Q1 2023 Credo Technology Group Holding Ltd Earnings Call

August 31, 2022

of reach requirements, delivering a comprehensive family of options that span from longest reach LR plus links with more than 40 dB loss to the short XSR links required in multi-chip module SSE designs. CRETA is unique compared to other CERDIES IP providers in that CRETA will develop and deploy this same IP in our next generation 5 and 4 nanometer products for our AEC Optical DSP and Line Card by Solutions. This becomes a great benefit to our IP licensing partners since CRETA is walking the walk on product deployments right in step with our CERDIES IP customer deployments. I will also say that we expect to again deliver the best power and performance combination for all our IP and product solutions in 5 and 4 nanometer. In the past, we've talked about CRETA's core advantage of using more mature and less expensive process technology while delivering lower power to smaller sizes than our competition. We refer to this as an N-1 process advantage. We believe we've extended this N-1 process advantage to 5 and 4 nanometer and that our competition will need to move to more advanced and expensive processes to be competitive with CRETA. Regarding our CERDIES chiplet efforts, we were honored to be mentioned by Tesla at TSMC's Technology Symposium in June as their key connectivity partner for their leading-edge Dojo Super Computer Design where CRETA provided their 112-gig XSR CERDIES IP and their 3.2 meter-bit per second chiplets. Also notable, we recently became a UCIe contributing member.

building on the market momentum for our industry-leading XSR series IP and our two 3.2 Tbps production chiplets. In summary, we continue to be excited about our progress as we deepen relationships with current customers and as we receive commitments from new customers. We're also encouraged by the prospects of our next generation 100 Gb per lane solutions based on strong customer feedback and engagement.

Near term, we remain focused on delivering strong results in our fiscal 23 as we continue to expect to achieve at least $200 million in revenue, which would represent an annual growth of more than 88%.

Now, I'll turn the call over to our CFO , Dan Fleming, to provide more details on our first quarter and to give guidance on Q2.

Thank you, Bill, and good afternoon. I will first review our Q1 fiscal 23 results and then discuss our outlook for Q2 of fiscal 23. As a reminder, the following financials will be discussed on a non-dap basis, unless otherwise noted.

I'm pleased to share with you that in Q1 we achieved another quarter of record revenue at $46.5 million above the midpoint of our guidance range and up 24% sequentially.

Sequential growth was driven by strong revenue growth of our products, which also reached a record of $36.1 million for the quarter, up 37% sequentially.

This growth in product revenue was led by a continued wave of AEC adoption that will continue to transition our revenue mix from being IP focused to product focused.

The fundamental driver of our product growth, a strong HSDC expansion outlook at the highest speeds remains in place in the face of an uncertain economic and geopolitical landscape.

Our IP business generated $10.4 million of revenue in Q1. IP remains a strategic part of our business, but as a reminder, our IP results may vary from quarter to quarter, driven largely by specific deliverables to pre-existing contracts.

While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q1 was 22% IP, above our long-term expectation for IP, which is 10 to 15% of revenue.

With a strong product result this quarter, we delivered gross margin of 60.5%, above the midpoint of our guidance.

This was down 316 basis points sequentially, driven principally by revenue mix changes.

Our IP gross margin was 91.2% in Q1.

And our product gross margin was 51.8% in the quarter. Up 326 basis points sequentially, and up 11.6% percentage points year over year. This product gross margin expansion is principally due to leverage from our strong product growth.

Total operating expenses in the quarter were $22.6 million at the midpoint of our guidance, and up 43% year over year as we scaled the organization for growth.

We expect to continue to deliver considerable leverage in the business.

Our op-ex increase was driven by a 50% year-over-year increase in R&D, as we continue to invest in the resources to deliver innovative solutions.

Our SG&A was up 33% year over year as we continue to build out public company infrastructure.

We delivered operating income of $5.7 million in Q1, up 138% sequentially.

Our operating margin was 12.2% in the quarter, up 584 basis points quarter over quarter, as we continue to gain operating leverage.

We delivered net income of $5.4 million in Q1, up 96% sequentially.

Cash flow from operations in the first quarter was negative $12.2 million, a decrease of $14.6 million sequentially, as a large receivable of $11.5 million came in the week after our quarter ended.

CAPEX was $5.3 million in the quarter, driven by production mask spending. And free cash flow was negative $17.5 million, a decrease of $7.2 million year over year.

We ended the quarter with cash and equivalents of $243.8 million, a decrease of $15.5 million from the fourth quarter. This decrease in cash was a result of continued working capital investments to support our top line revenue growth.

Our accounts receivable balance increased 86% sequentially to $54.8 million.

while day sales outstanding increased to 107 days, up from 72 days in Q4.

Our Q1 ending inventory was $37 million.

up $9.7 million sequentially as we continue our product ramp while successfully building AEC buffer inventory to minimize the impact of any manufacturing disruptions in the future.

Now, turning to our guidance for the second quarter, we currently expect revenue in Q2 to be between $48.5 million and $52.5 million.

up 9% sequentially at the midpoint in 91% year over year.

We expect Q2 gross margin to be within a range of 59 to 61 percent.

We expect Q2 operating expenses to be between $23.5 million and $25.5 million.

And finally, we expect Q2 rated average deluded share count to be approximately 159 million shares. Deluded share count to be approximately 159 million shares.

As Bill mentioned, we remain on track to achieve at least $200 million of revenue in fiscal year 23.

And coupling our strong growth with our fiscal discipline, we will continue to generate leverage in the business and expect to deliver a double digit operating margin for the full year.

And with that, I'll open it up for questions. Thank you.

At this time, I'd like to remind everyone in order to ask a question, please press star 1-1 on your telephone keypad.

We'll pause for just a moment to compile a Q&A. Rasa?

Your first question comes from the Vick Araya of Bank of America. He'll slide us open.

I'm curious, how are you thinking about the mix between AEC, optical, you know, Lion Cart 5 and IP now versus what you thought three or six months ago? How has that mix evolved? And have you seen any headwinds or pushbacks at all from a macro perspective that a number of your larger peers have pointed to in their recent earnings calls?

Thanks for the question. I appreciate that.

Appreciate that.

You know, from the mixed perspective, I think we're right on track with what we expected six to nine months ago.

Of course, we've quickly seen our AEC business turn into our largest from a revenue standpoint. Line card follows and then optical is going to be next. Long term, we expect that our revenue mix will really match the market TAM in a sense that long term we expect AEC to be our largest product business, followed by optical, and then followed by line card. So really no changes there.

And then on a macro level, I think we're in a very good position generally. If you look at our engagements with our customers, they're all really on the leading edge for new technology deployments that really deliver the necessary next generation bandwidth that is really forefront in their requirements.

And so.

If decisions are made by our customers to slow the quantity and rate of deployments, we still see large and ramping volumes for the programs that we're on. So I would say that we're not seeing the same kind of macro level impact to our business just given our positioning.

And for my follow-up Bill, on the topic of AEC and your lead customer, I'm curious which innings of adoption do you think your product is in? If you look at the total number of high-speed ports being deployed at your large customer and you look at the adoption of your AEC, where are we in that adoption phase? Because I'm trying to determine whether we should be expecting a digestion phase or is it too early in the ramp?

to expect any kind of digestion phases, where are you in the adoption process at your largest customer?

Sure, sure again thanks for the question. I would say that we're in the the middle innings of the first initial ramp.

So it's reflected in the fact that we grew so significantly this quarter and our expectation is that ramp will really continue through the next quarters.

Do you expect it to go next year as well?

Well, generally speaking, the opportunity that we've got really matches the number of servers that are deployed at each one of our...

hyperscale customers.

And so.

I would say that also we're engaged in multiple programs as they change technology for the network interface card or NICs at the server level.

And so ultimately I believe that the ramp that we've got with our first customer will continue. It's hard for me to say from a volume standpoint will the volumes continue to increase after we're fully ramped.

But then we expect to add more customers to our mix that will be significant in the fiscal 24 timeframe.

Thank you.

Thank you. Our next question comes from Tashia Hari of Goldman Sachs. Your line is open. Your line is open.

Thank you so much for taking the question. I had two questions as well, one for Bill and one for Dan. I guess in terms of your optical solutions business, Bill, I think you did a great job in talking about your customer engagements qualitatively. I was hoping you could give perhaps some guidance on the quantitative front. You talked about it being a big growth contributor over the next couple of years. How much do we think about fiscal 24 and...

products that we're promoting.

I will say that you know there is

There are some surprising trends in the end markets where we see that the 200 gig optical module is much, much higher volume than the forecasters showed going back two or three years ago.

400 gig we see is something that's really still increasing, where it was really a small percentage of the market up until the first major hyperscaler round. But we see others adopting 400. 800 gig, we see it will not be adopted by every hyperscaler in the market, as some look towards the next generation 1.6T. So in general, we look at every hyperscaler as an independent market, and that's really how we're pursuing the different opportunities.

So we've gotten many irons in the fire across the industry on many different port markets, really from 100 gig through 800 gig, and even we have early conversations going on about 1.6T.

So just as a follow-up, Bill, is it fair to assume that some of the commentary that you provided at the time of your IPO still stands today? You're on track to hit kind of the medium to long-term numbers in optical DSP.

Yes, we believe we're on track. Okay, got it. And then as my second question for Dan, product gross margins were up nicely both sequentially and year over year in the quarter. As we think about the next couple, if not several quarters, as you continue to ramp at your largest AEC customer, your second customer comes in toward the end of the fiscal year and from a low base your DSP business starts to ramp. How should we think of that?

And we've demonstrated throughout all of fiscal year 22 and now starting into fiscal 23 that these product gross barges will expand as we gain scale. So we expect that expansion to continue fundamentally just because of the scale we're attaining over the next three to four quarters. You know, beyond that the fiscal year 24 and fiscal year 25 stories are similar to what we had described before. There will be, we believe, some favorable delays because of the timing in which we came across these, what you're currentlyfeely representing, were specifically Tony swimming and uncertainly saying, you know, plus And a problem can be solved over those deposits, it can be kind of tricky but, you know, it's at the bottom of all it's bad for you and you're better off management. We're setting it up to be fantastic for Guests on an intentional credit this month. So folks and All the work that's been done byoa Thank you. So I appreciate that someone pointed out its wonderful shift and

Revenue mix trends over those years that will help further increase that or further expand that gross margin and Some of the dynamics and the the AEC market will also contribute to that margin expansion When 800 gig ports are kind of the predominant port So there's a lot of different Trends that we've seen that we've described in the past that we believe will will we expect to see as we described in the past

Very helpful. Thank you.

Our next question comes from Vijay Rachig of Missouha, your line is open.

Please make sure your phone isn't on mute.

Hey Bill and Dan, just on the 64 gig optical transceiver side, how many customers would you be engaging with? Are you seeing basically the RAMP going with multiple customers or are you starting with one and then slowly ramping other ones into fiscal 24-25?

Good question. And so, our main partner is a large networking OEM. We are shipping these optical DSPs, these 64 gig single lane, to multiple optical partners that are fulfilling that demand that comes from the networking OEM that we're working with.

Got it. And on the supply side, I know you guys have been building a buffer inventory, et cetera, but can you talk to how you have probably improved your supply chain logistics, et cetera? That's why inventory is up a little bit. But can you talk to what you're doing there in terms of securing your forecast and securing the supply side as well, giving that customer supply assurance at least?

Thanks. Sure, sure. Yeah, that's a very good question. I would say from a supply standpoint, we find ourselves in much better shape right now than we were in the past quarter when we had the issue with the shutdowns in China. And so there's different elements of our supply chain that we look at. Of course, we are actively planning wafers with TSMC, and that's a very regular discussion we have with them. We see no issues for the foreseeable future there. Thank you.

Packaging substrates are another very frequent conversation we're having with our partners. We feel very good about our position today with those supply chain partners as well.

And then finally, with our AEC supply chain partners, we find ourselves in a much better position now. We did exactly what we said we were gonna do on the last call from June 1st.

to avoid any kind of near-term disruptions that are caused by COVID. In China, we built an inventory and that's why you see the inventory tick up. So we're not surprised, it's absolutely right on track with where we wanted to be.

Longer term, we mentioned also that we're going to be working towards having geographic diversity.

time, but we have made progress during the last quarter in starting and making progress with those discussions.

Generally, I think we are in good shape from a supply chain partner perspective.

Thank you.

Generally, I think we're in good shape from a supply chain partner perspective.

in good shape from a supply chain partner perspective. Thank you.

Thank you. Our next question comes from Suji DeSelva of Roth. Your line is open.

Maybe asking the cabling question a little differently for the customers that are going to ramp up. Should we expect pricing to trend similar to the initial customer or higher with more features? Just any indication there would be helpful along with the margin discussion you already gave us.

Sure, that's a good question.

I would say that not every one of the AECs that we're building is similar. And so as we...

develop AECs that are built towards a different specification, there will be some variance in the ASPs.

I would say right now with the current AECs that we're shipping, I think there is an opportunity for the ASPs to increase from that point. It's really based on the type of AECs we'll be shipping as well as we move towards increasing speed. The first products that we're shipping are really tethered to the passive AECs that we're shipping are

cable market. And so there's a real perception that our AECs are a premium over these passive copper solutions. And so we've been a bit tethered in a sense when we're having the discussions when it relates to our 100 gig, our 200 gig, our 400 gig AECs. As we start looking at the future 800 gig.

DAX will not be in the, passive copper cables will not be in the conversation. And so this is really where

you know, the solutions that are alternatives to ours, we're going to be in a much, much better position from a pricing and power standpoint.

And so, in a sense, we'll be untethered at that point, and we expect that ASPs will naturally rise as a result.

So, you know, I would say that.

near term as we look at ramping our second customer and we look at fiscal 24 in particular.

that because the cable that we're building is a much more complex cable, the SPs will be a bit higher.

And so we'll see it trending up just based on the fact that we're shipping AECs that are more complex to build.

with a heavier cost content.

Yeah, much of that cost, of course, from a production mass perspective, becomes fixed assets for us.

So there will be a consumption of cash, but that's really FY24 and beyond. We've got engineering tape outs before that point in time, but they are not, they're baked into our OPEX forecast and they're not overly material from that perspective.

Thanks guys.

Thank you.

Our next question comes from Matt Ramsey of Cowan. Your line is open.

Flashback all through on behalf of Matt. Thanks to my question and congrats on the results. I want to ask about with your data center exposure, there've been some well-documented delays in CPU upgrade cycles that have I-O upgrades, the DDR5. Is there any line that we should be drawing between your exposure and upgrade that your customers to the CPU upgrades, or is it sort of irrelevant at this standpoint?

you know, a series of upgrades that will, from a connectivity standpoint is really, you know, the way we view it. They'll be moving to lanes of 50 gig per lane and then lanes of 100 gig per lane. And so, yeah, we are a bit, you know, we're not gonna ship AECs until these new NICs and servers are shipping. And so there is some dependence there and that's why we can't be too specific with the timing of the ramp. It's really...

based on the best feedback that we're getting as our customers go through their next generation development and planning on their deployments.

Thank you. That's very helpful. I know you mentioned that the IP license revenue has been running higher than the target 10 to 15%. How should we, I guess, square that away with the flat gross margin guidance? Should we expect licensing to remain elevated near term? I don't know how the Tesla Dojo supercomputer is layering in or if there's a consumer piece in there. Or is it just, you know, licensing is expected down next quarter, but it's going to be

it's a little bit more challenging to figure out what that overall revenue mix is going to be. Whereas over a full fiscal year, we have a high degree of confidence in the overall revenue mix that we see.

So from that standpoint, you see our IP revenue went from about 30% of revenue in our Q4 to 22% in Q1. Long term we said it'll be 10 to 15%. So over the course of the next few years we'll get to that range, but there's going to be some variability from quarter to quarter as we get there.

Hopefully that's helpful.

So that is thank you guys. I'll hop back in the queue.

Okay.

on our end, we're not hearing anything. There's some sort of difficulty. Mr. Swabenberg, please make sure your phone isn't on mute.

I didn't hear anything either. Thank you all very much for all of your questionsrim dive into this because we love that you give a valuable

So I had a question on sort of your revenue mix. Obviously, you have a lot of green feed opportunities and you've got new businesses ramping, but we are obviously hearing selectively about, you know, some softness here and there, even on the data infrastructure side of things. So could you quantify for us, you know, how much of your business may be subject to, you know, softness on the data infrastructure side?

Sure, it's a good question. If we look at our end customer for Ethernet products, it's really data centers and supply chain partners of data centers, so networking OEMs and ODMs as well as optical manufacturers.

And so, definitely there is a high dependence on the data center market in general.

For us, near term, we are not going to be impacted as much by changes that happen within that group of players. Really because we're ramping on new next generation technology deployments that really deliver the necessary bandwidth increases that everybody's planned. And now we expect that our customers are going to ramp new technology as fast as they can.ipers.

And because we're in an early stage in our company development, many of the programs that we ramp are really the first programs that we're ramping with a given customer. So although they may decide to spend a little less or spend at a rate that's less than they had originally planned, what we see is ultimately...

large ramps, large volume ramps, whether they're slightly down compared to what was planned. To us, it views, as you said, a greenfield new ramp. So I don't expect near-term for our business, meaning the next year, two years, that we're going to track with any kind of changes within our customer base.

since we're really on the new technology end of the spectrum.

Yeah, thank you Bill. That's great perspective. My other question is on supply. You did talk about some of the disruptions now being behind you. I know you're also working on further diversifying your supply chain so I was hoping you could update us with a little bit more detail there and you know when would you expect especially on the on the AEC side you know to have a more diversified commodities.

Good question. Good question.

You know, we've been working very closely with two different partners really over the past several years as we've pioneered this market.

We are in production mainly with one of those suppliers now, and the second supplier will ramp.

really in the near term in the upcoming couple of quarters. So we'll have a nice diversity as we look at fiscal 24.

Great, just one last question for Dan. You talked about some of the working capital dynamics and especially the DSOs, that being hard and unusual, but any read of the next few quarters how the DSO will trend?

Yeah, we would expect it to come down, certainly. You know, as we mentioned, the timing of AR sometimes is a little bit out of our control, and as we have customers ramping, our AR, you know, just specific invoices have become much larger, and we received one particular one, you know, four days after the quarter ended.

So.

When you start calculating balance sheet metrics, that actually has a significant impact on things.

So, quarter over quarter, we're going to see fluctuations in these working capital items, including payables and some other accruals. But over the long term, it will smooth out, and we expect DSOs, DPOs, and even days of inventory will normalize over the next year or so.

Sounds good. Congrats on the results. Thank you.

Thank you.

Thank you. Our next question comes from Trevor Janoski of Needham & Company. Your line is open.

Hi, this is Trevor on for Quinn Bolton and thanks for taking my question. I'm wondering, have you seen any competitors begin designing solutions that could compete with your AEC opportunities at the first and second hyperscale customers? And or do you see Credo as the sole supplier through fiscal 24?

Good question. For sure we've seen

competitors beginning to make investments in this space.

And I think that's a great indicator that at an end customer perspective that it's of high priority and that's why anybody would start investing in a new business.

really based on customer-driven demand.

We haven't really seen competitors begin to deliver products.

that we would see in the field.

But we know that there are several companies that are making large investments.

So we feel comfortable with where we are competitively.

And I think that as it relates to the first couple of ramps that we'll go through, we never take anything for granted.

I'm never going to say that our customer base is comfortable with a single supplier, just like we would be uncomfortable in that same situation.

And so I will say that from the standpoint of the demand forecast that we've got, I feel very confident in the demand forecast.

And in the near term, I think we expect it to be quite predictable.

Thank you. And in your comments, you mentioned being in the middle innings of the ramp with that large customer. Does that mean that your large customer is still providing order forecasts that extend past 12 months? Or has that visibility come in at all?

Our relationship with the first customer is one where they frequently give us a 12-month outlook.

and

I can say that for the 12 month outlook, I think everything makes sense. And every time we get extended another month, to date there's been no surprises. So our expectation is that this program is gonna run through.

calendar 23 and into 24.

But we're well positioned for the next generation programs as well as they would maybe ramp down that given technology deployment and ramp into the next generation one. So that's really the goal that our team has in working with this customer as well as every other customer that we're engaged with.

Awesome. Thank you.

Thanks for taking my question. A quick follow-up from an earlier question regarding supply diversification on AECs. Is this a diversification by supplier or is it also diversified by geography, meaning out of the Shanghai area or even out of China?

Good question. The diversification that we'll see near term is with supply partners. So we'll go from having one in production to having two in production.

Geographically, that will come a bit later. That will be later in calendar 23.

So.

So just as expected, we're right on track. So both suppliers will be building in China short term, and then we'll look to build diversity geographically following that.

Okay, perfect. Thanks for that bill. My follow up question is on a C's. Can you talk about the applications and the specific products you're referring to? I know that with the first partner, I think they've been first, at least the first two are Nick to tour. And I think maybe your second customer is also a similar similar approach here. Are you seeing any expansion into your other AC AC categories like the switch or the span or anything like that? And so when do we start to see that happening?

Sure.

You're right that the first two customers that we've talked about, these are both Server rack or NIC to tour

applications.

We do also see customers that are looking to adopt.

our AECs for the switching and routing layer as well.

And these are primarily 400 gig, but as we look at 800 gig or 100 gig per lane, I think it's going to be quite common for those customers that choose to go with disaggregated switch racks.

But I think near term, say this year and next fiscal year, predominantly we'll be shipping.

ADCs that are in a server rack application.

Okay, perfect. That's great detail and that's all from you, Bill. Thank you.

I'm just want to know further questions at this time. This does conclude today's conference call. You may now disconnect. Have a great day. Thank you.

The conference will begin shortly. To raise your hand during Q&A, you can dial star 11. The conference will begin shortly. To raise your hand during Q&A, you can dial star 11.

And.

you

Ladies and gentlemen, thank you for standing by. At this time, all participants are on a listen-only mode. Later, we'll conduct a question and answer session. At that time, if you have a question, please press Stone 1 on your touchstone telephone.

I will now turn the conference over to your host, Mr. Dan O'Neill. Please go ahead, sir.

Good afternoon, and thank you all for joining us today for our fiscal 2023 first quarter ending earnings call.

Joining me today from Credo are Bill Brennan, our Chief Executive Officer, and Dan Fleming, our Chief Financial Officer.

I'd like to remind everyone that certain comments made in this call today may include forward-looking statements regarding expected future financial results, strategies and plans, future operations, the markets in which we operate, and other areas of discussion.

These forward-looking statements are subject to risks and uncertainties that are discussed in detail in our documents filed with the FCC.

It's not possible for the company's management to predict all risks, nor can the company assess the impact of all factors on its business, or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement.

Given these risks, uncertainties, and assumptions, the forward-looking events discussed during this call may not occur, and actual results could differ materially and adversely from those anticipated or implied.

the company undertakes no obligation to publicly update forward-looking statements for any reason.

after the date of this call to conform these statements to actual results or to changes in the company's expectations, except as required by law.

Also, during this call, we will refer to certain non-GAAP financial measures.

which we consider to be an important measure of the company's performance.

These non-GAAP financial measures are provided in addition to, and not as a substitute for, superior to financial performance prepared in accordance with US GAAP.

A discussion of why we use non-GAAP financial measures and reconciliations between our GAAP and non-GAAP financial measures is available in the earnings release we issued today as well as in our SEC filings.

which both can be accessed using the investor relations portion of our website.

With that, I'll now turn the call over to our CEO . Bill? Good afternoon.

Thank you, Dan. Good afternoon and thank you to everybody for joining the call.

During this call, I'll review our fiscal Q1 results and then share why we continue to be excited about our progress and our plans moving forward.

When I conclude, Dan Fleming, our Chief Financial Officer, will provide a detailed review of our financial results and expectations moving forward.

Credo's mission is to deliver high-speed connectivity solutions to break bandwidth barriers on every wired connection in the data infrastructure market.

We provide innovative, secure, high-speed solutions that deliver improved power efficiency and cost as data rates and bandwidth requirements increase exponentially.

Our connectivity solutions are optimized for both electrical and optical Ethernet applications, including the 100 Gbps, 200 Gbps, 400 Gbps, and 800 Gbps port markets.

All our products are built with our proprietary CERDYS and DSP technologies.

Our product families include integrated circuits or ICs.

Active Electrical Cables or AECs.

and CERTIS chiplets. Our intellectual property or IP solutions consist primarily of CERTIS IP licensing.

I'm happy to report that in the July quarter, we continued our strong execution.

Achieving $46.5 million in revenue, an increase from $37.5 million from the last quarter, up 24% sequentially.

Our product revenue, which is a key indicator we track closely, was up 37% sequentially, showing the strong progress we're making ramping our AEC products.

I would like to now provide an update on our product and CERTIS IP licensing businesses.

Starting with an update on active electrical cables, our AEC solutions represent a new high-speed connectivity product category that Credo pioneered.

As connection speeds increase, passive copper cables or DACs become obsolete due to severe signal integrity and size challenges.

Optical connections or AOCs have prohibitive challenges with power and cost.

AECs offer compelling in rack solutions, achieving half the power, half the cost, with better reliability and a more rugged physical design than AECs.

We continue to gain traction due to our engineering ingenuity and customer first mindset. To date we've sold ABCs to more than 30 customers including solutions for 50GB, 100GB, 200GB, 400GB and 800GB ports.

Our target customers include data centers, 5G carriers, networking OEMs and ODMs, as well as others in the Ethernet ecosystem.

During Q1, we continued to ramp the first two programs at our first major data center customer.

We also had our first revenue shipments to that same customer on a third next generation program.

With regards to our second major data center customer, we continue to make progress shipping the first pre-production AEC units for qualification prior to their ramp.

We remain encouraged by our prospects at this customer given the innovative nature of our AEC solution, and we continue to expect the initial ramp of this customer to happen towards the end of this fiscal year.

I'm pleased to share that we fully recovered from the supply chain shortfall caused by the COVID shutdowns in China last quarter, successfully meeting demand in Q1 while building a buffer inventory that will help to minimize the impact of any supply or manufacturing disruptions in the future.

We continue to invest aggressively in our next generation 800 gig ports AEC solutions with our leading 100 gig per lane series technology.

We've been working closely with our AEC customers to meet their future needs with innovative solutions to address opportunities for both the Server Rack and the disaggregated Switch Rack applications.

To this end, we've delivered and verified 800 gigaport AEC solutions to multiple data center customers, multiple networking OEMs, as well as additional ecosystem partners.

Now, turning to our optical solutions.

In this market, we work closely with both optical module manufacturers and data center customers to deliver disruptive solutions for optical DSPs, laser drivers, and TIAs.

We are in production with two data center customers.

through numerous optical module manufacturers in a joint development model or JDM where our data center customers specify the key components to be used in their optical modules such as a Credo optical BSP.

We are also engaged with several optical manufacturers across various applications including 100GB, 200GB and 400GB Ethernet solutions.

beyond the data center including TON, 5G, and Fibre Channel.

Notably, during Q1 we began production with a leading networking OEM for a 64 gig fiber channel optical module.

We recently announced our optical DSP with integrated laser driver solutions for next generation 800 gig and 400 gig optical modules with 100 gig per lane SIRDEE's technology.

FITO is now in a strong position to continue to deliver the same disruptive advantages on the combination of performance, power efficiency, and cost for these next generation 100 gig per lane deployments. Thank you.

With this strong progress, we continue to expect our optical solutions will contribute significantly to our growth in the future. And moving to our line card five, we are very pleased with our progress here as well. Credo has quickly become a leader in Maxxec solutions that provide data encryption for the growing number of applications requiring high security. We're happy to report that we are now ramping production directly with a second major data center customer deploying our 400 gig port Maxxec solution.

We see the market trend towards high security applications growing significantly in the future and we remain bullish on this business.

We continue to make strong progress with our Blackhawk 400-gig port retimer solution as well.

Numerous networking OEM and ODM customers are currently transitioning from qualification to mass production.

As the market trends toward higher speeds, we will continue to see increasing demand for retimer and gearbox solutions.

Given the signal integrity challenges at 100 gig per lane, Credo is well positioned on our next generation 800 gig LAN card 5 solutions driven by the same theme of delivering disruptive performance, power efficiency, and cost. Earlier this year, we announced our first generation 800 gig port LAN card solutions, and I'm happy to say that Credo has already been adopted by several customers as they developed their next generation 100 gig per lane platforms. Finally, we had another strong quarter with our Cerdys IP licensing and Cerdys Chiplet systems.

This market is very strategic for us and we had a strong revenue contribution in the quarter.

Since our last earnings call, we made two significant announcements on our SerDes IP offerings.

We announced the industry's first 40 gig PAM3 SerDes IP, which will be important for next-generation consumer designs.

This CERTIS IP is leveraged from the work we've done with our lead consumer partner, making our IP a clear choice for next generation consumer designs.

We also recently announced availability of our 112 gig SerDes IP in TSMC's 5 and 4 nanometer processes.

We believe we've set a new industry benchmark for lowest power across a broad range of reach requirements. Thank you.

delivering a comprehensive family of options that span from longest reach LR plus links with more than 40 dB loss to the short XSR links required in multi-chip module SoC designs.

Credo is unique compared to other CERDYS IP providers in that Credo will develop and deploy this same IP in our next generation 5 and 4nm products for our AEC, optical DSP and line card by solutions.

This becomes a great benefit to our IP licensing partners since Credo is walking the walk on product deployments right in step with our Cirdes IP customer deployments.

I will also say that we expect to again deliver the best power and performance combination for all our IP and product solutions in 5 and 4nm. In the past, we've talked about Credo's core advantage of using more mature and less expensive process technology.

while delivering lower power to smaller die sizes than our competition. We refer to this as an N minus 1 process advantage.

We believe we've extended this N-1 process advantage to 5 and 4 nanometer.

and that our competition will need to move to more advanced and expensive processes to be competitive with Credo.

Regarding our CERTES chiplet efforts, we were honored to be mentioned by Tesla at TSMC's Technology Symposium in June as their key connectivity partner for their leading-edge Dojo supercomputer design, where Credo provided their 112 gig XSR CERTES IP and their 3.2 terabit per second chiplets.

Also notable, we recently became a UCIE contributing member building on the market momentum for our industry leading XSR series IP and our two 3.2 Tbps production chiplets.

In summary, we continue to be excited about our progress as we deepen relationships with current customers.

and as we receive commitments from new customers. We're also encouraged by the prospects of our next generation 100 gig per lane solutions based on strong customer feedback and engagement.

Now, I'll turn the call over to our CFO , Dan Fleming, to provide more details on our first quarter and to give guidance on Q2.

Thank you, Bill, and good afternoon. I will first review our Q1 Fiscal 23 results and then discuss our outlook for Q2 of Fiscal 23.

As a reminder, the following financials will be discussed on a non-GAAP basis, unless otherwise noted.

I'm pleased to share with you that in Q1 we achieved another quarter of record revenue at $46.5 million, above the midpoint of our guidance range, and up 24% sequentially.

Sequential growth was driven by strong revenue growth of our products, which also reached a record of $36.1 million for the quarter, up 37% sequentially.

This growth in product revenue was led by a continued wave of AEC adoption that will continue to transition our revenue mix from being IP focused to product focused.

The fundamental driver of our product growth, a strong HSDC expansion outlook at the highest speeds remains in place in the face of an uncertain economic and geopolitical landscape.

While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q1 was 22% IP, above our long-term expectation for IP, which is 10-15% of revenue.

With a strong product result this quarter, we delivered gross margin of 60.5% above the midpoint of our guidance.

This was down 316 basis points sequentially, driven principally by revenue mix changes.

Our IP gross margin was 91.2% in Q1.

and our product gross margin was 51.8% in the quarter, up 326 basis points sequentially, and up 11.6 percentage points year over year. This product gross margin expansion is principally due to leverage from our strong product growth.

Total operating expenses in the quarter were $22.6 million at the midpoint of our guidance, and up 43% year over year as we scaled the organization for growth.

We expect to continue to deliver considerable leverage in the business.

Our OPEX increase was driven by a 50% year-over-year increase in R&D as we continue to invest in the resources to deliver innovative solutions.

Our SG&A was up 33% year over year as we continue to build out public company infrastructure.

We delivered operating income of $5.7 million in Q1, up 138% sequentially.

Our operating margin was 12.2% in the quarter, up 584 basis points quarter over quarter, as we continue to gain operating leverage.

We delivered net income of $5.4 million in Q1, up 96% sequentially.

Cash flow from operations in the first quarter was negative $12.2 million, a decrease of $14.6 million sequentially, as a large receivable of $11.5 million came in the week after our quarter ended.

CAPEX was $5.3 million in the quarter driven by production mask spending. And free cash flow was negative $17.5 million, a decrease of $7.2 million year over year.

Our accounts receivable balance increased 86% sequentially to $54.8 million.

while day sales outstanding increased to 107 days, up from 72 days in Q4.

Our Q1 ending inventory was $37 million.

up $9.7 million sequentially as we continue our product ramp while successfully building AEC buffer inventory to minimize the impact of any manufacturing disruptions in the future.

Now, turning to our guidance for the second quarter, we currently expect revenue in Q2 fiscal 23 to be between $48.5 million and $52.5 million.

up 9% sequentially at the midpoint and 91% year over year.

We expect Q2 gross margin to be within a range of 59 to 61 percent.

We expect Q2 operating expenses to be between $23.5 million and $25.5 million.

Finally, we expect Q2 weighted average diluted share count to be approximately 159 million shares.

As Bill mentioned, we remain on track to achieve at least $200 million of revenue in fiscal year 23.

And coupling our strong growth with our fiscal discipline, we will continue to generate leverage in the business and expect to deliver a double digit operating margin for the full year.

And with that, I'll open it up for questions. Thank you.

At this time, I'd like to remind everyone in order to ask a question, please press star one one on your telephone keypad.

We'll pause for just a moment to compile a Q&A. Rasa?

Your first question comes from Vivek Araya of Bank of America. Your line is open. Okay.

Thanks for the question. Appreciate that.

So, from the MIPS perspective, I think we're right on track with what we expected six to nine months ago.

And then on a macro level, I think we're in a very good position generally. If you look at our engagements with our customers are all really on the leading edge for new technology deployments that really deliver the necessary next generation bandwidth that is really forefront in their requirements. And so,

For my follow-up, Bill, on the topic of AEC and your lead customer, I'm curious, which innings of adoption do you think your product is in? If you look at the total number of high-speed ports being deployed at your large customer, and you look at the adoption of your AEC, where are we in that adoption phase? Because I'm trying to determine whether we should be expecting a digestion phase, or is it too early in the ramp to expect any kind of digestion phase? Where are you in the adoption process?

at your largest customer? Sure, sure again, thanks for the question. I would say that we're in the middle innings of the first initial ramp.

So, it's reflected in the fact that we grew so significantly this quarter, and our expectation is that ramp will really continue through the next quarters.

Do you expect it to grow next year as well?

Well, generally speaking, the opportunity that we've got really matches the number of servers that are deployed at each one of our...

Well, generally speaking, the opportunity that we've got really matches the number of servers that are deployed at each one of our hyperscale customers.

speaking, the opportunity that we've got really matches the number of servers that are deployed at each one of our hyperscale customers.

I would say that also we're engaged in multiple programs as they change technology for the network interface card or NICs at the server level.

But then we expect to add more customers to our mix that will be significant in the fiscal 24 timeframe.

Thank you. Thank you. Our next question comes from Tashia Hari of Goldman Sachs. Your line is open.

I will say that there is.

There are some surprising trends in the end markets where we see that the 200 gig optical module is much, much higher volume than the forecasters showed going back two or three years ago.

So we've gotten many irons in the fire across the industry on many different port markets, really from 100 gig through 800 gig, and even we have early conversations going on about 1.6T. So we've gotten many irons in the fire across the industry on many different port markets, really from 100 gig through 800 gig, and even we have early conversations going on about

So just as a follow-up, Bill, is it fair to assume that some of the commentary that you provided at the time of your IPO still stands today? Or is it just a matter of whether or not you're on track to hit kind of the medium to long-term numbers in optical DSP?

all of fiscal year 22 and now starting into fiscal 23, that these product gross barges will expand as we gain scale. So we expect that expansion to continue fundamentally just because of the scale we're attaining over the next three to four quarters. Beyond that, the fiscal year 24 and fiscal year 25 stories are similar to what we had described before. There will be, we believe, some favorable revenue mix trends over those years that will help.

further increase that or further expand that gross margin. And some of the dynamics in the AEC market will also contribute to that margin expansion when 800 gig ports are kind of the predominant port. So there's a lot of different trends that we've seen that we've described in the past that we believe we expect to see as we've described in the past.

Very helpful. Thank you. Our next question comes from Vijay Rachig of Missouha, Yolanda's open.

Thank you. Thank you. Our next question comes from Vijay Rashid Amazuho, your line is open. Please make sure your phone isn't on mute.

Oops, sorry I was on mute. Thanks for that. Hey, Bill and Dan, just on the 64 gig optical transceiver side, how many customers would you be engaging with? Are you seeing basically the ramp going with multiple customers or are you starting with one and then slowly ramping other ones into physical 24, 25? Good question. Our main partner is a large networking OEM.

We are shipping these optical DSPs, these 64 gig single lane, to multiple optical partners that are fulfilling that demand that comes from the networking OEM that we're working with.

Packaging substrates are another very frequent conversation we're having with our partners. We feel very good about our position today with those supply chain partners as well. And then finally with our AEC supply chain partners, we find ourselves in a much better position now. We did exactly what we said we were going to do on the last call from June 1st.

to avoid any kind of near-term disruptions that are caused by COVID in China, we built an inventory and that's why you see the inventory tick up. So we're not surprised, it's absolutely right on track with where we wanted to be.

Longer term, we mentioned also that we're, you know, going to be working towards having geographic diversity. It's going to take some time, but we have made progress during the last quarter in starting and making progress with those discussions.

Generally, I think we're in good shape from a supply chain partner perspective.

Generally, I think we're in good shape from a supply chain partner perspective. Thank you.

Generally, I think we're in good shape from a supply chain partner perspective.

Generally, I think we're in good shape from a supply chain partner perspective. Thank you.

Our next question comes from Suji DeSilva of Ross. Your line is open.

Sure, that's a good question. I would say that not every one of the AECs that we're building is similar.

develop AECs that are built towards a different specification, there will be some variance in the ASPs.

that our AECs are a premium over these passive copper solutions. And so we've been a bit tethered in a sense when we're having the discussions when it relates to our 100 gig, our 200 gig, our 400 gig AECs. As we start looking at the future, 800 gig Every opportunity from you begins with AECs without even Christina.

DAX will not be in the, passive copper cables will not be in the conversation. And so this is really where...

you know, the solutions that are alternatives to ours, we're going to be in a much, much better position from a pricing and power standpoint.

And so, in a sense, we'll be untethered at that point, and we expect that ASPs will naturally rise as a result. So I would say that.

near term as we look at ramping our second customer and we look at fiscal 24 in particular.

that because the cable that we're building is a much more complex cable, the SPS will be a bit higher.

And so we'll see it trending up just based on the fact that we're shipping AECs that are more complex to build.

So we'll see it trending up just based on the fact that we're shipping ADCs that are more complex to build with a heavier cost content.

That's very helpful. Appreciate the detail color there. And then maybe for Dan, on the 5 nanometer, 4 nanometer products coming, can you give us a sense of the timing of when the R&D and CAPEX mask costs might come in and whether there would be a bump up there or whether that would be absorbed with the overall budget? Yeah, much of that cost, of course, from a production mass set perspective, becomes fixed assets for us. So there will be a consumption of cash, but that's really FY24 and beyond.

on behalf of Matt. Thanks for taking my question and congrats on the results. I want to ask about with your data center exposure, you know, there've been some well-documented delays in CPU upgrade cycles that have IO upgrades to DDR5. Is there any line that we should be drawing between your exposure and upgrades that your customers to the CPU upgrades, or is it sort of irrelevant at this standpoint?

Good question. I would say for the first customer that we've ramped with and that we continue to ramp with, there's really nothing on that front. These are nicks with 25 gig per lane connectivity. As we look at the next generation, there's a series of upgrades that will – from a connectivity standpoint is really the way we view it. They'll be moving to lanes of 50 gig per lane and then lanes of 100 gig per lane.

And so, yeah, we are a bit, you know, we're not gonna ship AECs until these new NICs and servers are shipping. And so there is some dependence there, and that's why we can't be too specific with the timing of the ramp. It's really based on the best feedback that we're getting as our customers go through their next generation development and planning on their deployments. I understand. Thank you.

That's very helpful. And then I know you mentioned that the IP license revenue has been running higher than the target 10 to 15 percent. How should we, I guess, square that away with the sort of the flat gross margin guidance? Should we expect licensing to remain elevated near term? I don't know how the Tesla Dojo supercomputer is layering in or if there is a consumer piece in there. Or is it just licensing is expected down next quarter, but it's going to be made up for by improving?

product margins as you scale. Thanks guys. Yeah, let me address that. So a great question, you know, IP as Bill mentioned is considered a very strategic part of our business and one thing about the revenue recognition process when it comes to license revenue is it can vary quite a bit from quarter to quarter. So as you look at our quarter over quarter results, it's a little bit more challenging to figure out what that overall revenue mix is going to be.

Whereas over a full fiscal year we have a high degree of confidence in the overall revenue mix that we see.

So from that standpoint, you see our IP revenue went from about 30% of revenue in our Q4 to 22% in Q1. Long term, we said it'll be 10 to 15%. So over the course of the next few years, we'll get to that range. But there's going to be some variability from quarter to quarter as we get there.

Hopefully that's helpful. Thank you guys. I'll hop back in the queue.

So that is thank you guys. I'll hop back in the queue. Okay.

On our end, we're not hearing anything. There's some sort of difficulty. Mr. Swabenberg, please make sure your phone isn't on mute.

Thank you. I didn't hear anything either. This is Torres from CIFO. We have a question from the audience. This is from

So I had a question on sort of your revenue mix. So obviously you have a lot of green feed opportunities and you've got new businesses ramping, but we are obviously hearing selectively about some softness here and there, even on the data infrastructure side of things. So could you quantify for us how much of your business may be subject to softness on the data infrastructure side?

And so, definitely there is a high dependence on the data center market in general.

our customers are going to ramp new technology as fast as they can. And because we're in an early stage in our company development, many of the programs that we ramp are really the first programs that we're ramping with a given customer. So although they may decide to spend a little less or spend at a rate that's less than they had originally planned, what we see is ultimately...

since we're really on the new technology end of the spectrum.

So we've been working very closely with two different partners really over the past several years as we've pioneered this market.

We are in production mainly with one of those suppliers now, and the second supplier will ramp really in the near term in the upcoming couple of quarters. So we'll have a nice diversity as we look at fiscal 24.

Great, just one last question for Dan. Dan, you talked about some of the working capital dynamics and especially the DSOs, that being hired unusual, but any read over the next few quarters how the DSO will trend?

Yeah, we would expect it to come down, certainly. You know, as we mentioned, the timing of AR sometimes is a little bit out of our control, and as we have customers ramping our AR, you know, just specific invoices have become much larger and we received one particular one, you know, four days after the quarter ended. So when you start calculating balance sheet metrics, that actually has a significant impact on things. So quarter over quarter, you know, we're going to see fluctuations in these working capital line.

question. I'm wondering have you seen any competitors begin designing solutions that could compete with your AEC opportunities at the first and second hyperscale customers and or do you see Credo as the sole supplier through fiscal 24? Good question and so for sure we've seen competitors beginning to make investments in this space.

And I think that's a great indicator that at an end customer perspective that it's of high priority. And that's why anybody would start investing in a new business.

really based on customer-driven demand. We haven't really seen competitors begin to deliver products.

on customer-driven demand. We haven't really seen competitors begin to deliver products that we would see in the field.

But we know that there are several companies that are making large investments.

So we feel comfortable with where we are competitively, and I think that as it relates to the first couple of ramps that we'll go through, we never take anything for granted.

I'm never going to say that our customer base is comfortable with a single supplier, just like we would be uncomfortable in that same situation.

And so I will say that from the standpoint of the demand forecast that we've got, I feel very confident in the demand forecast.

And in the near term, I think we expect it to be quite predictable. Thank you. And in your comments, you mentioned being in the middle innings of the ramp with that large customer. Does that mean that your large customer is still providing order forecasts that extend past 12 months, or has that visibility come in at all? Our relationship with the first customer is...

for the next generation programs as well, as they would maybe ramp down that, you know, given technology deployment and ramp into the next generation one. So that's really the goal that our team has in working with this customer, as well as every other customer that we're engaged with.

Awesome. Thank you.

Awesome. Thank you. Thank you.

Thanks for taking my question. A quick follow-up from an earlier question regarding supply diversification on AECs. Is this diversification by supplier or is it also diversified by geography, meaning out of the Shanghai area or even out of China?

Good question. The diversification that we'll see near term is with supply partners. So we'll go from having one in production to having two in production.

Geographically, that will come a bit later. That will be later in calendar 23.

So, you know, and so just as expected, we're right on track. So both suppliers will be building in China short term, and then we'll look to build diversity geographically following that.

Okay, perfect. Thanks for that Bill. My follow up question is on AECs. Can you talk about the applications and the specific products you're referring to? I know that with the first partner, I think they've been first, at least the first two are niktator. I think maybe your second customer is also a similar approach here. Are you seeing any expansion into your other AEC categories like the switch or the span or anything like that? When do we start to see that happening?

Sure. You're right that the first two customers that we've talked about, these are both server rack or NIC to Tor applications.

We do also see customers that are looking to adopt.

our AECs for the switching and routing layer as well. And these are, you know, primarily 400 gig, but as we look at 800 gig or 100 gig per lane, I think it's going to be quite common for those customers that choose to go with disaggregated switch racks.

But I think near term, say this year and next fiscal year, predominantly we'll be shipping.

ABCs that are in a server rack application. Okay, perfect. That's great detail and that's all for me, Bill. Thank you. Thank you. I'm showing no further questions at this time. This does conclude today's conference call. You may now disconnect. Have a great day. Thank you.

Q1 2023 Credo Technology Group Holding Ltd Earnings Call

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