Credo Technology Group Holding Ltd (NASDAQ:CRDO) Q3 2024 Earnings Call Transcript
Credo Technology Group Holding Ltd (NASDAQ:CRDO) Q3 2024 Earnings Call Transcript February 27, 2024
Credo Technology Group Holding Ltd beats earnings expectations. Reported EPS is $0.04, expectations were $0.03. Credo Technology Group Holding Ltd isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and thank you for standing by. Welcome to the Credo Fiscal 2024 Q3 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Dan O'Neil. Please go ahead.
Dan O'Neil: Good afternoon. Thank you for joining us on our Fiscal 2024 third quarter earnings call. Today, I'm joined by Bill Brennan, Credo's Chief Executive Officer, and Dan Fleming, our Chief Financial Officer. As a reminder, during the call, we will make certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties that are discussed in detail in documents filed with the SEC, which can be found in the Investor relations section of the Company's website. 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 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 assessed using the investor relations portion of our website. I will now turn the call over to our CEO. Bill?
Bill Brennan: Thank you, Dan. I'll begin by providing an overview of our fiscal Q3 results and our outlook for the future. Our CFO, Dan Fleming, will then provide a detailed review of our Q3 financial results and share our expectations for fiscal Q4. For Q3, Credo reported revenue of $53.1 million and non-GAAP gross margin of 62.2%. These results and our future growth expectations continue to be driven by the accelerating opportunity for high speed and energy efficient connectivity solutions throughout the data infrastructure market. Our connectivity solutions include Active Electrical Cables or AECs, Optical DSPs, laser drivers, and TIAs, Line Card PHYs, SerDes chiplets and SerDes IP licensing, each leveraging our SerDes technology.
Core to Credo's success is our SerDes technology, which is the fundamental connectivity building block of all of our solutions. Credo continues to invest deeply in SerDes' architectures that enable application-specific solutions, optimized for speed, reach performance, energy efficiency and cost. Our 100 gig per lane SerDes portfolio spans process geometries from 12 nanometer to 3 nanometer, with optimized reach performance from the longest reach links to the most power sensitive die-to-die links for Chiplets. Credo will continue our innovation for 200 gig per lane SerDes as the opportunity to differentiate increases, specifically related to the optimization of tradeoffs between process geometry, DSP architecture, performance and energy efficiency.
Credo SerDes technology expertise, combined with our system-level, customer-focused design approach has led to our success with a diverse and growing set of industry-leading customers. In 2023, the technology industry experienced an inflection point driven by Generative AI applications. The acceleration in the deployment of AI clusters has put high-speed connectivity on center stage, given the fundamental need for higher bandwidth. For Credo, this need for higher bandwidth translates to the demand for higher speed, higher density and more energy-efficient connectivity solutions. This plays directly to Credo's strength and underpins our growth expectations. I'll now provide more detail of our overall business. First, I'll discuss our AEC business, where Credo continued to build momentum during the third quarter.
We believe our AEC leadership derives from our comprehensive systems level approach to the AEC market. We've built this from the ground up over many years and as a result, we now have the ability to quickly innovate to support the diverse AEC needs of our customers. Given increasing single lane speeds, and the shortcomings of both passive copper cables and active optical cables and transceivers, we foresee continuing adoption of AEC's for in-rack connectivity. We expect U.S. hyperscalers to remain the majority portion of AEC demand in the foreseeable future. Many of these customers have distinct architectural requirements that demand innovation and tight collaboration between the engineering teams at Credo and the customer. We're engaged at different stages with the five U.S. hyperscalers as well as other global hyperscalers and Tier 2 data center operators.
We've delivered a range of products with non-standard optimized hardware and firmware features to meet our customers' needs for port speeds from 100-gig to 800-gig, depending on the customer application. Credo continues to work closely with our first two hyperscale customers, delivering AEC solutions for both front-end and back-end Ethernet networks, as each publicly highlighted during their conferences last quarter. We're gaining better visibility with these customers into their near-term product ramps, and we're also engaged in a range of AEC solutions to address longer term roadmaps. While advanced programs of this nature take time to achieve material deployment rates, we continue to expect an inflection point in the second half of our fiscal '25.
Credo is also working with additional U.S. and global hyperscalers to develop 400-gig and 800-gig AEC solutions that we expect will yield significant revenue for Credo in the future as next generation network architectures transition to AEC solutions. Additionally, we see broader acceptance of AEC solutions among service providers and Tier 2 data centers. As a group, these customers represent a meaningful and growing revenue opportunity. Last quarter, we discussed the introduction of our P3 - Pluggable Patch Panel solution, developed in collaboration with a lead service provider. Over the past quarter, we've been encouraged by customer feedback that the combination of the P3 and the AECs can help overcome multiple networking challenges related to power and thermal distribution, lane speed disparities, and the trade-offs of operational efficiency, latency and power.
We expect to generate meaningful future revenue as the P3 enables AECs to be easily utilized in a more broad set of operational opportunities, thereby expanding our addressable market. In summary, we were very pleased with our AEC progress in Q3, and due to our expanding customer base and focus on innovation, we expect further progress in Q4, fiscal '25 and beyond. Now, regarding our optical solutions, Credo continues to gain traction in the optical DSP market. During the third quarter, we continued production shipments of optical DSPs to multiple global hyperscale end customers for a variety of applications across numerous port speeds. We closely target the combination of optical module partners and hyperscale end customers, and we're making progress on optical DSPs for 400-gig and 800-gig optical transceiver and AOC opportunities.
Enabled by our SerDes' design approach, Credo wins by delivering a compelling combination of performance, energy, efficiency and value, as well as focusing on innovative ways to solve complex customer needs. Last quarter, we talked extensively about the industry call for action for better power efficiency for 800-gig and 1.6T optical solutions. As we discussed, we believe eliminating the DSP with the Linear Pluggable Optics or LPO architecture is simply too far a leap, especially for 1.6T. Credo quickly responded with our innovative Linear Receive Optics or LRO DSP architecture that directly addresses the power challenge while delivering better signal integrity, maintaining industry standards, IEEE compliance in interoperability and extending to 1.6T solutions.
Since our discussion last quarter, we've made meaningful progress. Our first 800-gig LRO DSP partner has built and tested 800-gig optical modules, and the results are exactly as expected, successfully delivering on the promise of much reduced power and great signal integrity while overcoming the shortfalls of the aspirational LPO architecture. Next month at OFC in San Diego, we'll be demonstrating both 800-gig LRO DSP and full DSP solutions, highlighting our progress. We'll be demonstrating 800-gig solutions with five different optical module partners. Our 1.6T roadmap includes both LRO DSP and full DSP solutions with 200-gig per lane speeds, with our top priorities being energy efficiency and signal integrity, which are both critical to achieve robust 1.6T optical solutions.
We believe the growth in our optical business will be primarily driven by U.S. hyperscaler end customers, with further contributions from global hyperscalers. I'll now discuss our Line Card PHY business, which delivered another solid quarter in Q3. In this segment, our customers include networking OEMs and hyperscalers, and our products include Retimers, Gearboxes, and MACsec PHYs for data encryption. Our customers are the leaders in the space. We have close working relationships and our design wins typically have long lifecycles once they ramp to production, contributing nicely to our overall results. In the upcoming months, we'll tape out our customer sponsored 5-nanometer 1.6T MACsec PHY, and our power optimized 1.6T retimers and gearboxes.
Credo is among the industry leaders for 50-gig and 100-gig per lane line card PHY applications. We have many customers that have deployed our 50-gig per lane solutions in production, and we count more than ten customers designing in our 100-gig per lane Screaming Eagle line card PHYs. And now turning to our IP and Chiplet business. Our SerDes IP and SerDes Chiplet businesses continue to be a strategic component of our overall business. These solutions enable our partners to address the ASIC market for next generation solutions. Due to revenue recognition rules, our SerDes IP revenue can vary meaningfully from quarter to quarter, which is what we saw in Q3, and we will likely see in the upcoming quarters. Our funnel for SerDes licensing opportunities remains strong, bolstered by the increased opportunity on ASICs with high-speed SerDes for data center applications.
We have a comprehensive portfolio of SerDes IP for our ASIC customers, including 100-gig per lane SerDes across the broadest range of process geometries from 12 nanometers to 3 nanometers, and the broadest range of reach performance from long reach to die-to-die reach. Our SerDes IP offering enables our ASIC partners to optimize their solutions for process geometry, reach and power. Last quarter, our chiplet business was highlighted by a win with significant NRE at one of our leading customers for a next-generation, five nanometer chiplet solution which speaks loudly regarding our differentiated SerDes portfolio. When complete, Credo will be able to market and sell this chiplet to the broad market. Overall, we remain optimistic about the prospects of the chiplet category, given our results to date, and due to our belief that chiplets will be a key enabler in the most advanced system solutions.
In summary, we're pleased with our results for fiscal Q3, and we're optimistic about the increasing market demand for high-speed connectivity. Credo's competitive advantage is driven by our focus and execution on our core SerDes technology, and that leads Credo to being one of few companies capable of delivering the necessary breadth of connectivity solutions at the highest speeds, while optimizing for energy efficiency and system cost. For these reasons, we expect continued long-term growth across a diversified customer base, and a diversified set of connectivity applications. I'll now turn the call over to our CFO, Dan Fleming. Dan will provide additional financial details, and then we'll be happy to take questions. Thank you.
Dan Fleming: Thank you, Bill, and good afternoon. I'll first review our Q3 results and then discuss our outlook for Q4 of fiscal '24. In Q3, we reported revenue of $53.1 million, up 20% sequentially, and down 2% year-over-year. Our IP business generated $1.3 million of revenue in Q3, down 83% sequentially, and down 90% 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 pre-existing or new contracts. While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q3 was 2% IP, below our long-term expectations for IP, which is 10% to 15% of the revenue. We expect IP, as a percentage of revenue to be within our long term expectations for fiscal '24 and near the high-end of the range.
Our product business generated $51.8 million of revenue in Q3, up 41% sequentially and up 24% year-over-year. Our top three end customers were each greater than 10% of our revenue in Q3. Our team delivered Q3 non-GAAP gross margin of 62.2% above the high-end of our guidance range and up 235 basis points sequentially. Our IP non-GAAP gross margin generally hovers near 100%, and was 92.7% in Q3. Our product non-GAAP gross margin was 61.5% in the quarter, up 877 basis points sequentially, due to a large increase in product NRE revenue, and up 1,420 basis points year-over-year. Total non-GAAP operating expenses in the third quarter were $30.6 million, above the high-end of our guidance range, up 13% sequentially and up 19% year-over-year. Our OpEx increase was a result of a 24% year-over-year increase in R&D as we continue to invest in the resources to deliver innovative solutions.
Our SG&A was up 12% year-over-year. Our non-GAAP operating income was $2.4 million in Q3, compared to a non-GAAP operating loss of $0.7 million last quarter, due to increased topline leverage. Our non-GAAP operating margin was 4.6% in the quarter compared to a non-GAAP operating margin of negative 1.7% last quarter, a sequential increase of 622 basis points. We reported non-GAAP net income of $6.3 million in Q3, compared to non-GAAP net income of $1.2 million last quarter. Cash flow used in operations in the third quarter was $1 million. CapEx was $5.1 million in the quarter driven by R&D equipment and production mask spending. And free cash flow was negative $6.1 million, an increase of $3.1 million year-over-year. We ended the quarter with cash and equivalents of $409.1 million, an increase of $168.6 million from the second quarter.
This increase in cash came from the net proceeds of our successful follow-on offering of shares completed in December of 2023. We remain well capitalized to continue investing in our growth opportunities while maintaining a substantial cash buffer. Our accounts receivable balance increased 36.8% sequentially to $44.8 million, while day sales outstanding increased to 77 days up from 68 days in Q2. Our Q3 ending inventory was $31.5 million, down $4.3 million sequentially. Now, turning to our guidance, we currently expect revenue in Q4 of fiscal '24 to be between $59 million and $62 million, up 14% sequentially at the midpoint. We expect Q4 non-GAAP gross margin to be within a range of 64% to 66%. We expect Q4 non-GAAP operating expenses to be between $33 million and $35 million, and we expect Q4 diluted weighted average share count to be approximately 180 million shares.
We are pleased to see fiscal year '24 playing out as expected. The rapid shift to AI workloads has driven new and broad-based customer engagement, which has continued to enable us to diversify our revenue through fiscal year '24 and beyond. As a result, we look forward to driving operating leverage in the coming quarters. And with that, I will open it up for questions.
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