Stephen Ferranti - MACOM Technology Solutions Holdings, Inc. John R. Croteau - MACOM Technology Solutions Holdings, Inc. Robert McMullan - MACOM Technology Solutions Holdings, Inc..

Harlan Sur - JPMorgan Securities LLC C.J. Muse - Evercore Group LLC J. Steven Smigie - Raymond James Financial, Inc. Blayne Curtis - Barclays Capital, Inc. Quinn Bolton - Needham & Co. LLC Mark Delaney - Goldman Sachs & Co. Tore Svanberg - Stifel, Nicolaus & Co., Inc. Harsh V. Kumar - Stephens, Inc. Richard Cutts Shannon - Craig-Hallum Capital Group LLC.

Good afternoon and welcome to the MACOM Fiscal First Quarter 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 conference call is being recorded today, Tuesday, January 31, 2017.

I will now turn the call over to Steve Ferranti, Vice President of Investor Relations at MACOM. Please go ahead..

Thank you, Karen. Good afternoon everyone and welcome to MACOM's first fiscal quarter 2017 earnings conference call. Joining me today are MACOM's President and Chief Executive Officer, John Croteau; and Senior Vice President and Chief Financial Officer, Bob McMullan.

If you have not yet received a copy of the earnings press release, you can obtain a copy on MACOM's website at www.macom.com under the Investor Relations section.

Before I turn the call over to John, I'd like to remind everyone that management's prepared remarks and answers to your questions contain forward-looking statements, which are subject to certain risks and uncertainties.

Because actual results may differ materially from those discussed today, MACOM claims the protection of the Safe Harbor forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

For a more detailed discussion of the risks and uncertainties that could result in those differences, we refer you to MACOM's filings with the Securities and Exchange Commission, including its current report on Form 8-K filed today, Annual Report on Form 10-K filed on November 17, 2016, Registration Statement on Form S-4 as filed on December 21, 2016, and Amendment No.

1 thereto filed on January 18, 2017. Any forward-looking statements represent management's views only as of today, January 31, 2017, and MACOM 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 adjusted 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 a reconciliation of GAAP to adjusted non-GAAP results are provided in the company's press release and related Form 8-K, which was filed with the SEC today and can be found at the Investor Relations section of MACOM's website.

For those of you unable to listen to the entire call at this time, a recording will also be available via webcast for at least 30 days in the Investor Relations section of MACOM's website. With that, I'll turn the call over to John for his comments on the quarter..

Thank you, Steve. Welcome, everyone, and thanks for joining us today. I'll begin today's call with an overview of our first quarter results for 2017, 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 and key highlights during the quarter, followed by an update on the AppliedMicro closing and guidance for the fiscal second quarter of 2017. Straight to the results; I'm pleased to report that for our fiscal first quarter of 2017 revenue came in at $151.8 million.

Adjusted gross margin was 57.2% with adjusted earnings coming in at $0.57 per diluted share. Looking at our end markets, as we guided, top line revenue for the quarter was essentially flat due to expected seasonality across our businesses. Networks and Multi-market were flat to slightly down sequentially, but up year-on-year 31% and 48%, respectively.

Aerospace and Defense grew sequentially due to strength in high-performance MMICs and was up 20% year-on-year. Now, let me turn it over to Bob to review our fiscal first quarter financials in more detail..

Networks $108.4 million and 71.5% of total revenue, up 31% year-over-year; Multi-market $21.4 million and 14.1% of total revenue, up 48% year over year; and Aerospace and Defense $22 million and 14.5% of total revenue, up 20% year-over-year.

Of our total Network revenue in the fiscal first quarter, Optical revenue was $82.3 million or 54.2% of total revenue, and up 38.1% year-over-year led by Long Haul, Metro and DCI revenue, which was up 85.5% year-over-year.

Non-GAAP gross profit and gross margin in the fiscal first quarter was $86.9 million and 57.2% of revenue respectively, compared to $68 million and 58.7% of revenue respectively year-over-year and $89.3 million and 58.5% respectively on a sequential basis.

Adjusted gross margin declined sequentially due to slightly lower revenue from higher gross margin products. In terms of operating expenses in the fiscal first quarter, total Non-GAAP operating expenses were $45.9 million compared to $40.3 million year-over-year and $51 million sequentially.

Adjusted operating expenses were up 13.9% year-over-year and down 10% sequentially, primarily due to lower variable compensation expenses. Adjusted R&D and SG&A expenses were $27 million and $18.9 million respectively in the fiscal first quarter.

Non-GAAP income from operations and operating margins were $41 million and 27% of revenue, up 47.8% and 12% respectively year-over-year and up 6.9% and 7.6% respectively on a sequential basis. Adjusted operating margin expanded 310 basis points year-over-year and 190 basis points sequentially.

Net interest expense increased to $6.7 million due to the full quarter's inclusion of our additional Term B debt of $250 million issued in August. Other income of $1.9 million represents revenue from the consulting contract from our auto business divestment that will continue through fiscal 2017.

Our normalized non-GAAP income tax rate in the fiscal first quarter was 12%, down from the previous 15% due to the expanding mix of international revenue managed by our offshore entities with lower tax jurisdictions. As to cash taxes, we did not pay cash taxes in the fiscal first quarter and received a $700,000 refund during the quarter.

Our fiscal first quarter non-GAAP net income and EPS were $31.8 million and $0.57 per fully diluted share respectively, growing from $21.8 million and $0.40 year-over-year, and $31.1 million and $0.54 sequentially. Non-GAAP net income grew 45.6% year-over-year and 5.6% sequentially. Non-GAAP EPS grew 42.5% year-over-year and 5.6% sequentially.

The share count used to compute non-GAAP EPS was 55.6 million shares fully diluted for the fiscal first quarter. Adjusted EBITDA or earnings before interest, taxes, depreciation and amortization was $48.4 million, up 44.5% from $33.5 million in our fiscal 2016 first quarter and up 7.8% from $44.9 million sequentially.

GAAP cash flow from operations was $20.4 million in the fiscal first quarter as compared to $15.5 million in the fiscal 2016 first quarter, increasing 31.6%, and down from $24.9 million sequentially.

Fiscal first quarter cash flow from operations represents 64.2% of non-GAAP net income, down from 71.1% in the fiscal first quarter of 2016, and 82.7% sequentially. The timing effect of an increase in our 2017 fiscal first quarter working capital is the reason for the decline.

After deducting capital expenditures, free cash flow was $15.5 million or 48.7% of non-GAAP net income in the fiscal first quarter, compared to $8.8 million and 40.7% of non-GAAP net income in the fiscal first quarter of 2016, and $17.7 million and 58.8% sequentially. Fiscal first quarter free cash flow was lower due to higher working capital.

Turning to the balance sheet. At fiscal first quarter-end, our cash, cash equivalents and short-term investments were approximately $377.7 million, up $20.9 million sequentially. Accounts receivable were $112.2 million, up from $108.3 million sequentially. Day sales outstanding were 67 days compared to 65 days.

Inventories were up to $115.2 million compared to $114.9 million sequentially. Inventory turns were 2.3 times compared to 2.2 times. Long-term debt was $587.1 million, inclusive of capital leases. We also had $130 million of availability in an undrawn credit line.

Capital expenditures in the fiscal first quarter were $4.9 million or 3.3% of revenue, compared to $7.2 million or 4.7% of revenue sequentially. Depreciation expense for the fiscal first quarter was approximately $5.5 million and compared to $4.7 million sequentially.

Our capital expenditures were lower, essentially funded by depreciation expense for the first time from a cash flow perspective. Now I will provide a high level overview of AppliedMicro's non-GAAP results for its quarter ended December 31, 2016.

In AppliedMicro's fiscal third or December quarter, it's last full quarter as a public company, revenue, gross margin, and non-GAAP EPS were in line with consensus estimates. It is important to note the consensus revenue includes AppliedMicro's Compute business.

Revenues associated with the communication processors has been end-of-life by AppliedMicro. MACOM will report revenue and associated expenses from the ARM-based products as discontinued operations. For these reasons, post-close, investors should not view AppliedMicro's prior consensus revenue as translating to MACOM revenue.

AppliedMicro ended its December quarter with approximately $73 million in cash and equivalents. Looking to MACOM's fiscal second quarter, the partial quarter inclusion of AppliedMicro's revenue will increase Enterprise and Data Center source revenue and will be a measurable market.

Considering the expected hyper growth potential, we plan to add our Data Center revenues to AppliedMicro's revenues and report Data Center and Enterprise separately, excluded and independent from our Optical revenue.

We believe Enterprise and Data Center opportunity is another secular growth driver further diversifying our markets and revenue sources. As we have previously communicated, one of the assets of AppliedMicro is approximately $500 million in realizable net loss operating carry-forwards.

We plan to integrate AppliedMicro into our international operating structure, allowing us to lower our effective U.S. tax rate. MACOM now believes, based on the mix of worldwide taxable earnings and current income tax rates, our long-term permanent tax rate will be 10% in future quarters. Back to you, John..

one of them has now asked us to bid on a 900 megahertz platform in addition to the earlier 1.8 gigahertz and 3.5 gigahertz programs.

Subtle but very important is the fact that when customers consider new sources for legacy narrowband programs, where LDMOS has thrived, they do so with a major shift in suppliers in mind and with the intention of qualifying that GaN supplier for all frequency bands. This significantly improves our SAM model.

We now believe that GaN adoption will end up widespread at all frequency bands simultaneously, which would provide us access to the full $1 billion TAM and base stations. This is exactly what I saw with the adoption of LDMOS many years ago. When the first movers adopted LDMOS technology, it triggered a domino effect.

Base station OEMs know they can't be left behind with outdated power amplifier technology.

I believe this domino effect can only be enabled by someone like MACOM who can deliver the benefits of GaN at the required cost structure and, more importantly, with the supply chain flexibility to support search capacity for global wireless infrastructure deployments.

At this juncture, our ability to execute operationally will determine the magnitude and scope of the GaN revenue ramp over the coming quarters and years.

Now, moving over to MMICs; as we reported previously, the really big news for MACOM is that the growth rate of our RF and microwave businesses is now poised to match, if not exceed, our Optical businesses. The driver of this today is MMICs. Last quarter, MMICs across all of our end markets were up sequentially and grew 38% year-on-year.

We continue to exploit a void in the marketplace that's left as competitors undergo consolidation. We launched 33 new MMICs over the last year with Tier 1 customers sponsoring these new products across RF catalog networks and A&D portfolios. It's also worth mentioning, we've completed the Metelics integration on schedule and on budget.

The Londonderry and Sunnyvale sites are now closed, with manufacturing fully transitioned over to Lowell. With that behind us, we're now squarely focused on integrating AppliedMicro. Speaking of AppliedMicro, last Thursday, we closed the transaction.

We're now heads down executing our 100-day plan to integrate connectivity and divest the Compute business. We received unsolicited interest from numerous parties since we announced the definitive agreement. And we believe we'll be able to find a good home for the Compute team within that 100-day window.

Now that the transaction is closed, I can speak more freely about our view of the upside potential of the portfolio coming over with AppliedMicro.

With the geopolitical storm that's brewing around cyber security, the move to hardware-based encryption, specifically MACsec as well as PAM4 have given the AppliedMicro team a seat at the table for architectural discussions with the world's leading enterprise and cloud data center providers.

AppliedMicro is way out in front as a strategic supplier of MACsec to all of these major OEMs, helping secure their network links with hardware encryption which is critical in this age of cyber security at 100-gig and beyond.

With the closing of the transaction, we can expand those architectural alignments to include analog and photonic road maps, which we expect will far outpace the sales of MACsec itself.

When you see the list of all the major OEMs who are adopting MACsec as well as PAM4 for 100-gig to 400-gig applications, you'll understand why we believe cloud data centers have the potential to be yet another explosive growth driver for MACOM.

Not only is MACsec expected to be a material contributor to growth, but it's an accelerant in our ability to ramp the rest of our portfolio and data centers. So that brings us to PAM4.

In the March quarter, the AppliedMicro team is on track to deliver initial production units to our lead customer, a world leader in network infrastructure equipment, who tells us that they expect to be in production with single-Lambda PAM4 transceivers in the second half of this year 2017.

Furthermore, at least four of the six major cloud data center players have already made the architectural decision and are poised to move forward focusing their efforts on single-Lambda PAM4 as their standard of choice for 100-gig and beyond.

Beyond the initial customer ramps, we believe that broad industry adoption of PAM4 will be unlocked by the ecosystem of companion analog, laser and photonic components. This is something that MACOM can uniquely enable.

As of this, the March quarter, we're also sampling units of companion lasers and analog components for single-Lambda PAM4 to be followed by integrated L-PICs later this year.

Because of the explosive growth opportunity in enterprise and cloud data centers, we'll break this out and speak to it as a separate secular growth driver for the company independent from Optical going forward. So, wrapping it all up, we're now targeting multiple major growth waves in our industry. We're riding the optical super-cycle.

We're leading the technology transition to GaN and RF. We're filling the vacuum for MMICs that's been created by industry consolidation. We're securing the Internet with hardware encryption for cyber security. And we're servicing the exploding demand for connectivity within cloud data centers.

We're not just diversified in Optical; we're diversified across multiple end markets and multiple secular growth drivers. Again, this is the reason why we're confident we can continue to outperform as we have for the past three years despite the inevitable ebbs and flows and market gyrations in the semiconductor industry.

With that, let's talk about next quarter guidance. For the fiscal second quarter ending March 31, 2017, we expect revenue to be in the range of $180 million to $186 million. Adjusted gross margin is expected to be between 58% and 61%. And adjusted earnings per share between $0.59 and $0.63 on an anticipated 64 million fully diluted shares outstanding.

Operator, you can now open the call to questions..

Thank you. Our first question comes from the line of Harlan Sur from JPMorgan..

Good afternoon. Thanks for taking my question. Maybe if you could just help us clarify, given this is the first quarter of inclusion with the AppliedMicro.

So, on the two-thirds of the AMCC business you're recognizing here in the March quarter, are you including both the Connectivity and embedded businesses or just the Connectivity businesses?.

It includes both, Harlan, but the Compute business will be treated as discontinued operations and the embedded business is really been end-of-life, and so they've kind of pushed their numbers up, which is not a real run rate going forward..

So, on that note, on the embedded business, if we looked at the proxy, I think that AMCC's forecast was for that business to decline like 60% over the next 12 months.

So is that how we should be modeling this segment over the next 12 months or do you guys have a different view of the revenue decline for embedded?.

It could be even a bit faster..

Yeah, it could be faster. And the other thing that I'm not sure is mentioned is, that tends to operate at very low gross margin. So, the quicker we do it, the more gross margin dilution we experience. And there are scenarios where the buyer for ARM business takes the embedded business.

So, you really got to be careful including pretty much any of that revenue in the model..

Okay. Got it. And then, on a brighter note, like on the growth prospects on A&D, that business grew 20% year-on-year in the December quarter. I think you guys have had a view that – and it's been growing quite strongly given the strength on the MMIC design wins you've had.

I think the team has had a view that A&D business would grow about 40% type of growth rate over the next few quarters, so I guess the question here is, do you guys still anticipate 40% growth rates on a go-forward basis for A&D?.

Yeah. For the year-on-year, for the entire year 2017 versus 2016, we're still anticipating more than 40% growth year-on-year. And as you know, we're well into our second fiscal quarter. So the visibility is pretty good on that at this juncture..

Great. Just one last question. So, can you just give us an update on the L-PIC, the silicon photonics products? This is a product that has pretty high level of integration.

Are you guys still on track to kind of start ramping this over the next few months? And is this going to be more for – I believe it's going to be more for data center applications, but if you could just confirm. Thank you..

Sure. Yeah. The initial L-PIC is absolutely targeted at data centers, NRZ 100-gig. It is right on track in terms of qualification. Anybody interested, you might want to go to OFC; you'll see it in action and as production units. And the good news is the assembly process, what we call the Self Aligning EFT technology, is operating spectacularly.

So where that is going to be a fantastic complement to the AppliedMicro portfolio and actually in advance of the AppliedMicro portfolio for NRZ applications. So it's one of the reasons why we're so bullish for the cloud data center opportunity..

Great. Thank you..

You're welcome..

Thank you. And our next question comes from the line of C.J. Muse from Evercore..

Yeah. Good afternoon. Thank you for taking my question. I guess first question around AMCC.

Can you quantify what you're including in terms of the March guide partially for AMC, both from Connectivity and embedded? And I guess as a follow on to that, can you talk about the PAM4 large customer? I'm curious as that business ramps in the back half of the year, given the resources that they will presumably require, how we should layer in the margin impact for that business for you guys..

Yeah. One of the things we're very cautious about – I'll start with some of the latter parts of the series of questions – is we don't like to pre-announce our customer's product plans. If you understand the kind of the market for PAM4 in single-Lambda, you can probably infer from that who the lead customers are.

But, Bob, do you want to speak to the....

Yeah. So we're not – really don't want to be bifurcating two businesses because we run it as one business. But in a range we're in line with our consensus. And the balance is plus or minus around what makes up the difference with the AMCC revenue in the forward quarter..

Yeah. If you break it down, it's a pretty logical mathematical equation this quarter. I think on a go-forward basis, the caution we have is, as AppliedMicro telegraphed, they began an end-of-life exercise with the embedded business that started well before we got involved. So that's going to be tailing off fairly rapidly.

So you got to be careful on the forward quarters..

Helpful. And I guess as a quick follow-up, I think I read in one of the Registration Statements that you had NOLs of $1.23 billion. I think you've been talking about $600 million plus.

So can I infer from that that a portion of the NOLs will stick with Compute upon that asset sale?.

No, that's not the way it works. So under [section] 382 change of control, there's a limitation based upon fair market value of the acquired business, with that calculation of fair market value, which is about $772 million, times the rate you're limited by that calculation as to what you can use in total NOLs.

So the difference dissipates into the world of not being used unfortunately or fortunately depending on the value you look towards AMCC..

Got you. Very helpful. Thank you..

You're welcome..

Thank you. And our next question comes from the line of Steve Smigie from Raymond James..

Great. Thanks a lot.

Just wanted to follow up, as we think about June, I know you don't like to guide that far out, but if you only have a partial quarter of AMCC in March, so are you willing to give any color on what maybe AMCC could look like in June at this point? And we could maybe make a call ourselves on June? Or just how we should think about seasonality now for like June?.

So we traditionally do not have seasonality in our June quarter. I don't expect it with the acquired business. We're going to – again don't like to identify these businesses and that's why we pointed to the Enterprise and Data Center revenue category, because there is complementary and product overlaps that push and pull each other.

But overall, I think if you were to look at the trend by quarters in line with the shaping of MACOM. I think from this point here, you'd see similar shaping for the balance of the year..

Okay, great. And then, it sounds like you guys continue to make progress on GaN. It feels like this is a year where you get some production revenue, but where maybe calendar 2018 is a year where maybe you see more substantial revenue.

Should we think about the 2018 revenue is probably an order of magnitude larger – or maybe not order of magnitude, but a multiple or two larger in terms of revenue in 2018 versus 2017?.

Yeah, no question. I think that's not an unfair assessment. There is material contribution in the back half of the year to GaN beginning to ramp. It just layers on top of the other things that are turning on.

Bob made the comment that there isn't seasonality, I would actually describe our third and fourth quarter as the absence of negative seasonality, so maybe that's seasonality. So traditionally, our third and fourth quarter are pretty strong. You start layering in the GaN stuff and it starts looking better and better.

But no question, talk about our numbers, top line numbers are big enough now that GaN has to get sizable to have a material contribution to our growth. And there's no question 2018 would be the year where that happens. Again, riding on top of cloud data centers, Metro/Long Haul seems to have a lot of juice to continue at least for another year.

So it all layers in nicely. But that's not an inaccurate description. And it's coming off a small enough number that its order of magnitude is pretty easy to be honest.

The question is how many orders – how many multiples of an order of magnitude? And again, once we get through the field trials and the customer qualifications, we'll have a much better sense. As I mentioned, customers are now asking us about global procurement agreements.

That is a clear indicator they're looking to move forward and turn on significant share of wallet. Same thing when they're exercising us on 900 megahertz programs. That's a clear indicator they're looking at a wholesale transition from a supply chain standpoint. So all the indicators are good, but there's still a lot of execution before us..

If I could just – one quick one in on – John, you have a lot of experience in this space.

Can you talk about how – if there is any sort of second sourcing, so let's say you have a major OEM, you win certain platforms, even within a specific platform you might win, could you share that platform 50-50 with somebody? So how many suppliers would an OEM adopt within a specific platform? How many suppliers would they adopt?.

So when a program goes into production, there's no such thing as a second source. During the development process, they'll have two or three runoff, typically two, more as a risk contingency in terms of technical execution. But once the business is awarded, it is impossible to have two sources.

The behavior of the devices and the designs are different, so there's no way to have two sources. The way they achieve the spirit of what you're describing is, these base station OEMs are very mature and controlled in terms of awarding programs to stick-handle share of wallet within their – of their overall purchase.

And they're buying $200 million plus each of power transistors. And for a given year, depending on how the different vendors are performing, they'll have targets increasing or decreasing for each of those vendors. But on a program by program basis, they're all sourced..

Okay. That's really helpful. Thank you..

You're welcome..

Thank you. And our next question comes from the line of Blayne Curtis from Barclays..

Yeah, just a semi question.

I was wondering, just looking at the March guidance, maybe we can talk about the core MACOM segments which just directionally are they all growing or are you seeing any seasonality?.

So A&D, consistent with the question – the line of questioning earlier, that's going to have a strong quarter. Network is going to have a strong quarter and Multi-market kind of a neutral quarter.

The way I described that when I looked into it that kind of surprised me when I looked at it, but basically, our catalog MMICs are selling into applications that are ramping more aggressively and customers that we describe as A&D and Networks. Multi-market is basically other, so there's no reason why that's not growing.

It's just our MMICs are very hot on the A&D and on the Network side right now. But, as you would expect, as you start getting into our second and especially our third and fourth quarter, things lift pretty materially..

Got you. And then maybe just talk about that.

In the second half, you talked about 100G lasers, can you just talk about what you need to accomplish to get these to revenue?.

Design wins and orders. We launched three lasers, I think, it was about 90 days ago at our last earnings call or just before that. And now, we're hot and heavy. I think we've got 25 or 30 customers that we're actively in design wins.

And there are some qualifications required of end customers, so that's what – it's all leading to 100-gig demand, so this is four times 25G. So it's big numbers, healthy ASPs, great gross margin so it's all good stuff. That's one of the contributors, but it's pretty much across the board.

The Metro/Long Haul stuff, that is insatiable; it's all capacity expansion there. That's a growth driver. We have some contribution from GaN, A&D, you can refer from the previous comments that's strong. It's pretty much everything.

When you get into the third and fourth quarter, everything is kind of clicking on all cylinders or that's the way it looks..

Okay. Thanks. Nice job..

Thanks..

Thank you. And our next question comes from the line of Quinn Bolton from Needham & Company..

Hi, guys.

Just wanted to first ask on the AppliedMicro, should we be thinking about that quarter, since you have a partial contribution this quarter, is that business fairly linear across the three months, meaning that we should take effectively two-thirds of whatever we forecast AMCC to do in a full March quarter and then you'll pickup sort of that third month in June? Or does it tend to be a little bit more back-end loaded in February and March that your guidance would actually include more than kind of two-thirds contribution for AMCC?.

Yeah. So, as Bob said, we don't bifurcate the business between the two but, yeah, if you take two-thirds of the number, it's probably good math, not inconsistent with the previous expectations..

But it's not what they did two-thirds of what they did last quarter though. That's the caution here, because of the end-of-life and the dynamics going around the embedded processor..

Yeah, well, you're talking about for the second quarter or third quarter?.

For the forward quarter..

Yeah. So the forward – when you go forward to the third quarter and so on, you have a very substantial tail off on that embedded business..

Right, right. Got it. And then sort of a similar question on the expenses.

I know sort of when you announced the deal, you said that the Connectivity business carried about 49% of the OpEx, will that other 51% from day one of the acquisition be included in those discontinued ops or could some of the AMCC expenses be a little bit higher here in the stub period for March that that could weigh on OpEx?.

Quinn, as we talked about it, as we announced the deal, there are some imbalance in the first partial quarter of timing of expenses, so it's possible the expenses, could be a little higher on this partial quarter that's mismatched against the more traditional linear revenue..

And to put in perspective here, we're three days into this post closing, so we're always very cautious because every deal we've done, there's always things that we learn. So, let's just say we guide with caution..

Yeah. No, understood. And then, just wanted to come back to the core business. Non-GAAP gross margin sort of towards the lower-end of your guidance and I think you said in the script that you've now fully integrated Metelics and once you had done that I thought you were sort of going to be tracking towards the 60% gross margin on the Metelics business.

Just kind of wondering where we are on the gross margin ramp for both Metelics and FiBest.

Are they still a distance away from that kind of 60% gross margin target that you're aiming for or are they getting closer to that target, especially on the Metelics side now that you've integrated the two manufacturing facilities into Lowell?.

Yeah, I would say both on the Metelics integration, we closed Sunnyvale and Londonderry and moved that production to Lowell. That's now a tailwind in terms of gross margin expansion. Likewise on FiBest, we restructured our supply chain. There's new product transitions where we have the majority, if not, 100% semiconductor content.

So that's a tailwind in gross margin expansion. The issue with the last quarter, as bizarre as this sounds, is the weakness in PON. PON is actually one of our highest gross margin – higher, not highest – the higher gross margin areas for commodity. And in those lasers, the Etched Facet Technology has just a fabulous economic position in that market.

So with the weakness in PON being compensated by Metro/Long Haul, part of that is actually compensation with the TOSA/ROSA portfolio that came over with FiBest, which is, even on a good day, not nearly what we get from the etched-facet lasers. So it's really a mix issue that was this weakness in PON and strength in the Metro/Long Haul.

What you get is counterintuitive. You would think PON would be low margin; Metro/Long Haul would be high margin. The modulator drivers are a great margin, the TOSAs/ROSAs are modest margin. So it's just a bunch of moving parts in the past quarter..

Got it. Great. Thank you..

Welcome..

Thank you. And our next question comes from the line of Mark Delaney from Goldman Sachs..

Yes. Good afternoon and thanks very much for taking the questions. First question is on some of the radar opportunities around tiles with MPAR and the SPAR tiles.

Can you just give us an update on when you can maybe convert some of those opportunities for Aerospace and Defense and weather applications into revenue?.

Yeah. We try to avoid talking a lot about that because until we've landed the progress, we can't say that we've landed the programs. I can tell you our lead customer in Northrop has some very active focus within Northrop on specific programs that would be thoroughly inappropriate to talk about.

But, on the civil side, where we work with Northrop and everyone else, MPAR continues to move down. The bidding is this year in 2017 with RFPs that are going out. Our customers are all kind of scrambling to come up with their own competitive strategies on how they plan to bid. But that's still ways off in terms of production.

The one thing I would say though is, if you actually look at even modest levels of initial production builds for some of these guys, for their own bidding process, it adds up to not immaterial revenue to us in terms of growth.

So, in the medium term, if MPAR gets traction in terms of through that RFP process, we could see material contribution next year..

That's helpful. And then a follow-up question, if you could just talk a bit more on the Multi-market business, just any sort of trend you're seeing in terms of distribution changes and changes in inventory patterns at the channel..

No, there wasn't anything really material in terms of inventory trends for our catalog portfolio. Again, catalog transcends Multi-market, A&D and Networks. So that was not a primary factor. Things were relatively flat to be honest..

With the growth of the Networks business, the reliance upon the contribution of distribution revenues continued to decline as the Networks business primarily direct OEMs or their contract manufacturers..

Yeah, big guys..

Got it.

And then just one clarification, as you guys go to the new segment reporting for next quarter with AMCC, I think a piece of AMCC in the acquisition presentation was allocated out to be Optical, so is the part of AMCC that you consider the optical going to be in the Optical line or is all of AMCC going to go into your Data Center segment?.

There is a small piece, most of it though is going to go to the Enterprise Data Center..

Yeah, I don't think we're talking about reporting even our analog data center products as Optical..

No..

We'll pull it out of Optical. And in the spirit, we want to provide greater visibility and granularity in terms of that Data Center business is really driven by a different set of economics than the service provider side.

So, now that we're going to have such a mass of revenue, it makes sense to report on that separately as it really behaves differently. But we got to get to the point of actually slicing and dicing the AppliedMicro revenue to come up with definitive answers 90 days from now..

Understood. Thank you very much..

You're welcome..

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

Yes. Thank you.

Can you just clarify what exactly is going to be reported under Data Center revenue?.

So we sell many products, clock data recovery, TIAs, the L-PIC would be a Data Center product, some of the framers, OTM, MACsec is a Data Center primarily, and the PAM4 when that kicks off that would be more of Optical application..

Data Center..

Okay.

I just got a bit confused because you said some of the analog parts you're actually not going to included in Data Center or did I not hear that correctly?.

No. So the products that we have that we started reporting as Data Center last quarter, these are VCSEL and laser drivers, TIAs, CDRs and so on. We will report those separately as Data Center separate from Optical.

And then, a sizable chunk of the AppliedMicro portfolio, notably PAM4, but they sell a lot of product into enterprise data centers, so that's the part of their revenue that we'll be reporting as Data Center. So it's not just cloud data centers, its enterprise and cloud data centers..

That's very helpful. And you also talked about some competitors kind of flushing out inventories in the March quarter in the PON area.

I'm just wondering, are these same competitors going to be around or they're basically just – these are older parts that they need to flush out? I'm just trying to understand the dynamics a little bit better there, which obviously gives you confidence that maybe PON is going to start growing again in the June quarter..

Yeah. So basically, what happened is, coming in Mitsubishi and CyOptics, Avago, Broadcom or whatever they're called now were really the two incumbent big guys. And when there was a supply shortage, there were four Asian competitors that attempted to try to fill the void in addition to buying optics.

And what happened was when we got so aggressive in taking share a few quarters ago during the summer, we got up to about 70% share. We've got a cost structure that is well below what any of these guys have. We could meet the market price targets and basically consolidate down to the three big guys.

Well, three of the four guys basically decided, what we understand is, to exit the business and started liquidating inventories. When that behavior starts, as you could imagine, there's dumping that goes on, they'll sell at any price.

So we assumed a posture of saying, okay, we got to let that stuff flush, because our primary concern is preserving ASP such that when that stuff flushes, we still have a healthy cash flow business, because the end market demand has not changed. Our customer is telling us the end market demand is the same.

There are some other dynamics with one of our customers changing from an in-sourcing to an outsourcing with five sub con (52:31), so lots of kind of moving parts. But at the end of the day, there's three definitive guys, second tier guys that are exiting the business. And the fourth one, they're on the ropes..

Okay..

So that's something that frankly we didn't fully anticipate that when guys exit, that happens, but it is what it is..

Okay, very good. And then the last question is on GaN. So maybe you could talk a little bit about some of the milestones from your own manufacturing perspective.

And my understanding is that you're going to be manufacturing all this in-house, is that the case? Would you consider doing outsourcing? And again, what are some of the milestones for us to monitor as far as manufacturing on your side as you gear up for bigger GaN ramps?.

Yeah, so the answer is really time dimensional. So that when the Nitronex business came over it was outsourced. Nitronex was not manufacturing wafers. So we still have that source that supplies some of our GaN. We then brought it into Lowell, so we have Lowell as a source – as a qualified source now for our Gen4.

And then we have another partner that I'm just chomping at the bit to announce, which is the game changer in terms of the cost structure. We're within spitting distance now of being able to announce that and be off to the races. So in terms of wafer supply, it's going to be multi-sourced.

That's one of the things that if you're going to supply a proprietary product to base station guys, you can't be supplying it from one factory, right? You need to have surge capacity. So that supply chain is really being tuned with partners both on the front-end as well as back-end.

The back-end manufacturing is equally critical in terms of surge capacity. So it's not fully internally sourced; partially, but not entirely..

That's helpful. Thank you very much..

You're welcome..

Thank you. And our next question comes from the line of Harsh Kumar from Stephens..

Yeah. Hey, Bob, a lot of us are trying to triangulate on the March guide and trying to figure out what's what in that.

Is there any way you could give us a range or point us in the direction of how much is switch and how much is Compute business, or give us some idea thereof?.

So it was in the 20% to 25% range of total revenues last quarter, for their December quarter..

Okay. That's helpful, Bob. And that's together, right? Obviously, the Compute business was not very much so – okay. That's very helpful. And then you're saying it falls off really, really fast from there..

Yes..

Okay. Also second question, in terms of – and then this is for John and Bob.

Guys, so in terms of – you have it now, it's a little early, couple of days now, but obviously, I would suspect there's some consolidation at least at some level that will happen? How do you view these? Is there even an opportunity here?.

I'm sorry, consolidation of....

Like cost cuts. Cost cuts..

Oh, yeah. Yeah. People have already been informed; the people who are not staying on. Many have already left.

And then one of our goals and what we've achieved at this time is, at the time of closing, everyone knows definitively if they are staying, if they are going, if they are staying temporarily for 90 days, 180 days, transitional, we owe it to them to be very clear.

And for those who are not necessarily in the short term – necessary in the short term, they're informed immediately and walk away with very generous packages. So yeah, there is a lot of cost savings going on right now..

Understood. And another one for Bob.

Bob, in terms of OpEx, would you be able to give us an idea of how that – the new OpEx for March, how that breaks down into R&D and SG&A considering it's going to have a pretty big component from AMCC?.

So I think you'll see a continued – the way I'll tell you is, you'll see continued expansion of operating margin by 100 basis points to 200 basis points, something like that. So I think on the guide, you can kind of get to the number there..

Fair enough. That's helpful. And then, sorry, back up to John. John, you mentioned there is a – on the GaN side, there is a global requisite from a customer, one of your potential customers. And then you've separately mentioned there is a 900 megahertz bid request on the product side.

Are these two from the same guy or customer? Or are they from the two separate customers?.

The one I was referring to are both from the same guy. There are other 900 megahertz requests that are not as far along. By the way, there are other customers where we already have global purchase agreements.

The reason why I called out the new one was the fact that it's new, specifically for base station business, is an indicator that they are looking to move forward and to bring us on as a mainstream supplier. I can't say – if we have a GPA that pre-exists, I can't make that statement. We're already covered by a GPA.

But what I was trying to do is really provide our investors visibility into the leading indicators that we're on the right track. And that to me, for that particular customer, which is a very substantial player, is a very big deal..

Understood. Thanks, guys. This is all I have. Thank you..

You're welcome..

Thank you. And our next question comes from the line of Richard Shannon from Craig-Hallum..

Hi, John and Bob. Thanks for taking my questions. Maybe just a couple for me; first on the topic of PON.

Taking into account both your prepared remarks as well as one of the questions, John, curious what your expectations are for share that you might have after the three of the suppliers liquidate their inventory? I think you mentioned CyOptics and Mitsubishi as ones who've historically been there.

Do you expect them to maintain or could you have a share easily higher than the 70% number you talked about over the summer?.

It's quite possible we could end up with higher share. It's just when you get above 70%, it's kind of diminishing returns in terms of incremental share. I think when you get up to that level, you're going to be guided more by the end market health than anything else, but I can't predict those competitors' behaviors.

We suspect that this is relatively poor margin business for them, so it's not something at all that they care to fight over. But it's not like we're looking to rule the universe with a monopolistic supply condition either. So at 70%, we're happy; we accomplish what we want which is a great cash flow business..

Okay. Fair enough. Question on your L-PIC products and, if I could, I'd like ask you to repeat the comments about the products you intend to come out with here. I thought I heard you say CWDM4 and PSM4, but if you could just repeat which products you specifically anticipate for L-PIC that would be great..

Yeah. So the product that we'll be showcasing in OFC is the first product which is quad L-PIC for CWDM4. So that is a very hot commodity for data center applications; really showcases the benefits of that self-aligning technology..

Okay.

And just to verify, you also said PSM4 as well, John?.

Yeah. I don't think we've announced anything about product plans beyond that, but we have very ambitious plans taking advantage of that L-PIC capability..

Okay.

And then on CWDM4, is there any way you can give us a sense of timeframe you expect to be in the volume production for that?.

Second half of the year, unequivocally, we'll have production units at OFC. In fact, I believe we have production units today. We're just completing the qualifications. It's kind of like analogous to the GaN ramp. There's issues of getting the supply chain aligned to be able to scale to the volume acquired for these datacenters.

And we have complete alignment with our manufacturing partner on that stuff and it's a matter of just locking down supply and securing the designs.

We've actually got the same customers who we would anticipate to be the lead customers for the L-PICs with previous generation where we're not supplying the L-PIC, we're providing all the analog content at a higher level of solution with the right supply chain lined up.

So, the L-PIC really kind of slots in as the next generation that disrupts the cost structure that much more. But it's not like our revenue and data centers is waiting for the L-PIC..

Right, of course. Understood. Last question for me, you mentioned you're still capacity constrained.

Anyway you can give us a sense of what product or products you are constrained on and how long those will remain?.

We have insatiable demand for the modulator drivers where we have leadership share as well as for the TOSAs/ROSAs; every single product that we can manufacturer, we can sell for the foreseeable future..

Okay. Perfect. That's all the questions for me, guys. Thank you very much..

You're welcome..

Yeah, I just like to – Harsh, to your question on operating margin, the right range is about 50 basis points to 100 basis points, not 100 basis points to 200 basis points. I want to make that clear..

Thank you. And that concludes our question-and-answer session for today. I would like to turn the floor back over to John Croteau for any closing comments..

Very good. Before closing out today's call, please note that we will be attending a number of upcoming investor events, including the Goldman Sachs Conference on February 15 in San Francisco and the Raymond James Institutional Investors Conference in Orlando on March 6.

In addition, we'll be taking meetings at Mobile World Congress in Barcelona and OFC in Los Angeles if any of you have planned to attend. If you'd like to request a meeting at one of these upcoming events, please email us at ir@macom.com. We look forward to reporting our fiscal second quarter results and continued progress on next quarter's call.

That concludes today's remarks. Operator, you may now disconnect the call..

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a great evening..