Credo Technology Group Holding Ltd (NASDAQ:CRDO) Q1 2024 Earnings Call Transcript

Credo Technology Group Holding Ltd (NASDAQ:CRDO) Q1 2024 Earnings Call Transcript August 24, 2023

Credo Technology Group Holding Ltd beats earnings expectations. Reported EPS is $0.03, expectations were $-0.03.

Operator: Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Dan O’Neil. Please go ahead, sir.

Dan O’Neil: Good afternoon, and thank you for joining us on our first quarter earnings call for fiscal 2024. Joining me today from Credo are our Chief Executive Officer, Bill Brennan; and our Chief Financial Officer, Dan Fleming. 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 SEC. 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 statements.

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 important measures of the company’s performance. These non-GAAP financial measures are provided in addition to and not as a substitute for or superior to financial performance prepared in accordance with U.S. GAAP.

A discussion of why we use non-GAAP financial measures and reconciliations between our GAAP and non-GAAP financial measures is available in the earnings release we issued today, which can be accessed using the Investor Relations portion of our website. I’ll now turn the call over to our CEO. Bill?

Bill Brennan: Thank you, Dan, and thank you all for joining our Q1 fiscal ’24 earnings call. I’ll begin by providing an overview of our fiscal Q1 results. I’ll then highlight what we see going forward into fiscal ’24. Dan Fleming, our CFO will follow my remarks with a detailed discussion of our Q1 financial results and share the outlook for the second quarter. We would then be happy to take questions. For Q1, Credo reported revenue of $35.1 million. Additionally, we reported non-GAAP gross margin of 59.8%. Our Q1 results and future growth are driven by the accelerating market opportunity for high-speed connectivity solutions. Our electrical and optical connectivity solutions delivered leading performance of port speeds ranging from 50 gigabits per second up to 1.6 terabits per second.

While we primarily serve the data center Ethernet market today, we continue to extend into other standard-based markets as the need for higher speed and more power-efficient connectivity increases exponentially. The changing workloads in the data center specifically with regards to the onset of generative AI applications are driving the demand for higher bandwidth and higher-density networking. This plays directly in to Credo’s strengths. All of Credo’s connectivity solutions leverage our core SerDes technology and our unique customer-focused design approach, enabling Credo to deliver optimized, secure high-speed solutions with significant benefits in power efficiency and cost. Credo continues to see increasing customer engagements across our products and IP solutions, which include active electric cables or AECs, optical DSPs, laser drivers and TIAs, Line Card PHYs, SerDes Chiplets, and SerDes IP licensing.

I’ll now review our overall business to give more perspective. First, regarding our AEC business. Credo remains a pioneer in the AEC market. Industry analysts forecast increasing AEC market penetration as port speeds increase for intra-rack connectivity. Our AEC solutions offer significant benefits compared to both passive direct attached copper cables, which are physically cumbersome and poor signal integrity at higher speeds, and active optical cables or AOCs which are significantly higher power and higher cost. Today, our largest customer deploys our AECs for both general compute and AI applications. Additionally, we continue to design custom AEC solutions to solve for their next-generation deployments, including our first internally developed 100 gig per lane AI deployment.

At our second hyperscaler customer, our production ramp for both general compute and AI programs remains on track with expectations for continued growth throughout this fiscal year and fiscal ’25. We also continue to make progress on their next-generation platforms with Credo receiving commitments from multiple 100 gig per lane AEC programs. We attribute much of our success to our existing customers to our system-level approach to the AEC market. Our approach enables us to quickly respond to customers’ requests and deliver innovative feature-rich AEC solutions tailored to our customers’ specific requirements. This approach has led us to making further progress with additional hyperscalers who are in various stages of evaluation and qualification of our AECs. We’ve also seen a growing number of Tier 2 data center operators and service providers adopting Credo AEC solutions.

We have earned meaningful revenue from these customers to date and expect this customer category to grow in the future. In summary, we’re happy with our progress with customers and we’re encouraged by the accelerating market demand for 50-gig and 100-gig lane rates for in-rack connectivity. Regarding our optical solutions, within this market, we remain a disruptor. We leverage our core SerDes technology and customer-specific approach to deliver a compelling combination of performance, power, and cost. Credo’s optical solutions comprise DSPs, laser drivers, and TIAs for 50-gig through 800-gig port applications including optical transceivers and AOCs. We expect AI deployments to drive a large optical opportunity given the high-density rack-to-rack connections with AOCs or optical transceivers in the back-end RDMA network within a cluster.

I’m pleased that during Q1, we started the ramp-up of our 400-gig optical DSP for a U.S. hyperscaler. Our optical manufacturing partner is delivering 400-gig AOC solutions for an AI deployment at this hyperscaler. We expect the production ramp will continue throughout our fiscal ’24 and into fiscal ’25. We’re also seeing demand restart from data centers in China. While too early to create meaningful expectations, Credo stands to benefit as spending returns in this market. Credo has designs in progress with several optical manufacturers and hyperscalers targeting next-generation 800-gig and 400-gig programs and we expect ongoing progress in winning production commitments. Beyond the hyperscalers, we see additional optical opportunities with networking OEMs and service providers.

We remain engaged with many partners and prospective customers for Fibre Channel, 5G, OTN, and PON applications. The optical market seems to have turned the corner in the last couple of quarters. We aim to announce and demonstrate new optical solutions at upcoming optical trade shows later this calendar year and we remain optimistic about our prospects for our optical solutions business. Within our Line Card PHY business, we’re an established market leader with our Line Card PHY solutions for port speeds up to 1.6 terabits per second. We think our overall value proposition becomes even more compelling as the market is now accelerating for 100-gig per lane deployments. During the first quarter, we saw design engagements increasing specifically with our Screaming Eagle 1.6 terabit per second PHYs. We’ve stronger customer feedback that we have again achieved a leading combination of performance, signal integrity, and power efficiency and we’ve already had success in winning design commitments from leading networking OEMs and ODMs. We’ve also made significant development progress with our customer-sponsored next-generation 1.6 terabits per second MACsec PHY, which we believe will extend our MACsec leadership well into the future for applications requiring encryption.

Going forward, we expect to remain a leader in this category given our core technology differentiation and deep collaborative relationships with leading networking OEMs and ODMs, as well as hyperscalers directly. Regarding our SerDes IP licensing and SerDes chiplets business, while we see quarter-to-quarter variability in revenue for our SerDes IP licensing business, our customer traction and funnel remained consistently strong. We’ve seen a breadth of wins in this category, including 50-gig and 100-gig lane speeds and process nodes ranging from 5-nanometer to 28-nanometer. End applications include networking, AI, 5G, as well as a wide range of other applications. In addition to IP, we’ve also developed SerDes chiplets solutions with two high-profile lead customers reaching production, Credo is beginning to see meaningful revenue in our fiscal ’24.

One of our lead customers is Tesla and as they’ve publicly presented Credo is their connectivity partner for their Dojo supercomputer delivering SerDes IP for their D1 ASIC and SerDes chiplets for off-tiled connectivity. We’re receiving increased interest in our SerDes chiplets from additional customers and prospects, which supports industry expectations that chiplets will play an important future role in the highest-performance designs. To sum up, we’re happy with our results in fiscal Q1 and we’re encouraged about demand drivers for the balance of the year and beyond. Credo’s position as a market leader for high-speed connectivity solutions has been years in the making and the market acceleration towards high bandwidth solutions at low power with more networking density plays into our strengths.

We continue to expect sequential growth throughout fiscal ’24. We believe our growth will be led by multiple customers across our range of connectivity solutions, which would result in a more diversified revenue base as we exit fiscal ’24. I’ll now hand the call over to our CFO, Dan Fleming, who will provide additional details. Thank you.

Dan Fleming: Thank you, Bill, and good afternoon. I will first review our Q1 results and then discuss our outlook for Q2 of fiscal ’24. As a reminder, the following financials will be discussed on a non-GAAP basis unless otherwise noted. In Q1, we reported revenue of $35.1 million, up 9% sequentially and down 24% year-over-year. Our IP business generated $2.8 million of revenue in Q1, down 51% sequentially and down 73% year-over-year. 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 preexisting contracts. While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q1 was 8% IP, below our long-term expectation for IP, which is 10% to 15% of revenue.

We expect IP as a percentage of revenue to come in within our long-term expectations for fiscal ’24. Our product business generated $32.3 million of revenue in Q1, up 22% sequentially and down 10% year-over-year. Our team delivered Q1 gross margin of 59.8% at the high end of our guidance range and up 160 basis points sequentially due to product mix. Our IP gross margin generally hovers near 100% and was 94.8% in Q1. Our product gross margin was 56.8% in the quarter, up 703 basis points sequentially and up 551 basis points year-over-year, due principally to product mix. Total operating expenses in the first quarter were $27.4 million within our guidance range and up 1% sequentially and 21% year-over-year. Our year-over-year OpEx increase was a result of a 30% increase in R&D as we continue to invest in the resources to deliver innovative solutions.

Our SG&A was up 8% year-over-year as we built out public company infrastructure. Our operating loss was $6.4 million in Q1 compared to operating income of $5.3 million a year ago. Our operating margin was negative 18.3% in the quarter compared to 11.5% last year due to reduced top-line leverage. We reported a net loss of $4.7 million in Q1 compared to net income of $5.0 million last year. Cash flow from operations in the first quarter was $24.6 million, an increase of $36.8 million year-over-year, due largely to large receivables collected in the quarter. CapEx was $5.3 million in the quarter driven by R&D equipment spending. And free cash flow was positive $19.3 million, an increase of $36.8 million year-over-year. We ended the quarter with cash and equivalents of $237.6 million, an increase of $19.8 million from the previous quarter.

This increase in cash was a result of large receivables collected during the quarter. We remain well capitalized to continue investing in our growth opportunities while maintaining a substantial cash buffer. Our accounts receivable balance decreased 43.5% sequentially to $28.0 million while days sales outstanding decreased to 73 days down from 140 days in Q4 due to collection of several large receivables. Our Q1 ending inventory was $40.8 million, down $5.2 million sequentially. Now turning to our guidance. We currently expect revenue in Q2 of fiscal ’24 to be between $42 million and $44 million, up 23% sequentially at the midpoint. We expect Q2 gross margin to be within a range of 58% to 60%. We expect Q2 operating expenses to be between $27 million and $29 million.

We expect Q2 basic weighted average share count to be approximately 150 million shares. We’re pleased to see FY ’24 continue to play out as expected. While we see some near-term upside to our prior expectations, the rapid shift to AI workloads has driven new and broad-based customer engagement. We expect that this rapid shift will enable us to diversify our revenue throughout fiscal year ’24 and beyond as Bill alluded to. However, as new programs add new and existing customers ramp, we remain cautious about the back half of our fiscal year until we gain better visibility into forecasts. In summary, as we move forward through fiscal year ’24, we expect sequential revenue growth, expanding gross margins due to increasing scale and improving product mix, and modest sequential growth in operating expenses.

As a result, we look forward to driving operating leverage and returning to double-digit operating margins by Q4. And with that, I will open it up for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Toshiya Hari from Goldman Sachs. Your line is now open.

Toshiya Hari: Hi, good afternoon. Thank you so much for taking the question. Just one question from me. Bill, I was hoping you can talk about the revenue drivers for the current quarter. You’re guiding revenue up 23%. It’s really nice to see you guys reiterate the sequential growth in the back half as well. You talked extensively about your AEC business obviously your largest customer your number two customer, you seem to talk up the Tier 2 customers there as well. And then you sounded quite good on optical. So I was hoping you could rank order, the drivers again for the current quarter on a sequential basis, and what you’re most excited about as you go into the second half? Thank you.

Bill Brennan: So I can say that we’re seeing strength really across the board with all of the product lines that we’ve got from AECs to optical to Line Card PHYs, even SerDes chiplets. It’s hard for us to rank order in such a short period of time. We really see things – we see things generally moving in a positive direction. I’ll say that if you look at the year, I think we’ve been pretty clear thus far to say that our AEC business is not going to grow this year, and that’s really due to the fact that our largest customer had a big reduction in the forecast that they have for the current year. With that said, our other AEC business is growing quite rapidly as well as our other product lines. And so, we see significant growth year-over-year if we subtract the number from our largest customer.

So we feel pretty good about the way that demand is shaping up. I think we’ve got growing visibility for this year. And again, I see us really benefiting with the acceleration in lane rates generally. And it’s really positively impacting all of our businesses.

Toshiya Hari: Sorry, one quick follow-up. Thank you for that, Bill. Just the optical DSP business. You talked about the 400 gig opportunity with the U.S. hyperscaler and the production ramp in fiscal 24 through ’25. You also talked about China coming back a little bit. Again, if you can – I know it’s a relatively small percentage of your business today, but how should we think about the contribution from your DSP business over the next, call it 12 months to 18 months? Thank you.

Bill Brennan: Right. So I’ve said in the past that one of my benchmarks for this business is when do we achieve 10% of our overall revenue and I have signaled that we don’t expect that to happen this year, but we’ve got all of the activity that would suggest, we’ll see that in FY ’25. With that said, I feel good about where we are the fact that we’re executing to the ramp, we are seeing signs of life in China, we’re qualified at multiple hyperscalers there, and as spending returns in that market we will see benefit. Now, as far as what Dan has got built-in for the year, it’s not a big number for China, it’s relatively small number. But I think this year we’ll do a good job in approaching that 10% threshold, and then we’re – I think we’re on track for next year.

Toshiya Hari: Thank you.

Operator: Thank you. And one moment for our next question. And our next question comes from Quinn Bolton from Needham & Company. Your line is now open.