transitions from old school incumbents. Bullies don't take losing lightly. Infineon's behavior is a clear indication that even they believe our GaN technology is at the tipping point of market adoption.

Adoption of M/A-COM GaN for RF threatens large silicon incumbents like Infineon, who have an incentive to retard rather than accelerate innovation. The potential stifling of innovation and other anti-competitive effects of Infineon's bullying tactics are deeply troubling.

Allowing such behavior by industry behemoths to go unchallenged would lead to erosion of ethical business practice and the rule of law, and would have a chilling effect on the innovation driven U.S. economy.

To our M/A-COM shareholders, know that we're committed to vigorously defending our IP rights against infringement or disruption by any party, regardless of that party's size, stature or circumstances. It's an important part of our stewardship of your investment in our company.

Indeed, we have previously prevailed against large company infringement of our rights, such as in 2014, when we protected our Ford business by securing a permanent injunction against Laird for infringing our IP. Let me close by emphasizing something. The outcome of this litigation is immaterial to our near term operating results.

It has everything to do with securing long-term returns for those who have honestly and genuinely invested in moving the industry and society forward. With that, let me bring it back and talk about next quarter guidance. For the fiscal third quarter ending July 1, 2016, M/A-COM expects revenue to be in the range of $138 million to $142 million.

Adjusted gross margin is expected to be between 57% and 59%, and adjusted earnings per share between $0.49 and $0.52, on an anticipated 56.5 million diluted shares outstanding. I'd like to close today's scripted remarks by thanking the team for another quarter of solid execution. Operator, you can now open the call to questions..

Thank you. Our first question comes from the line of Blayne Curtis of Barclays. Your line is open..

Thanks for taking my question and nice execution. John, I don't know how much you can talk about on the litigation, but one, how much is it costing you in the June quarter, has that kind of layered in yet or is it just starting? And then I guess what I'm confused on is there was an agreement where Infineon had rights to the power product.

Is there anything that Infineon is doing that's going to impact your ability to sell the GaN on silicon into some of the markets you were targeting first like base station?.

Yeah. Good question Blayne. Yeah that's exactly the point. Bottom line is, we have a very, very, very clear legal case.

It became pretty apparent shortly after the acquisition of IR by Infineon that they were not going to be planning to adhere to the letter or spirit of any of the agreements that worked quite well for 10 years preceding that between IR and Nitronex.

And to put it bluntly, they just aspired to get access to be able to participate in base stations along with us. So I don't anticipate it having, first of all, any material effect in the short to medium term, real question is long-term, do they get to try to steal away some share from our investments..

Got it. Thanks. And then the network business had a large step up in March.

I'm just curious as you look into June with the guidances by segment, I was just curious what areas you expect to be the most strongest and within network where are you seeing that strength?.

Yeah. Good question. So you're right, networks is where there is incredible strength across every single one of our optical sub-segments, the PON we anticipate growth in access there. Backhaul is absolutely exploding. We saw double-digit growth in both of those, very, very strong growth and anticipated growth.

The backlog is tremendous for both the Metro build outs as well as datacenter with our high performance analog products. So, everything is keyed up for some remarkable growth in the networks side through the second half of the year.

In terms of the rest of the segments, we are cautiously optimistic that we are going to see some good recovery in the catalog business, but that at this juncture is still hard to predict but it's pretty much up into the right for us everything at this point..

Great. Thanks, John..

You're welcome..

Thank you. Our next question comes from Mark Delaney of Goldman Sachs. Your line is open..

Hi, guys. Good afternoon and thanks very much for taking the questions. First question is on the base station opportunity. John, in your prepared remarks and also in the press release you mentioned making good progress towards getting those design wins for LTE.

Can you just give us an update on what milestones you still need to achieve in order to convert those into revenue?.

Yeah, the big one that still lays out there is process qualification in our first production fab, and that is 100% on track as outlined at our Analyst Day. The further you get into this, the greater the confidence grows. I would say it's very, very high confidence at this point.

If something were to go wrong, it would be at this point a surprise, honestly. Beyond that, obviously the next critical thing is customer engagement, and the beauty of it is we've gotten clear targets lit up with initial commercial discussions closed on some initial production ramps of what I would describe to be mainstream 4G LTE deployments.

So, we are not talking about the esoteric high end, high frequency stuff where GaN has traditionally played. This is going after right in the heart of LDMOS land, which is great news.

And the design targets that we're given is right in a sweet spot in terms of performance, integration and efficiency that technically could not be met by the incumbents and that's the reason why they were awarded to us.

But there is still execution on the product and the design validation, and that's going to be happening through the month of May as I understand it. And similar things are lining up in the other major customers. And by the way, I should say that's one of the three majors, and the other guys are opening up in a very similar manner.

So, it's all looking very, very favorable as articulated in our Analyst Day..

That's helpful. And for a follow-up question on Aeroflex, can you just give us an update on how the integration is going in terms of moving those products into the Lowell fab? And then on the cash flow side, just a sense for how much inventory you need to put on the balance sheet related to Aeroflex as you move through that transition..

Yeah, I will defer the second part of the question to Bob. But in terms of the integration, absolutely spectacular. We've become quite good at this in terms of integrating factories.

I can tell you the soft issues of being able to engage the people and to be able to bring factories in both Sunnyvale and Londonderry, New Hampshire to closure through the course of this calendar year, it's a core competence in my opinion and it's going right on track, if not ahead of schedule.

And I liked Robert's comment at the Analyst Day that we should be able to realize that gross margin expansion associated with those closures sooner rather than later. But the plan is calendar 2016.

Bob, the second half?.

Yeah. Mark, it's less than 10% of total inventory, so it ranges by what process – the state it's in, whether it's raw materials, any add-ins (28:05), work-in-process and finished goods. But the point is there is to provide the confidence to the customer that they can get what they need..

Thank you very much..

You're welcome..

Thank you. Our next question comes from Vivek Arya of Bank of America Merrill Lynch. Your question, please..

Thanks for taking my question. Maybe one more on this Infineon litigation.

Just to clarify, does this need to be resolved one way or another before you can ship into the base station market and recognize revenue, or the resolution just impacts Infineon's ability to be a player in this market?.

It's the latter, the license rights. I'm kind of hamstrung here because the original Nitronex-IR agreement has confidentiality provisions, so I can't really speak to the details of what's been claimed and counter claimed and so on. But the bottom line is our rights and our ability are black and white, that's not the issue.

What it really comes down to is will Infineon be able to annex our position or part of our position in particularly base stations if not beyond. And our position is clear, I mean, we're not negotiating with ourselves. They have no rights and we've asked the court to confirm our position..

Got it. And then as a follow-up, I think, John, you mentioned upside to some of the backhaul revenues and then also, some improvement in the cable business. Is there a way to quantify some of this upside, that do you think you'll see that more in September or December? Any way to help us better understand this upside? Thank you..

Yeah. We're really reluctant to provide breakdowns by segment quantitatively rather than providing color on moving parts. I can tell you on the backhaul side, we grew over 50% sequential on the backhaul business.

And we thought, well, you know, it just might be market exuberance, this wireless infrastructure segment tends to be very – in quite a rollercoaster.

But the interesting experience we had at OFC is that that's not the case, that the market's really just in the early stages of deployment of bringing out fiber backhaul, and that the customers are actually anticipating sustained growth in that segment.

Now, whether you can put together back-to-back quarters of that kind of sequential growth is not what we're suggesting, but it's something that we thought was actually a mature market penetration, and it's not whatsoever. Likewise, a similar situation with PON. We put together double-digit sequential growth in PON and the outlook looks similar.

The product that we're shipping out of Lowell is deemed to be higher quality, has associated benefits of lower cost and product manufacture, and even in an environment where you might see some softening in the overall PON market, customers are awarding us more and more and more share. So it's just a great story right now..

Got it. Maybe quick one for Bob. I think, Bob, in the past there was a sense that at some point you could get back to the 60% gross margin, 30% op margin level over the next several quarters. I was wondering if you could walk us through what the drivers would be from here on to get to those targets. Thank you..

Yeah. As we said, the current state of the acquisitions, the recent acquisitions, FiBest and Metelics, is bringing down our overall pre-acquisition M/A-COM gross margin from the 60%s into the 50%s, the high 50%s.

As we continue to translate those businesses to the M/A-COM plan, and that will happen over the next couple of quarters, we'll get closer to that 60% and possibly exceed it..

Thank you. Our next question comes from the line of Harlan Sur of JPMorgan. Your line is open..

Good afternoon, guys. Nice job on the quarterly execution. A&D and multi-markets, on the last earnings call you guys had described the demand environment as cloudy with sort of flattish backlog coming into the March quarter, but at the same time you guys did think you were at a bottom.

You guys ended up delivering pretty good growth in multi-markets in the March quarter. So, I guess the first question is, what drove the upside there and your cautious optimism on growth for multi-markets in June? And then on the A&D front, it came in flattish as expected in March.

Wondering if the (33:23) the F-16 program upgrades start to drive some growth in the second half of this calendar year..

Yeah. So the answer to the latter part of the question is, yes. Second half of the calendar year is exactly when the MMIC programs turn back and sustain production. Yeah, I would say that it's difficult with our catalog business other than looking at backlog trends to really predict the broad market, the health of the broad market.

And I would not describe the backlog trends to be indicative of a strong upsurge, but it certainly feels like we could be seeing an uptick, but it's just too early to call. In our guidance, we're assuming relatively flat for the catalog business. So, if it turns up, there would be upside to our guidance..

Got it. Thanks for that.

And then Bob, how should we think about operating expenses beyond the June quarter? I assume that in order to hit your 30% up margin goal, I think probably exiting this calendar year with the assumption that there is going to be continued revenue growth for the company that your OpEx is going to be relatively flattish from the June levels, is that a fair assumption?.

Yes it is..

Okay. Great. Thank you..

Thank you. Our next question comes from Harsh Kumar of Stephens. Your question please..

Yeah. Thanks, guys. This is Richard in for Harsh. I just wanted to touch on the backhaul market a little bit more. I know that you talked about that being a positive surprise.

Could you give a little bit more color there? And are you seeing this in a specific geography or a specific product or where are you seeing the strength?.

Sure. So the product area has been lasers. Fiber backhaul, we inherited that business with the acquisition of BinOptics 1.5 year ago. And as I said, the sequential growth was over 50% last quarter up from, I would say, a previous modest recovery on that segment.

If you remember, go back a couple or three quarters, it had bottomed out with the China management restructuring.

So recovery was anticipated, but certainly not as strong as we saw, and again the backlog is – and these are 10g lasers, very nice gross margin structure, the backlog is indicative of continued growth, and again the color we got at OFC was our customers – and to answer your question about regional, there was no particular regional correlation, so it's global demand that's being serviced..

Got you. That's extremely helpful. And then specifically on the datacenter side, it seems like on the optical side within datacenters, revenues were starting to ramp there.

How should we think about that ramp in the second half of the year and where are we from a cost structure on the datacenter side?.

Yes, so all of the business this year is really reimplemented telecom design products. So it is not the cost driven, cost-optimized stuff that we talked about at the Analyst Day.

The word at OFC was a lot of concern across a lot of customers about capacity limitations, the industry limiting the ability to supply the demand which is ahead of their expectations. We don't think we're going to have capacity problem servicing their demand. They are concerned about aspects of their supply chain.

So it's all very strong, but the real inflection point is next year when we talk about the cost-optimized solutions that really drive 100 G connectivity, the cost of it, and the fabulous news there was the message that we delivered as it related to the L-PICs, laser PICs where the safety technology was unbelievably not only acknowledged but there was a feeding frenzy among the cloud service guys wanting to work with us directly and hoping to drive the economics for their solution.

So that was frankly the biggest news and validation for us coming out of OFC..

Got you. And if I can sneak one more in. That was very helpful.

On SPAR, or the SPAR tiles, when should we expect that to ramp? Is there any update on that project?.

Well, there's revenue contributions for the second half of this year from the first production build out for the MPAR program, the first full production system, but if you are – I infer from your statement, you're talking about the real inflection point of full scale production systems. That would be in 2017 at the earliest.

As we said at the Analyst Day, we're building our capacity plan to be able to support initial program volume production in middle of 2017. We have nothing to look forward in terms of actual programs being awarded for 2017, but we're building capacity in anticipation of that timeline..

Great. Thank you very much and congratulations..

Thank you..

Thank you. Our next question comes from the line of Erik Rasmussen of Stifel. Your question please..

Yes. Thanks, guys. Nice results. I wanted to ask questions on the optical business. Can you just fill us in on how you're ramping with the AOI.

I know you talked about that contribution being several million dollar opportunity, but has there been any follow-on or changes in orders and what does that ramp look like?.

Yes, I'm going to be careful here. I mean, we're always very reluctant to be talking about specific business levels with specific customers. I realize we put a press release, so we're probably asking for it. But we began shipping against that order and the demand continues. I would say AOI is one of multiple customers servicing datacenters.

So it's certainly not by any means the only one. But I don't think there is any material change in that business outlook and scheduling from the time we talked about it at the Analyst Day..

Okay, thanks. And maybe for my follow up for Bob. Bob, looks you had nice operating cash flow and free cash flow and looks like the last two quarters now you're at a little bit more of a sustainable rate.

Is this what we should be expecting from this type of model? And do you have any targets for free cash flow? And then in the CapEx, I know you mentioned there's a lot of moving parts and I think last quarter was 8% to support a lot of new initiatives that you have. But is there a target range for that? That's all I had..

Yes, so concurrent with our target operating model that includes gross margin at 60%, the operating margin at 30% going to 40% as big revenue opportunities are realized here in the future.

We target a 60% free cash flow to non-GAAP net income, and that's with the assumption at the 60% level that it's a 30% operating margin and that we're a continuing growing company making continued investment in our capacity, which is very different than a very mature company that has a lot of depreciation and not a lot of new investment in facilities..

Okay. Thank you..

Welcome..

Thank you. Our next question comes from Mark Lipacis of Jefferies. Your question please..

Hi. Thanks for taking my questions. First question on the BinOptics products. I think I heard you talk about a 25 gig product that you're shipping.

When do you think that ships into qualified production 100 gig modules?.

Last quarter..

Pardon?.

Last quarter..

Started shipping already in the production modules. Okay, great. And then on Infineon how much is this hitting OpEx, like how should we think about the expenses to stay with this? And is Infineon shipping GaN on silicon right now or are you just seeing them in bake-offs and you're just trying to hit them off with a pass? That's all I had.

Thank you?.

Yes, we're treating the legal expenses as we did with the Laird because our confidence in the legal case, some of these expenses may be potentially reimbursed to us as part of the damages we claim. So they're not in our operating earnings today. If that situation changes, we may reevaluate that.

I have no comment with respect to what Infineon is doing in their business..

Yes, so okay. They ship GaN on silicon products and inherited the business from International Rectifier which focused on power management applications, so switching power supplies, for instance. I guess I can't speak to their ambitions or products in the RF space. I'll leave it at that..

Fair enough. Thank you.

Thank you. Our next question comes from the line of Steve Smigie of Raymond James. Your question please..

Great. Thanks a lot, guys. Just wanted to follow up with some of your recent products on the Optoelectronics side. You have some solutions where you're integrating the CDR in with the laser driver.

And I was just curious if you could talk a little about how important you think it is to have integrated parts like this versus keeping the parts separate and giving maybe more flexibility to customers versus a more fully integrated design.

And I guess beyond that would you argue that you've pretty much got both sides of that covered in any event, so kind of whatever the customers wants is, is what you can deliver?.

Yes, I mean your last point is spot on. It was going to be what I was going to say that different horses for different courses. Some customers would prefer things less integrated, some more integrated. I would describe it this way. Integration is also a double-edged sword. The weakest link in that combination defines your success.

We happen to have a spectacular, unequivocally highest-performing, lowest-power consumption CDR capability. So integrating that for the most cost-sensitive applications made all the sense in the world. It is incredibly successful. When you talk about things like 10 gig in datacenter connectivity, it's a requirement.

There is zero ambiguity about that integration in that particular configuration being important. But I would not pretend to say that that is singularly the case across all customers and all subsegments..

Okay.

And is Silicon Germanium the way to go in terms of material or again it's more what the customer wants and you can provide a variety of materials there?.

Yes, so for that class of the high-performance analog stuff, long haul, metro type power levels continue to drive, require Indium Phosphide, previously Gallium Arsenide. When you talk about relatively short reach, whether it's PON or the CDRs and TIAs for datacenter connectivity, for instance, absolutely SiGe is the way to go.

So we've got all of the above, whether it's datacenter, PON, backhaul, we've got every flavor for every potential subsegment..

Okay, great. I guess one more.

In terms of datacenter, do you anticipate that you would see greater strength that's something like a two-kilometer range or do you think something like 300 millimeter could be where you're expecting to see a lot of your growth, say, over the coming year?.

I think it's too early to predict the relative growth between the two. I would say different customers were engaged, different design objectives, and again I wouldn't pretend to be able to or crystal ball predicting which is going to be the biggest. DCI is the thing that's happening right now between datacenters.

But when you talk about connectivity within the datacenter, the answer is probably entirely different depending on which hyperscale datacenter, which system guy and which cloud service guy..

Thanks a lot..

Thank you. Our next question comes from the line of C.J. Muse of Evercore. Your question please..

Yes, good afternoon. Thank you for taking my question. I guess first question.

Bob, you've been pretty clear in terms of the headwinds near-term for gross margins from the two acquisitions, but just curious as we think about networking ramping in the back half of the year and the various products that will be coming in as well as GaN on silicon, how should we think about the trajectory for gross margins?.

C.J., I think we'll see the progression of gross margins continue to increase. Again, we feel pretty confident about getting back to that 60% and that's an overall product mix statement that that mix as we continue here will get us to the 60% as we exit the year. I hesitate – I just said a prediction and guidance beyond the quarter ahead of us.

We don't normally do, but well done for you, you got me to do it..

Well, I guess the question is also partially are there any headwinds, tailwinds that we should be thinking about as new products ramp?.

Not in this stage of the environment in our opinion..

Yeah. I'd suggest here's the way to think about it. With continued growth, that growth continues to come in high margin business. So that 60% number that we talked about pre-acquisition last quarter continues to expand, and then you get some significant, very significant dilution on top from the first full quarter of operations from the acquisitions.

As we address that dilution from the gross margin, you're going to see that gap drop and, again, with the continued growth this quarter and next quarter and the continued growth, start doing the math, you can see why Bob slipped and provided some additional guidance..

Great. Thanks. And I guess as my follow-up, going back to earlier questions around GaN on silicon, you talked about meeting that process qual.

But curious, once that comes in, what would the timing look like for first revenues there?.

So the difficult thing to predict is, when we deliver on these May deliverables, exactly when the deployments happen and when the customers – there's scenarios where they come in very rapidly and there's scenarios where they delay a quarter or so. So I'd put it this way, I mean, our position hasn't changed.

There are scenarios where this calendar year we have initial production ramps. There are also scenarios where those same programs delay into the first or second quarter next year.

At the very early stage of all these ramps, it's the absolute most difficult thing to predict, other than the fact, the more we get, with the law of large numbers, the likelihood of getting something coming in as a bluebird increases. So when you only have the first one or two, it's so hard to predict. So we really want to manage expectations.

To me, the most critical thing is, as we get over the goal line with the qualification and we start landing programs and we start expanding our footprint and we get fully qualified with the three major guys, it's very strong up and to the right.

And then it becomes the same kind of operational challenge for GaN ramping as we had with lasers last year, for instance, which is exactly the kind of challenge you want to have..

Excellent. Thanks so much..

You're welcome..

Thank you. Our next question comes from Quinn Bolton of Needham. Your question, please..

Hey, guys. I'll offer my congratulations on the nice results and good guidance. John, just wanted to come back. It sounds like really across the board strength in the optical business.

I'm just wondering, it feels like from your comments your backlog and visibility if anything over the course of the March quarter and to date in April was probably extended relative to where it was 90 days. I was hoping you might be able to comment on that.

And then for that optical business, I know you were a little bit capacity constrained late last year.

Now that you're ramping Lowell, is there any part of the optical business where you're capacity constrained that might be causing an extension in lead times or visibility or is all of that extension of your backlog really purely demand based? And then I've got a couple of follow-ups..

Okay, so lots of questions wrapped (51:17) there. So visibility has absolutely improved. As I mentioned at OFC, the concern was capacity availability to be able to service the growth in both metro and initial datacenter this year. So that absolutely leads to greater visibility. The visibility on the laser side is spectacular.

The agreements we have with the major customers are extended through the second half of the year. We will soon be engaging for share awards for next year and all that looks extremely favorable.

I would say the only – I wouldn't say capacity related issue is, we're in the early stages of ramping 25G lasers for 100 gig access in datacenters, and that really is – it's not capacity as much as yield. You want to be able to yield enough products, and it's the classic learning curve.

And we're rapidly driving down that learning curve and talking to some of our supply partners, actually today in a call earlier today, and with Robert Dennehy, our operations guy, we're confident that that's going to be relatively unconstrained within the next quarter or so.

And if datacenters do anything near what they're predicted to do, I mean, that's going to be just a rocket ship of growth layered on top of PON, on top of backhaul, on the laser side, on top of the metro buildouts and so on. So it's really incredibly favorable at this point across the board..

Great. And just to follow up on that datacenter. I think in the prepared comments you mentioned some 100 gig datacom modules with both Facebook and Amazon. Just wanted to confirm that I heard that right.

And if I did hear that right, can you give us – is that mostly on the analog component side or are you also seeing some photonic interest with some of those big datacenter customers?.

So the current revenue was all in the high-performance analog side, and every single one of those customers and the others that matter are absolutely engaged in the photonic side..

Great. And then lastly, it sounds like your comments on your initial contract discussions for the GaN on silicon product may not be the higher frequency, say, band 41 in China, that it may be more worldwide band. Sounds like you may be engaged in some of the lower frequency 1.8 gig to 2.0 gig with some of these initial contracts.

Is that the right way to be thinking about the current GaN contract discussions?.

Absolutely. I want to be clear, though. It's not instead of or only the lower frequency bands. Traditionally, the engagement on GaN related discussions is about higher frequency bands, which is great; nice, wonderful business and that's places that we expect we'll clean up.

To me, the real interesting tidbit is when you hit the more global bands and the relatively lower frequency bands and the value proposition has to do with efficiency and integration and so on. That allows you – you're not just operating in that top 20% of the market where GaN has that consideration. You're addressing the 80%.

And that is exactly the latent opportunity with our GaN on silicon, to take out the mainstream part of the LDMOS world..

Fantastic, great. Thank you..

You're welcome..

Thank you. Our next question comes from Richard Shannon of Craig-Hallum. Your line is open..

Hi, John and Bob. Thanks for taking my questions. Maybe just a couple of quick follow-ups here from some previous questions here.

So on the 25-gig lasers here, care to venture how many customers you might have, say, six months to a year from now? And any reason why you can't have all or most of the leading Web 2.0s as customers?.

Yeah, so it's interesting to speculate time dimensionally how many customers. I would say the world of people who manufacture in volume is relatively finite, would be less than a dozen guys who matter. So in terms of transaction and sales, that would be the first part of the question.

And given the cost benefits and the performance benefits of our etched facet lasers, my personal opinion is we will be able to sell every laser that we can produce for the foreseeable future. And with the enabling, with the expansions for the safety stuff, the self-aligning etched facet lasers even more so.

And the beauty here is we're bringing that up in Lowell first. In 4 inch cost structure, we get the yields to the point where we think we'll have in the next quarter or so, we're going to have a very strong position, not unlike that which we have in PON today..

Just a follow-up to that, John. If I recall from the analyst event when you introduced the L-PIC product that was something you were going to be qualifying and might be ready for production volume sometime next year.

Is that timeframe too far out? Is that something where you could see revenues this year?.

The year is very short at this point, and we're talking about almost in May and just to get products in qualification and you're talking about cycle times through fabs that are better part of three months. At this point it's very difficult to capture revenue in this calendar year, don't mind the fiscal year.

I would say that challenge, as I understand it right now, is not product performance and product qualification. It's getting into the right volume fab qualified I'd say analogous to our GaN on silicon issue.

And the other beautiful part of it is leading up to OFC and at the time of our Analyst Day it wasn't entirely clear that the value proposition was going to be understood, but I can tell you there was a feeding frenzy. The guys who matter they got it.

And combined with the confidence of being able to do the complete optical sub assembly and the confidence and the capability, the whole investment premise of the FiBest acquisition is providing it with Photonic Controls PIC and the BinOptics lasers, man, I'd say they got it. And now same thing as the GaN stuff, it's all about execution.

It's all about operational execution which is like I said that's the challenge one has..

Okay. I appreciate that color. I look forward to following up on that another time. Maybe another couple quick questions for me and I'll jump out of line here. On the backhaul, do you get the sense that the growth that you had in the past quarter here and going forward is this market growth here is any share gains involved here.

Do you have a sense of what's going on there?.

Yes, there's no question. I think the market drop last year with the China management restructuring in China, when we came out on the back end of that somehow I think it was through superior salesmanship or something, we came out and we think we've got a similar share now to what we have in PON.

I'm not exactly sure how we pulled that one off other than maybe it's just we've now got the reputation of having the high quality product at the best superior cost structure without supply chain restrictions. So there was absolutely share gain involved and then a healthy market recovery on top..

Okay, fair enough. And just one last quick question for me on the PON side here. You talked about some fairly substantial share gains.

Is there a limit to where you can go out a few quarters? I mean it's rare to see shares much above 50%, 60%, 70%, but it's clear that you're very willing to supply the market, but what's your limit there?.

Sky is the limit. I don't know. To be honest, my theory in the past is getting above 60% is very difficult, because customers just want to maintain a healthy supply chain.

In this particular instance, the two incumbents didn't support what the customers needed and wanted and we did, both from a capacity standpoint and cost standpoint and then the cost leverage, the benefits we have with Etched Facet Technology is such that we're the obvious guy to go to and now the product coming out of our old fab has surprisingly very high performance that leads to benefits of system cost reduction, so it's kind of an open playing field right now.

At some point I agree with you in our little balance and the lower end part of the market may stick with some of the other yielding comments, but quarter-by-quarter, by quarter we continue surprising ourselves to be honest..

Okay, great. I appreciate the detail. That's all from me guys. Thank you very much..

Thank you. Our next question comes from the line of Tore Svanberg of Stifel. Your question please..

Yes, thank you, very nice quarter. First question for John, so obviously you got the growth engines in optical and also the GaN business.

Should we think of all sort of new capital investments now being targeted at share gains and constant growth in those areas or are you starting to see maybe a fourth leg to the stool where you're leveraging your position already in those three segments.?.

So you're talking about capital investment?.

No, I'm talking about anything that you want to do now going forward, M&A or R&D spend?.

Oh..

Because you have three legs, right, of growth, but there's obviously other things you can do too, so?.

Well, I think the answer to that is quite time dimensional. We've got a lot in our plate in terms of operational execution at the current time. So we always have a healthy pipeline of potential acquisitions. These are taking time to digest.

We've got factories to consolidate in this case and then operational challenge is not small, but I would say this year, it's all about execution, it's all about execution. We don't need more secular growth drivers, we got three healthy ones time dimensionally, diversification within those, across those.

I think we've got enough strategically bitten off. But at the same time to be honest before the BinOptics acquisition, before the Mindspeed acquisitions, before some of these things, we didn't fully appreciate the opportunities that fell in our laps along with those.

So it may be that something comes along, but I can tell you right now, we don't have visibility into those, into another one of those at that magnitude..

That's very fair and just for Bob, so Bob, inventory days came in at 174, obviously they've been little bit all over the place with the divestitures and acquisitions, but is this sort of the level that you are going to operate at or do you have sort of an inventory based target going forward?.

Tore, I didn't get all the detail. Can you repeat that, the numbers faded out..

Yeah, the inventory days at 174, is this the level that you want to operate at or do you have a target for us?.

No, we'll come down off that. So we have erred to the high side, some of our inventories to be optimistic in terms of gaining turns and shares and supporting customers, but endemically is the way we integrate the fabs into Lowell, inventories will come down..

Very good and the DSOs were unusually low this quarter, I'm not saying that's a problem, but was this just the linear quarter or anything else going on there..

I don't know what to say. Thank you. We worked the balance sheet pretty hard. We understood where the inventory was going to be and planned for it way and we've been pushing the recollection process..

Sounds good. Very good. Thank you..

You're welcome..

Thank you. Our final question comes from Dave Kang of B. Riley. Your line is open..

Hi. Thank you. Good afternoon. First question is regarding your network business.

It was up looks like 16% sequentially, just wondering what the organic growth was?.

Yeah, the two huge growth drivers were lasers across both PON as well as backhaul and absolutely some growth beginning to contribute from datacenter, the 25G stuff beginning to ship for datacenters. And then the Metro long haul stuff were feeding into the deployments AT&T, Verizon, China Mobile, China Unicom.

So that the Metro build outs are a big deal for us in terms of driving growth, so I'd say the rest were the two primary driver areas..

Right.

Actually the question was, what was the organic growth excluding that acquisition in the December quarter sequentially? Is it up about – still double-digits or...?.

Close to double-digits..

Okay..

Close to double-digits. One thing that I'll point out that's problematic is we don't have an apples-to-apples situation there. We described last quarter, so FiBest was a customer of ours. So that will be coming into as a business unit.

The revenue is not incremental because if we lose the revenue claim into and it becomes – it shows up as products improvement, so it's impossible to do an apples-to-apples mathematical addition. Sorry, off the top of my head I can't answer the question, but I can guarantee you it's double-digit organic growth..

Got it, got it..

I know just from the fact that the lasers in the Metro long haul stuff were very strong..

Right.

And then regarding your comments about backhaul and PON, is that pretty much you are referring to China or is that sort of global?.

So all of the stuff at this point is built in China to service global demand. So if you talk about transactional sales, it's very heavily if not entirely China, whether it's Alcatel-Lucent demand or Cisco demand or whoever you're talking about, transactional sales are in China for production.

But I would say on the backhaul side which is the global demand situation is not just the China build out, and likewise China does have a build out for fiber-to-the-home, but it is not the majority of the share of global build outs for fiber-to-the-home. So certainly China has contribution, but it's truly global..

Got it, and my last question is regarding, you talked about AT&T and Verizon, any movements out of the Verizon supply chain since last week's strike?.

Yeah, so remember we are on the starting point of the supply chain, so we have seen activity that we believe is strongly related to Verizon, but it's not impacting, we see no slowdown in that demand process as we sit here today..

Got it. Thank you very much..

You're welcome..

Thank you. At this time, I'd like to turn the call back over to Mr. Croteau for any closing remarks..

Sure. Before closing out today's call, please note that Bob and I will be attending a number of investor events during the months of May and June.

These include road shows at Philadelphia, Baltimore and Boston, as well as the Jefferies conference in Miami, Craig-Hallum conference in Minneapolis, Cowen conference in New York and the Bank of America Merrill Lynch and Stifel conferences in San Francisco. If you like to request a meeting while we're in your area, please email us at ir@macom.com.

Operator, that completes today's call. You may now disconnect..

Thank you, sir, and thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a wonderful day..