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Edited Transcript of MRVL earnings conference call or presentation 6-Sep-18 8:45pm GMT

Q2 2019 Marvell Technology Group Ltd Earnings Call

HAMILTON Sep 12, 2018 (Thomson StreetEvents) -- Edited Transcript of Marvell Technology Group Ltd earnings conference call or presentation Thursday, September 6, 2018 at 8:45:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ashish Saran

Marvell Technology Group Ltd. - VP of IR

* Jean Hu

Marvell Technology Group Ltd. - CFO

* Matthew J. Murphy

Marvell Technology Group Ltd. - President, CEO & Director

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Conference Call Participants

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* Blayne Peter Curtis

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* John William Pitzer

Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head

* Joseph Lawrence Moore

Morgan Stanley, Research Division - Executive Director

* Karl Fredrick Ackerman

Cowen and Company, LLC, Research Division - Director & Senior Research Analyst

* Mark Trevor Delaney

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Quinn Bolton

Needham & Company, LLC, Research Division - Senior Analyst

* Ross Clark Seymore

Deutsche Bank AG, Research Division - MD

* Vivek Arya

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Second Quarter 2019 Marvell Technology Group Ltd. Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

Now, I'd like to turn the call over to Ashish Saran, VP of Investor Relations. Sir, you may begin.

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Ashish Saran, Marvell Technology Group Ltd. - VP of IR [2]

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Thank you, and good afternoon, everyone. Welcome to Marvell's Second Quarter Fiscal Year 2019 Earnings Call. Joining me today are Marvell President and CEO, Matt Murphy; and Marvell CFO, Jean Hu.

Before I turn the call over to Matt, I want to remind everyone that certain comments today may include forward-looking statements, which are subject to significant risks and uncertainties, and which could cause our actual results to differ materially from management's current expectations. Please review the cautionary statements and risk factors contained in our earnings press release, which we filed with the SEC today and posted on our website as well as our most recent 10-K and 10-Q filings. We do not intend to update our forward-looking statements.

During our call today, we will make reference to certain non-GAAP financial measures. A reconciliation between our GAAP and non-GAAP financial measures is available on our website in the Investor Relations section.

As you know, we closed the acquisition of Cavium on July 6, 2018, approximately 4 weeks before the end of our second fiscal quarter. Therefore, the results we report today for the second quarter of fiscal 2019 include the results from the Cavium businesses from July 6 to the end of the fiscal quarter.

To provide a direct comparison to the second quarter fiscal year business outlook we provided in our earnings call last quarter, we have provided a table which breaks out Marvell's stand-alone non-GAAP results for the second quarter and excludes partial quarter results from the acquired Cavium business in our earnings press release. We are providing Marvell's stand-alone non-GAAP results on a onetime basis only. As a reminder, there are no GAAP results for stand-alone Marvell. Matt and Jean's second quarter commentary will primarily focus on the results from the stand-alone Marvell business as it relates to the guidance we provided on our May call, unless stated otherwise.

Please note that the financial outlook for the third quarter of fiscal year 2019 includes expected results from the acquired Cavium businesses for the full quarter.

Prior to the acquisition of Cavium, we reported revenue for 3 core businesses, which were storage, networking and connectivity. We also reported revenue from a legacy set of businesses under the category of Other.

In order to incorporate Cavium's product lines, starting with the third quarter outlook and going forward, we will be changing the structure and composition for revenue reporting. We will categorize and report revenue by 2 core businesses, storage and networking. The new storage business would include Cavium's fiber channel products, in addition to all the prior Marvell storage product line.

The new networking business would include Cavium embedded processor, security processor and Ethernet connectivity products in addition to all the prior Marvell networking products. Marvell's Wi-Fi connectivity business will also be reported within networking.

We will still report revenue for the Other businesses, and the composition of that category remains unchanged.

Please also note that starting next quarter, we will provide a revenue outlook range for the upcoming quarter only at the consolidated company level. Given changes which can take place within different businesses through the quarter, some of which can be offsetting, providing specific revenue outlooks for individual businesses may not yield the most accurate projections at the company level. This change mirrors how the majority of our peers and customers already report as well.

We will, of course, continue to report and comment on actual results by business and we'll also provide directional commentary on revenue expectations by business for the upcoming quarter.

With that, let me turn the call over to Marvell's President and CEO, Matt Murphy. Matt?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [3]

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Great. Thank you, Ashish, and welcome to the Marvell team, it's great to have you onboard. And good afternoon to all of you on the call, and thank you for joining us today.

I'll start with a summary of our second quarter GAAP results for the combined company. Revenue for the combined company was $665 million; GAAP gross margin was 56.7% and earnings per diluted share was $0.01.

I'm now going to review stand-alone Marvell non-GAAP results, excluding those of Cavium. Jean will provide third quarter projections for the combined company. Q2 was another strong quarter for Marvell. Once again, we delivered solid results driven by the strength of our core businesses and continued operational excellence. We also received regulatory clearance to close our merger with Cavium and began integrating the 2 businesses. Together, we are on our way to becoming an infrastructure solutions leader. Marvell's stand-alone revenue for their second quarter came in above the midpoint of our guidance at $624 million, up 3% from a year ago driven by strong growth in networking and continued growth in our storage business.

We continue to improve our non-GAAP gross margin, reaching a record high of 63.5%. This reflects continued progress in improving operational efficiency as well as capturing more value from our world-class engineering effort. Looking ahead, we will continue to focus on expanding our gross margin as we integrate Cavium.

Marvell's stand-alone non-GAAP operating margin for the second quarter was 30.1%, up 4.3 percentage points from a year ago. I am very pleased to report that we have achieved this target 6 quarters earlier than we originally projected at our last Investor Day in March of 2017.

Non-GAAP earnings per share on a stand-alone basis was $0.35, above the midpoint of our guidance and up 17% year-over-year.

Moving to our core businesses. Our storage business met expectations with revenue of $320 million, growing 3% year-over-year. We continue to offset secular declines in client HDDs through 2 efforts. First, we are growing our position in the nearline segment of the HDD market, which is fueled by continued demand for data storage in the cloud. Second, we continue to increase Marvell's footprint in the SSD market, where we are also expanding our reach into the enterprise and data center segment. We believe that both of these efforts will continue to generate revenue tailwinds over the next few years.

As we look forward, we see significant data growth continuing at cloud and data center customers for which they need more efficient storage management that we are addressing with our new innovative solutions. For example, I'm proud to share that at last month's Flash Memory Summit, we announced 3 new storage architecture solutions based on emerging NVMe over Fabric interfaces and include both Cavium-developed products for servers and Marvell-developed products for SSD devices.

These architectures eliminate legacy bottlenecks in traditional server managed storage deployments, allowing customers to efficiently scale and share storage without adding additional servers. Cloud and data center customers will now be able to meet their growing demands for higher performance and higher capacity storage, while improving the utilization and lowering their total cost of ownership.

Moving on to networking. Our networking business delivered $170 million in revenue and grew 16% year-over-year, significantly higher than our guidance of high single-digit growth. This growth was driven by a robust IT spending environment as well as the continued ramp of our refreshed switch and buy products for the enterprise. We are also helped by the resumption of shipments to ZTE after the export ban was lifted part way through the quarter. In addition, we also continue to ramp Ethernet switch products into wireless base stations.

Overall, Marvell's networking business continues to perform exceptionally well driven by growth from our refreshed product portfolio. As a proof point within switching, the relative contribution of revenue from our refreshed switching products more than doubled from a year ago. The addition of Cavium's products further strengthens our networking portfolio.

Now moving onto connectivity. We continue to execute our strategy of shifting Marvell's connectivity business to higher performance opportunities away from older generation, lower-margin Wi-Fi products. As a result and as expected, connectivity revenue of $88 million declined 11% year-over-year in this quarter. Please note that we completed our transition away from the older gaming connectivity product during the second quarter.

In contrast, the rest of our connectivity portfolio grew year-over-year in the second quarter as we continue to pivot the higher performance, higher margin solutions. Anticipating the evolving needs of our customers who are increasingly looking for broad platform solutions, we have recently announced our 802.11 AX suite of solutions, which position Marvell to capitalize on the market shift in the next generation of Wi-Fi.

Overall, I'm very pleased with the performance of Marvell's core businesses and look forward to their continued growth, especially with the integration of Cavium's products and technologies.

Now let me move on to the integration of Cavium. As I've mentioned on past calls, we started integration planning early and the Cavium team is already an integral part of the new Marvell. It's been great to welcome them to our combined team.

Given that we had completed a significant amount of planning before the acquisition closed, our integration is proceeding at a fast pace. As we integrate, we're applying important lessons from the last 2-plus years of Marvell's own transformation.

All of this experience in planning is now paying off with rapid and efficient integration occurring across our sales, engineering, operations and G&A teams. For example, in the first 2 months since closing the acquisition, we have already integrated the XPliant in our modern road maps into their respective R&D teams.

We also quickly realigned Cavium's business processes and infrastructure with Marvell's, including robust forecasting, budgeting, project reviews and establishing P&L accountability at the product line level to better optimize resource allocation.

Similarly, our combined business and engineering leaders also completed a strategic portfolio review of all key products and technologies across the entire combined company in order to optimize future R&D investments.

One of the key changes we instituted on day 1 was applying Marvell's disciplined revenue and sales processes to the Cavium businesses. We believe that these actions will provide significant long-term benefits, including a more predicable business, lower levels of inventory across the supply chain, higher customer satisfaction and less pressure on the sales team to chase short-term revenue.

Our sales team is focused on attaining high-quality design wins that drive long-term revenue growth, and I'm confident that our disciplined approach will enable this across all of our new businesses. I'm very confident that our combined team will drive us towards our long-term 6% to 8% annual revenue growth target.

I'm also very happy with how well the Marvell and Cavium teams are collaborating. Already, as we have begun working together, we've identified additional cost savings opportunities. These additional synergies, combined with our rigorous and thorough approach to integration, are allowing us to increase our synergy target from our prior $150 million to $175 million outlook to $200 million by the end of fiscal 2020 on a run rate basis.

As Jean will discuss later, our combined third quarter outlook bakes in just over half of the long-term OpEx synergy target on a run rate basis. This will be significant accomplishment in our first full quarter as a combined company.

As I mentioned earlier, we also completed our annual strategic portfolio review to prioritize R&D resource allocation to maximize future growth and profitability. As a result, we have begun shifting resources to areas with higher return potential and deemphasizing investments in lower ROI products.

For example, we completed the sale of Cavium's MontaVista Software product line and have quickly converged road maps in switching and embedded processors. Our future switch development will be based on Marvell's Prestera product line, and we will be focusing our embedded processor efforts through Cavium's industry-leading OCTEON products. We'll, of course, continue to support customers who are currently using Cavium's XPliant switch products and Marvell's ARMADA embedded processors.

Before I turn the call over to Jean, I'd like to thank the entire team for their continued contributions both this quarter and throughout the integration planning process. We've made amazing progress due in large part to the hard work and collaboration across the Marvell and Cavium teams, and I am excited about what we can accomplish together.

Our combined company has significantly larger scale, more diverse products, a greater pool of engineering talent and a broader set of technologies that are very relevant to cloud and data center customers. I've been in a number of key customer meetings recently where the depth of architectural discussion and engagement with the most senior decision-makers far exceeded what we had previously seen as independent companies and they are excited to work with us on their most ambitious projects.

I look forward to sharing more about our business, technology and Marvell's trajectory at our upcoming Investor Day on October 16, in New York City.

With that, let me turn the call over to our CFO, Jean Hu, for more details on our second quarter financial performance and our outlook for the third quarter.

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Jean Hu, Marvell Technology Group Ltd. - CFO [4]

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Thanks, Matt, and good afternoon, everyone. I'll start with our GAAP results for the second quarter for the combined company. Please note our GAAP results include the impact of purchase price accounting items, amortization of intangibles, acquisition and integration-related and nonrecurring expenses as well as the stock-based compensation.

Revenue was at $665 million; gross margin was at 56.7%; operating expenses were $385 million; operating loss was $8 million; and earnings per diluted share was $0.01.

Turning to our combined balance sheet. I want to note that the inventory at the end of second quarter was $473 million, which include the impact of stepping up Cavium's inventory by $223 million due to purchase price accounting. We amortized $23 million of this step-up into COGS in the second quarter and we anticipate amortizing the remaining balance by the end of the fourth quarter for fiscal 2019. Please note, our non-GAAP results exclude the amortization of inventory step-up charges.

We exit the quarter with $524 million in cash and short-term investments. Our long-term debt was $1.9 billion, and currently, carry a blended interest rate of [4.3%]. Our gross debt-to-EBITDA ratio was 2x and the net debt-to-EBITDA ratio was 1.4x, based on our combined pro forma EBITDA.

We currently expect to start paying down the debt this quarter and anticipate stepping up the paydown rate to approximately $100 million per quarter starting at fiscal 2020. As a result, we believe we can quickly get to our targeted ratio of 1.5x gross debt-to-EBITDA.

In second quarter, we distributed $39 million to shareholders in dividends.

I will now move on to stand-alone Marvell non-GAAP results for the second quarter for fiscal year 2019. As Ashish has noted, we are providing stand-alone Marvell results on a onetime basis only this quarter because our previously provided financial outlook for the second quarter exclude any impact of the Cavium acquisition. Reconciliation of our stand alone and combined performance as well as GAAP to non-GAAP results are available in our press release.

Stand-alone Marvell revenue in the second quarter was $624 million, toward the high end of the outlook provided in May. Our core business of storage, networking and connectivity accounted for 93% of revenue and grew 4% year-over-year.

Storage accounted for 51% of revenue and grew 3% year-over-year, in line with our expectations.

Networking accounted for 27% of revenue and grew 16% year-over-year, much stronger than expectations as we benefited from a strong end market and the resumption of shipment with ZTE halfway through the quarter. I'm very pleased with this level of growth from networking, which is coming above what we think is sustainable in the long term.

Connectivity accounted for 14% of revenue and, as expected, it declined 11% year-over-year as we ramped down our older generation, lower-margin gaming product.

Other product accounted for 7% of revenue and it declined 5% year-over-year, consistent with our expectations.

Non-GAAP gross margin was 63.5%, a record level for Marvell, and increased over 2.3 percentage point from last year. Non-GAAP operating expenses were $208 million, declined 3% year-over-year, while we simultaneously delivered the year-over-year revenue growth. Non-GAAP operating margin was 30.1%, up 4.3 percentage points from a year ago. Non-GAAP earnings per diluted share were $0.35, exceeding the midpoint of our guidance range.

Before I go to our third quarter outlook, I would like to spend a moment discussing Cavium's recent revenue run rate and also provide some guidance about our $200 million cost synergy achievement plan. Cavium's revenue run rate before we closed the acquisition and its contribution of $41 million to our second fiscal quarter during the 4 weeks after closing the acquisition was well below expectations. The primary reason for this was the large inventory reduction at the Cavium distributors and certain customers to bring their inventory down to levels more consistent with Marvell's business practices. At Marvell, our days of inventory have typically been in the range of 2 to 2.5 months and our distributor inventory have been in the same range, too.

Cavium's revenue was also impacted by softer demand environment among some service providers as well as the decision to sell Cavium's MontaVista product line and the road map consolidation for Cavium's XPliant switch product.

Also, it's worth noting, Cavium typically had fairly nonlinear revenue generation through their fiscal quarter with the relatively low levels of revenue in the first month of their fiscal quarter, which was the last month of our fiscal quarter. The Marvell and the Cavium teams have worked together to quickly integrate our forecasting supply chain and the demand fulfillment processes. We believe Cavium's revenue bottomed out due to inventory reduction and acquisition-related impact during our fiscal second quarter, and we are forecasting a recovery in the third quarter.

We're currently projecting strong sequential growth from Cavium in the fourth quarter, anticipating that the inventory reduction will be completely flushed out in the third quarter. We believe from the combined company base, in the fourth quarter for fiscal 2019, we can drive long-term revenue growth to our target of 6% to 8% annually.

Turning to our synergy achievement plan, which we have raised to $200 million. 25% of the synergies will come from COGS, which typically take about 6 months to start taking effect. The balance, $150 million of synergy, will benefit operating expenses based on the combined pro forma operating expense run rate of $1.3 billion before the close of the transaction. The middle point of our third quarter outlook bakes in realization of $90 million of OpEx to synergy on a run rate basis.

As a reminder, our operating expenses have a certain amount of seasonality and tends to increase in the first half of our fiscal year, primarily driven by employee payroll tax matching and our annual merit process.

Let me now move on to our current outlook for the third quarter for fiscal 2019, which include the full quarter of Cavium contribution. We expect our total revenue to be in the range of $825 million to $865 million. At the middle point of this outlook, we expect approximately $210 million of revenue contribution from ongoing Cavium businesses. This expectation for Cavium revenue assumes approximately $20 million of excess customer and distributor inventory to be consumed in the third quarter. We believe that exiting the third quarter, Cavium's inventory level will be aligned with Marvell's practices.

We expect our storage revenue at the middle point of our guidance to be approximately 48% of total revenue. As a reminder, the business now include Cavium's fiber channel product in addition to other prior year Marvell storage product lines.

We expect our networking revenue at the middle point of guidance to be approximately 46% of total revenue. This business now includes Cavium's embedded processors, security processor and the Ethernet connectivity products in addition to other prior year Marvell networking and Wi-Fi connectivity product.

We expect Other revenue at the midpoint of our guidance to be approximately 6% of total revenue.

Our expected GAAP gross margin will be in the range of 44% to 45% and the non-GAAP gross margin will be in the range of 64% to 65%. We expect GAAP operating expenses to be approximately $390 million to $400 million, and the non-GAAP operating expenses to be in the range of $300 million to $305 million. We expect our GAAP tax rate to be 4% in the rest of fiscal '19. We'll update you on our fiscal '20 tax rate once we make a progress to integrate the 2 companies' international tax structure.

We expect our interest expense to be around $20 million. We expect diluted share count of 670 million shares. As you know, our share count increased from prior quarter due to the 153 million shares issued as equity consideration related to this acquisition. Please note that starting with this quarter, we'll be simplifying diluted share count projection to GAAP only as the difference to non-GAAP has become immaterial with the increasing total share count.

We anticipate GAAP loss per diluted share in the range of $0.04 to $0.08 and the non-GAAP income per diluted share in the range of $0.30 to $0.34.

We're now ready for your questions. Operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ross Seymore with Deutsche Bank.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [2]

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And Jean, thanks for all the details about the ins and outs with Cavium. One follow-up question to that, for either you or Matt, is it appears that the Cavium revenues, if you say they're clean in your January quarter, and we just added back in that [2] of the $25 million for the $210 million that you're guiding to in October, you'd still be down kind of high single digits year-over-year. So can you just talk about what you think that Cavium revenue growth rate can be off of that base and kind of the 235-ish range going forward? And why is it down that much year-over-year?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [3]

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Sure. Ross, this is Matt. I'll take this one and let Jean add if she'd like to. So yes, the way to think of it is we're guiding $210 million for Q3. Then, to the best of our knowledge and the analysis we've done, there's $20 million that will still get consumed. So you should assume a $230 million run rate. To answer one part of your question, that's the baseline run rate that we believe we can grow the company off of, based on the annual growth targets that we set when we announced the transaction. The year-over-year change, primarily, you can attribute to inventory, obviously, that we're now going back sort of year in time. And so reconstructing that in infinite detail is challenging, but what we do know is when we look through at the current set of customers, now that we've got Cavium under the Marvell umbrella, we look at the channel inventory and customer inventory and demand patterns, we feel very confident that we'll exit Q3 with inventory, overall normalized to the Marvell levels.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [4]

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Great. And I guess, for my follow-up, just switching gears to the storage side of your business and maybe just the classic Marvell side. Lots of debates these days on the NAND pricing market. I know that doesn't directly correlate to what your SSD business does one way or the other, but this is the first quarter in a while you haven't highlighted what SSDs were as a percent of the business. Can you just give us an update on how that segment of your storage business is ramping?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [5]

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Sure, Ross. No problem. And yes, I think we're adjusting here to having a much broader portfolio of products to talk about. And so with respect to SSD, that business continues to perform well. We've seen multi years now of pretty, pretty strong compounded annual growth in that business. With respect to -- I won't comment specifically on pricing or we're not sort of the barometer on demand and pricing but certainly, I think it's widely reported that supply continues to come free. And I think to that extent, that's going to be good for, certainly, people that supply into this market, including us. I'd also add that on top of all that, our progress and effort to really grow our presence in the enterprise and data center segment of SSD continues to make very good progress. And so I think as you -- we had the Analyst Day plus future calls when we have sort of the Cavium ins and outs settled, we can continue to give you more color there, but we still see strong business in SSD for the company.

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Operator [6]

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And our next question comes from Vivek Arya with Bank of America.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [7]

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Good to see that Cavium results integrated and all the details. First question, Matt, you mentioned strong sequential growth for Cavium in Q4. What does that imply? Does it get to you back to the $230 million baseline or can it to be stronger than that? I'm just trying to see what a normal Cavium contribution quarter looks like.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [8]

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Yes. I think I'll focus to -- just to be specific, what I said, which was -- and again, normally, we wouldn't lean out kind of 2 quarters out, that's never been our practice but given the circumstances, we felt we needed to get some color there. So yes, I think the way just to read it very simply is take the $210 million, assume that's the run rate, add $20 million back. And so $210 million going to $230 million is a baseline to think about. Obviously, we're not guiding that formally, and we've got to see how the business does during that time frame. But at this juncture, I think for everybody on the phone and the investors listening, I think that's the best view that we've got at this point. So that's really the growth we're talking about, the $210 million to $230 million.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [9]

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Got it. And for my follow-up, Matt, so good job on your gross margins. You're kind of close to the 65% or so pro forma target. And I recall that when you gave that target, Marvell's organic margins were $61 million but now they are $63.5 million. So is it possible that longer term, you could perhaps do better than the pro forma targets you had outlined before?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [10]

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Okay, yes. Thanks, Vivek. I think, yes, if you go back to when we announced the transaction, you're right. We said 65% was our long-term target and at that time, we were in that range. So we've been very pleased, right, with the performance of core Marvell since we announced this. That business has strengthened on revenue, it's strengthened on gross margin and operating income, and so that's been a nice tailwind heading into the closing of Cavium. We're certainly not -- we're not ready to update our targets at this point, although we have an Analyst Day coming up. But you should assume that the -- one of the guiding principles, I think, that I've infused in the company over the last 2 years has been to really drive the gross margin as a reflection of the quality of the engineering in the company and the value we deliver, and we think it's a huge lever on our company's overall value. So we pay attention to it, we manage it, and we're certainly happy in the first quarter out at the revenue level that we're guiding that we can already be in the 64% to 65% range. So look for us to keep driving that higher over time, but let's wait until Analyst Day to do a more extensive update on what we think we can do.

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Operator [11]

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And our next question comes from John Pitzer with Crédit Suisse.

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John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [12]

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Congratulations, Matt, on the good start with Cavium. You did a good job kind of outlining the synergies from cost of COGS and OpEx. Wondering if you'd talk a little bit more about, kind of, the icing on the cake, which is the revenue synergies. How do you think -- or how do you see that playing out from sort of the lowest hanging fruit to some of the higher hanging fruit? And I guess, as you answer the question, I'd love to kind of get sort of the customer reaction on the compute site of Cavium, ThunderX, ThunderX2, now that it's a part of your organization, a larger organization, with perhaps more support.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [13]

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Sure. So let me break that into 2 questions, and I'll start with the revenue synergy, which really ties into the customer feedback since we've closed the transaction and certainly, the fact that the customer base and the infrastructure market, right, whether that's cloud or hyperscale data center companies, the leaders in wireless base stations driving the 5G transition or traditional strong enterprise customers, the feedback has been resoundingly positive. And I think what we're finding is a few examples where -- I mean, one I can give is one of our large networking customers where actually, Cavium had more revenue and position than we did. We were chasing design wins there, kind of, for a few years, closed the transaction, engaged at the right level and I think on the basis of the hard work we've put in but also, I think, on the basis of the combined larger relationship. We were awarded sockets on products that we had never had before at that account. And so I think this -- and I think if you look at the switch products we have with our PHY technology plus the processor products from Cavium, we're seeing a lot of cross-selling opportunities. So we're not quantifying the revenue synergies, I want to be clear on that. We've been sort of out of the chute saying, "Hey, any revenue synergy gap would be on top of the growth targets that we've set," but we certainly see strong leading indicators that this could definitely be 1 plus 1 equals more than 2, from that point of view. With respect to Thunder, probably helpful to comment on that as well. That's been an interesting evolution, really, even since we announced the acquisition from sort of us announcing supercomputing. If you remember last year, in 2017, ThunderX2 had a very strong initial showing. Subsequently, if you look at it basically, the parts released to production got strong customer traction. We're shipping it now in production and I think the customer base is looking to us and the ecosystem to really continue to support that effort. Because if you look at the leading benchmarking companies out there like a non-tech and others, ThunderX2 is performing extremely well on especially memory-intensive applications versus Skylake. So that's an emerging business. But what I'd characterize it at right now is strong customer pull, parts out, released. It's a good product. And we'll be happy to update you on that as we make progress there.

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John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [14]

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That's helpful, Matt. And maybe as my follow-up, just going back to the core Marvell storage business. Clearly, there's been some more mix data points on the hard drive side of the market. I guess if you look out to your October guidance, is there any color you can give us as to how you're viewing hard drives versus SSDs? And can you remind us again kind of the mix benefit as more moves towards SSDs and/or perhaps the ASP benefit as densities of platters go up within core HDDs?

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Jean Hu, Marvell Technology Group Ltd. - CFO [15]

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John, yes, when we look at our storage business, we're actually very pleased with the performance. Looking into Q3 when we guided, frankly, we continue to see our storage business grow year-over-year, including both HDD and the SSD business. SSD business, definitely, is growing double-digit year-over-year. So overall, when we look at it, the momentum with our SSD business continues, and we are pivoting more into the enterprise data center with both our SSD and HDD business. So I think we're very pleased with our overall migration as the percentage of revenue, the enterprise data center becoming increasingly more. When we have our Investor Day, we'll definitely update you about the journey and the progress we have made during the last 1.5 years. So overall, we are pretty happy with the Q3, how we look at the storage business. There's not much significant change from a momentum perspective.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [16]

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And John, I'll just add, I think that was a great summary, just to close on that. I think your -- the part you mentioned around the HDD areal density opportunity improvements that we could potentially help enable to drive -- help drive that market forward. We're very much pleased with our progress there. Our latest read channel technology is, I think, going to help enable many new applications as HDDs in the cloud and data center for cold storage push up to higher and higher levels of capacity. And I think we're going to be at the leading -- at the forefront of enabling technologies like HAMR or MAMR or dual actuator. Those are all opportunities for Marvell's differentiated IP and strength in the market to enable a very important part of what we think is going to be the -- for the cloud and hyperscale companies.

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Operator [17]

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And our next question comes from Blayne Curtis with Barclays.

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Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [18]

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Just going back to the Cavium revenue, I think you've described it as multiple factors that caused the shortfall. You addressed the inventory portion. I was curious if you'd just address some of the end-market weakness, like service provider, as well as some of the new product forecasts versus actual revenue. And then kind of as you look forward here, can you just describe your level of confidence, at this point, in understanding all those moving pieces?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [19]

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Sure. Sure, Blayne. So I'll give you my perspective on this, and then Jean can add. So I'd say going back to the inventory question and the Cavium revenue, so if you think about it, the inventory that was built, that was sort of, you could imagine, was running at a higher base of inventory than Marvell had ran, whether it was in the channel or in the end customer or, quite frankly, even in the factory. That was fairly broad-based in nature, because that's just how they ran their business. So as we've now owned the company for 8 weeks and again, trying to -- under our watch, the -- I'd say, the inventory now that's impacting the revenue was really around end market, which is primarily the service provider base station market, which is going through its own -- lumpy to begin with. And then you layer on top this 5G transition, which, from everything we're hearing, is going to be meaningful next year and probably pull in certainly ahead of where people thought it would be a year ago. So I think that transition that's looming is causing some lumpiness. And so the bulk of the remainder inventory to be consumed is really in that area, and that's primarily sitting at our OEM customers. But that's how I'd characterize it. If you start broad and you just sort of narrow it down to the $20 million, that's the way to think about it. And to the extent that we continue to be successful in service provider, there's going to be lumpiness in that business. I think everybody understands that. But...

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Jean Hu, Marvell Technology Group Ltd. - CFO [20]

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Yes. And also, Blayne, we did say the XPliant and MontaVista, which we sold with the business, those combined revenue, impact revenue run rate is probably about a little bit more than $20 million a year. So that certainly is small, but it's some of the impact, too.

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Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [21]

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Helpful. And then for Jean, just on the OpEx, you're raising the range. I think Cavium came in higher in the March quarter by about that much. I'm just kind of -- how do you think about the increased savings that you're getting? Is it just really the upside that Cavium did or are you finding other areas? And then you had a higher range for a longer time period, I'm just kind of curious if that still holds too off the $200 million.

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Jean Hu, Marvell Technology Group Ltd. - CFO [22]

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Yes. I think our combined team, they did a great job to quickly integrate the R&D road map and also, all the other different functions. And so we certainly see the increase in the savings from more efficiency driving through the combination of the team to save more money on some of the investment areas and also on the SG&A support areas. So certainly, how we work through the process is we use the base run rate, the Cavium, as you mentioned, Q1 in 2018 and our last quarter run rate, that's the baseline, right? And then the team literally worked through every line item and every work stream to drive the synergy achievement. And so $200 million, I would say, across-the-board, the increase comes from both R&D and SG&A area.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [23]

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Yes, but -- and that's perfect, I just want to add one thing, Blayne, which is yes, Cavium OpEx ended up being higher in the March quarter, as you mentioned. But when you go back and even with our original models, right, we always had this $1.3 billion OpEx run rate, that was going to be our target baseline, which is $325 million a quarter. And as the year progressed, right, obviously, Cavium's OpEx was higher, but then Marvell's, as you can see even in our stand-alone results, was $208 million. So while theirs came in higher, ours came in actually lower, we managed it pretty efficiently. So that $1.3 billion run rate, actually, it's still the same. So we didn't -- said another way, getting to $200 million isn't because we were just resetting Cavium to whatever their level was. We looked at it as a combined run rate, and that's just the way that's worked. Hopefully, that's helpful to help you think about it.

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Operator [24]

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And our next question comes from Mark Delaney with Goldman Sachs.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [25]

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First question is a follow-up on the synergies topic. And Jean, thanks for all the clarity, but are there remaining OpEx synergies beyond this upcoming quarter? Can you help us understand the linearity that you'd expect to achieve those?

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Jean Hu, Marvell Technology Group Ltd. - CFO [26]

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Yes. That's a good question. So as all of you know, the system integration, the ERP integration typically takes 9 to 12 months. So there are a lot of synergy dollars that will be tied to 1 ERP, which typically will come off 4 quarters, 3 or 4 quarters from now. So the way we're thinking about to help you model is the Q3 OpEx is going to be largely flattish at that level. Then the first half of fiscal '20, you should see some step up because of the payroll matching and the merit increase. Then certainly, when ERP happens, you will see the step down to the run rate what we talk about, that Matt mentioned the -- from $325 million run rate before the close of the year to, it may end close to $290 million run rate exiting Q4 2020.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [27]

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Got it. That's helpful. And then for a follow-up question on the HDD controller business, one of your larger customers had announced a factory shutdown, and I know in the past, some of those factory shutdowns have led to some periods of inventory accumulation. And I don't know if that's anything that Marvell has seen or able to quantify or is something which you might be in the upcoming quarters?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [28]

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No, Mark, this is Matt. I'll take it. I think our perspective is the following. We've lived through many of these shutdowns in the 8 quarters I've been on the job here, so this is nothing new in terms of managing through these transitions. Actually, I remember back at the Analyst Day we had in 2017, this had just gone on and the way that we managed it then and we're managing it now, is you should think about that we -- we're very plugged in with those companies in terms of understanding their inventory and their supply chains. And so we've comprehended any transitions that they have in their business in our forecast. I can't really comment more on what each of these companies is doing and the reasons for and the details, but we're very aware of these things, and we have a number of things that we do also to monitor inventory that's at the end customer level as well as their sell-through, and so we have a number of ways that we use -- we manage our forecasting environment, sometimes, when there's these transitions. So all I can say is we're aware of it, we baked it in and it's part of our guidance.

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Operator [29]

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Our next question comes from Joe Moore with Morgan Stanley.

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Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [30]

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Wondering if you guys could talk about the China tariff situation. Do you see any impact that it's having on your customers, either the first couple of ways or the ways that are coming? And I guess, do you see any risk of customers trying to accumulate inventory to sort of manage moving a geographic footprint around the world?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [31]

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Sure. Joe, I'll take it. So yes, I'd say, the first point, just to make, I think you didn't ask it, but I'll just answer it, which is the tariffs themselves have really minimal to no impact on Marvell in terms of us manufacturing in China, and then shipping parts here for consumption in the U.S. So the tariffs directly on us is not really an issue. But as you point out, the bigger concern is what's the global impact of the tariffs on our customer base and does that drive different behavior. And certainly, we're concerned like everybody is about the global economic impact of the trade war escalating. I can't think of any specific issues related to customers that are telling us right now we're buying more inventory or we're taking less because of the tariffs, but we certainly know it's out there, and it's going to -- to the extent that this becomes a larger global GDP issue, then certainly, semiconductor companies will feel it. But I can't help much more than that because I can't give you any direct commentary because we're not getting that when we do our demand pulses right now, but it may be out there.

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Operator [32]

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Our next question comes from Karl Ackerman with Cowen and Company.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [33]

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Two questions, please. Matt and Jean, I want to go back to your comments on the synergy targets. Should we expect all of those cost savings to flow to the bottom line? Or are you looking to repurpose those monies into R&D within the core portfolio? And I guess, as a follow-up, as your portfolio has become more diverse, how do you prioritize R&D for your now very broad networking portfolio? Cavium's rule of thumb was half of sales growth. Is that still the right way to think about spending for your business?

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Jean Hu, Marvell Technology Group Ltd. - CFO [34]

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Okay. I'll take your question. Matt, can add on the R&D resource allocation side. So as far as the synergy, our objective is we are targeting $200 million run rate synergy, and they're all going to flow through the bottom line. That part is clear. There's certainly -- there's the time line we just outlined how we are going to achieve that synergy but our objective is to drive the earnings and the shareholder value there. As far as the R&D investment, frankly, Matt mentioned it during his prepared remarks. We just went through our annual strategy and portfolio review. That's the process that we look at all the different product lines to allocate the results among different product lines. So from investment dollar overall perspective, we feel we have the right investment. Matt probably can comment more on the process of how we look at the results allocation.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [35]

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Sure, sure. I think -- happy to take that one. So the first comment I'd make is even if you go back to when, as a stand-alone company, we went through our own transformation and we had our own plans there, which was $250 million of OpEx reductions at that time, actually, if you guys remember, we actually invested in key businesses during that time. So it was not just, "Hey, we're going to go take out cost," and everybody suffers. That we used that opportunity as an example to increase our headcount staffing in our SSD and networking areas and I think we're seeing the benefit of that now paying off. And so the way we look at it is, as Jean mentioned, that's $200 million, obviously, to the bottom line. But within that, you should assume there's some add backs that are netted out, meaning we're going to go deeper in some areas, we're going to add back in others, and we view this as one of the most important things we do in the company. We have an annual review where -- and by the way, every company does this differently. As you mentioned, Cavium kind of had a high level way of doing it; take sales growth, cut it in half and higher to that. We have, I think, a pretty rigorous approach to segmenting all of the investments we're making. So we actually have P&Ls now for all the Marvell businesses, all the Cavium businesses. We know what those businesses' relative market shares are, their gross margins, their growth trajectories and ultimately, what their operating margins are and their level of contribution to the company. And then based on that, we make decisions about how we're going to fund those businesses, whether we need to reduce or transfer people or rehire in certain areas. And so even though we're going through our synergy achievement, we have a significant number of open ranks in the company because we're hiring key talent in areas where we think we can grow. And we'll continue to do that and be good stewards of the R&D expense because we view that as the most critical resource we have. And so we deploy it in a very -- but we deploy it in a very thoughtful and data-driven way that, really, you should think of it as a combination of technical analysis on the products and their prospects as well as integrated with the financial analysis. And we've actually empowered the engineering leaders in the company, the business unit leaders as well as my executive staff, so we're looking at those as an integrated way to run the company. And so I know it's a little bit of a longer answer, but for those of you that might be new to the story, that's been the playbook and we plan on continuing that on an ongoing basis.

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Operator [36]

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And our next question comes from Craig Ellis with B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [37]

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Congratulations on the core Marvell performance in the quarter, and appreciate all the financial information. The first question I had was on revenues, Matt, and it's really more of a long-term question. As we look ahead to the fiscal fourth quarter when Cavium's back to a more normalized revenue level, if I understood you correctly, that's the base from which the company can proceed towards the 6% to 8% revenue growth target. So the question is how long does it take to get there? And what are the 3 or 4 key things that need to happen for you to attain that goal on a sustained basis?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [38]

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Great, yes. So Craig, on the first part, you captured that correctly. At this time, that's our best assessment, which is take the Q4 revenue and then apply the growth rate to it. And certainly, having come off of our strategy review process where we just reviewed all these businesses, we reviewed their next 3-year outlook, we've reviewed how fast the market is growing, and we'll give more details on this on Analyst Day, but from a market perspective, we see the end markets that we're targeting growing at least these kind of rates and certainly, we think if we're being good managers, we should be able to do that or better. I think the high level I would just give you is you think about, really, we have 2 big businesses now that are really portfolios, there's a strong portfolio under each in storage. I think the way to think about that one is it's got 2 very strong cash flow businesses in there where we have significant market share and differentiation, but they're slower growing markets and those are flattish, and those are HDD and fiber channel. And -- but if you layer in our SSD business and our flash business, which we really expanded from SSD controllers to, really, flash-based solutions, as seen at our FMS announcements, that business should continue to grow, so you can do your model thinking about it that way. And then within networking, if you just take a look at core Marvell networking as a pretty good proxy for what one can do in a networking business when you execute on R&D, you've got the right customers, you define the right products, we see that business continuing to grow, right, at double digits or greater. And we also think about OCTEON and Fusion and the processor business from Cavium having a similar type of profile. And again, as I mentioned, some of those we're finding are more than we thought are actually in the same application. So I think the way to think about that is you've got those businesses, you've got our security business, which is making a transition to the cloud, and there's been a number of announcements from large cloud providers on liquid security, so we see that as being a good growth business. And so the networking portion of the total should clearly grow faster than the storage, but I think when you start running your own models and you'll have your own view, based on end markets and what they're doing and based on our own kind of product line by product line view, we think that those targets we set are very achievable. And we're going to drive the company hard to go do that.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [39]

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And then the follow-up question goes back to comments that you've made on prior calls. You've expressed strong interest in returning to -- cash return via share buyback. Jean outlined debt paydown of $100 million per quarter beyond the current quarter. So in light of debt paydown, when do you expect you can return to share buyback? And Jean, if I could sneak one in for you since every client will be asking it tomorrow, what's the time line to quarterly earnings accretion on the former Cavium business? It doesn't look like we would be getting that in the fiscal third quarter, but can we expect that in the fiscal fourth quarter?

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Jean Hu, Marvell Technology Group Ltd. - CFO [40]

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Two questions, right, and so the first one on the cash return. Certainly, we want to target 1.5x gross debt-to-EBITDA ratio. So we do want to pay down the debt quickly. However, the combined company is going to generate a very significant amount of cash flow, right? So we do see -- we should be able to start to consider buyback once we get to 1.5x ratio, which should happen quickly. Our overall view, we'll share more about the capital allocation during our Investor Day. But overall, the strong cash flow generation, we should be able to deploy capital in a way benefit the shareholder the most going forward. Buyback is certainly one for the 2 elements. And we're going to focus on 2. So that's your first question. Second question on accretion. Certainly, right, I think if you look at Q3, as we mentioned earlier, we are resetting Cavium's side of the revenue to make sure their process is aligned with our processes, so we can be more efficiently run the combined business going forward. We do expect accretion in fiscal '20. And frankly, if we diligently manage our $200 million synergy-achieving plan and also really drive top line revenue growth, we do see double-digit accretion when we get to exiting fiscal '20. So we are very optimistic about our capability to run the business. As you know, we have the track record, as a company, to really drive the efficiency and also drive the top line revenue growth.

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Operator [41]

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And our next question comes from Quinn Bolton with Needham & Company.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [42]

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Just wanted to come back with the -- that you had sold the MontaVista business but can you say what have you done with the XPliant business?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [43]

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Sure, I can take that, so Quinn. Yes, so on XPliant, that product line and team and critical IP have been largely integrated into the Marvell switching team. So as you guys know, we have a large successful switching group inside of Marvell. There was a lot of discussion and integration planning on R&D on how to take the road map forward. And I think based on -- it was a joint decision between the Cavium team and Marvell team, but everybody agreed that the Prestera architecture, our ROS that we provide was the right way to go. And so we're going to drive that one forward. So that business has now been folded in. Clearly, there's some revenue headwind on the XPliant piece, as we mentioned, because once this was -- even once, actually, the acquisition was even announced, I mean, I think customers who were looking at both sort of were wondering and that definitely had a pause and that is resulting in some of those design wins probably ramping down faster than we thought and certainly, not getting new ones during this time frame. So Cavium, as Jean mentioned, MontaVista plus XPliant is about $20 million a year run rate. MontaVista's out and XPliant will wind down. Although we'll support it, any customer that's designed it in or was in the process of designing in, we're going to support them with our larger engineering team. But that's how you should think about XPliant. It's not a stand-alone business anymore, it's just run as part of Marvell switching.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [44]

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Great. And then a follow up. At Analyst Day, for the core Marvell storage business, I think you were targeting about a 3% growth rate for that business on a both combined HDD, SDD. As you bring in the fiber channel business from Cavium, does that 3% CAGR change at all?

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Jean Hu, Marvell Technology Group Ltd. - CFO [45]

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So we'll give you an update on our upcoming Analyst Day. But it should not change much, right? Matt just mentioned both HDD and the fiber channel, they're mature business, they generate a tremendous cash flow, and we are going to drive the business to grow flattish with the market at both of those businesses. So we'll share more during our Investor Day about the prospect of our storage business.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [46]

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Yes, I think that's the right forum. If you go back to the last one, a lot changed from now to then, right? I think SSD has significantly outperformed sort of where we thought it would be back then as a market and our own business. And I think Marvell's storage overall has actually done better than we thought. So I think that's the right forum. We'll have more time under our belt and we can give you the full view of the storage portfolio but...

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Operator [47]

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This concludes today's Q&A session. I would now like to turn the call back over to Ashish Saran for closing remarks.

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Ashish Saran, Marvell Technology Group Ltd. - VP of IR [48]

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Thanks, everyone, for joining us today. And we look forward to talking to you all again next quarter. Thank you, and goodbye.

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Operator [49]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.