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Edited Transcript of MRVL earnings conference call or presentation 3-Dec-19 9:45pm GMT

Q3 2020 Marvell Technology Group Ltd Earnings Call

HAMILTON Dec 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Marvell Technology Group Ltd earnings conference call or presentation Tuesday, December 3, 2019 at 9:45:00pm 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

* Christopher Caso

Raymond James & Associates, Inc., Research Division - Research Analyst

* Christopher James Muse

Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst

* Gary Wade Mobley

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Harlan Sur

JP Morgan Chase & Co, Research Division - Senior Analyst

* Joseph Lawrence Moore

Morgan Stanley, Research Division - Executive Director

* Ross Clark Seymore

Deutsche Bank AG, Research Division - MD

* Timothy Michael Arcuri

UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment

* Vivek Arya

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2020 Marvell Technology Group Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to your speaker, Ashish Saran, Vice President, Investor Relations. Sir, please 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 Third Quarter Fiscal Year 2020 Earnings Call. Joining me today are Matt Murphy, Marvell's President and CEO; and Jean Hu, our CFO.

I would like 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 refer 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. With that, I'll turn the call over to Matt for his comments on our performance.

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

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Great. Thanks, Ashish, and good afternoon to everyone on the call. As a reminder, we closed the acquisition of Aquantia in our third fiscal quarter, so our consolidated results include a partial quarter of results from their operations as well.

During the third quarter of fiscal 2020, we delivered solid results and achieved $662 million in revenue. Our GAAP loss per share was $0.12. Our non-GAAP earnings per share was $0.17, at the midpoint of guidance.

Our storage business grew sequentially, and we had better-than-expected results from our networking [business.] While we cannot influence the macroeconomic environment, I am very happy with our execution on the things we do control. Earlier this year, we discussed a number of significant design wins for our products in 5G base stations, enterprise switches, automotive Ethernet and data center storage.

In the third quarter, we continued to add to this growing list with more wins, which I will discuss later in the call. Our engagement with customers continues to strengthen, which is becoming evident in our success in winning high-value sockets in all our target markets, which we expect to drive sustainable growth over many years.

In fact, one of our important growth drivers has already started to benefit us. And I'm very pleased that we shipped a significant amount of our 5G products in the third quarter, helping our key customer rapidly roll out base stations for the initial wave of 5G deployments in Korea. Of course, this is just the start of 5G deployments, and we are looking forward to a lot more growth from 5G in the longer term.

More recently, we closed the acquisition of Avera on the first day of our fourth quarter. The acquisitions of Aquantia and Avera are very strategic to broadening our semiconductor solutions portfolio for our infrastructure customers. We are well on our way to integrating both teams within our networking business, and I would like to extend a warm welcome to all the new employees who have joined the Marvell team.

We also expect to complete the divestiture of the Wi-Fi connectivity business to NXP in the first half of this month. However, as we currently still own the Wi-Fi business, my comments today on revenue expectations for the fourth quarter include a full quarter of expected results from that business. I'd like to take this opportunity to personally thank the 600 dedicated employees in that business for their years of service to Marvell and for staying focused through this transition. We wish them all best.

Now moving on to the performance of our 2 core businesses. First, in our networking business, revenue during the quarter was $330 million, flat sequentially as compared to our expectations of a low single-digit decline. This improvement was split between partial quarter contributions from the Aquantia acquisition and organic Marvell businesses. During the quarter, macroeconomic uncertainty continued to impact demand from the enterprise end market. Additionally, as expected, demand for our Wi-Fi products declined seasonally. In contrast, our embedded processors delivered double-digit sequential revenue growth, driven by strong 5G shipments.

As you may recall, in the early part of this year, we had anticipated the start of initial production for our 5G products in the fourth quarter of this fiscal year. However, last quarter, we announced that we were able to start production in the third quarter. A key customer requested very aggressive delivery timelines to meet their commitments, supporting 5G rollouts in Korea. Outstanding execution by our engineering and operations team allowed us to rapidly ramp production and successfully deliver 5G products in volume within the third quarter itself. This was also a very impressive demonstration of the maturity of our platform and quality of our NPI process that enabled us to transition from sampling our new 5G processors in the first quarter to driving a production ramp shortly thereafter.

The third quarter was just the start of the 5G ramp for us and was driven primarily by a single region. We expect these initial deployments in Korea to continue to be the main driver for 5G revenue for another couple of quarters, and we should start to see the benefit from other geographies later in fiscal 2021. By the time we approach the second half of next fiscal year, we expect a strong increase in our 5G-related revenue, driven by continued Korean deployment and the start of 5G adoption in Japan and other countries such as the U.S. as they start to install 5G base stations in higher volumes.

In addition, we expect to start production of baseband processors for our second Tier 1 base station customer in the fourth quarter of fiscal 2021, further adding to our overall 5G revenue ramp. Our progress to date has also enabled us to engage with them in longer-term technology roadmap discussions. The broadening adoption of our 5G platform is a testament to the advanced capabilities of our multi-core embedded processor portfolio, further complemented by our Ethernet switch and PHY products. And we now have added Avera's full custom ASIC capabilities, enabling us to offer an industry-leading 5G suite of technology. But before I move on to the Avera acquisition, let me spend a couple of minutes on the unique capabilities of our OCTEON embedded processor platform.

As you may recall, OCTEON was the first multi-core processor architecture with a complete set of on-chip hardware accelerators for networking applications. Since then, the OCTEON platform has been widely adopted for control and data plane processing across a broad range of networking applications, including base stations, switches, routers, broadband access and firewall appliances. This platform now scales up to 48 optimized ARM cores and includes hardware-optimized packet processors, crypto engines, virtualization support and a wide variety of network interfaces.

Our Fusion baseband processors are built on the same proven OCTEON architecture, adding baseband-specific hardware accelerators and DSP cores. An important benefit for OCTEON and Fusion customers is the ability to reuse the entirety of their sizable control and data plane software investment as they design [in our] products across their portfolio. The software reuse not only speeds our customers' development cycles but also creates very sticky designs for Marvell.

Our OCTEON and Fusion family includes fully programmable ARM and DSP cores, enabling an extremely flexible and scalable architecture, further optimized by implementing certain fixed functions and hardware acceleration blocks. The speed, simplicity and scalability of the OCTEON programming model has been a key differentiator and an important driver for the adoption of our processors in multiple applications.

In addition, as processing spreads into new domains and base stations, such as the radio head, customers are also turning to our processors for new functions. As an example, as we discussed earlier this year, one of our customers adopted our existing Fusion baseband solution for massive MIMO processing. This represented their fastest route to market as their software was already up and running on the OCTEON architecture and the Fusion implementation was flexible enough to extend to their massive MIMO application.

Longer term, customers will often require customized OCTEON or Fusion processor optimized for specific applications, such as the complex beamforming needed for massive MIMO. I'm pleased to announce that we now have been awarded such a design win by a key customer for a Fusion-based solution customized for massive MIMO processing a radio head. The additional complexity in this solution is also enabling a higher ASP than our existing baseband product. In addition, we are driving a fast time-to-market by leveraging the flexibility in our processor platform and expect to complete development in under 1 year, allowing us to start ramping this product into production by the beginning of calendar 2021. We are also in advanced discussions with a second customer for processing solutions for massive MIMO.

Moving on to Avera. The combination of Avera and Marvell creates an infrastructure ASIC powerhouse with the scale and design flexibility leading wireline and wireless OEMs are looking for from their semiconductor partners. Kevin O'Buckley, who was Avera's General Manager, has joined Raghib's team and will be leading the ASIC business for Marvell. In addition to Kevin, we are fortunate to be adding multiple key leaders from Avera, who along with the talented global Avera team, bring a tremendous amount of industry experience and technical capability. This team, originally part of IBM's Microelectronics business brings a proven track record of delivering a large number of highly complex ASICs to very demanding customers. In terms of revenue, we continue to expect that Avera will contribute approximately $300 million in annual revenue next fiscal year. A significant amount of Avera's revenue is from the wireless infrastructure market, primarily for digital front end ASICs and radio heads, which aligns extremely well with Marvell's expanding presence in base stations.

The base station revenue from Avera will be in addition to the organic Marvell opportunities I discussed earlier. We estimate that Avera brings an incremental $4 billion to Marvell's addressable market across the data center, carrier, enterprise and automotive end markets. Avera's design capabilities, coupled with our broad technology platform, will allow us to leverage our combined IP portfolio across the full spectrum of custom, standard and semi-custom solutions. We also expect to benefit from a broader combined customer base.

As I mentioned earlier, we have now added Aquantia's leading multi-gig Ethernet products to Marvell's broad switch and PHY portfolio, extending our reach in both the network, infrastructure and the rapidly growing automotive Ethernet market. Faraj Aalaei, who was Aquantia's CEO, has joined Marvell and taken on a broader role as the General Manager for all our Ethernet products, including automotive. Faraj brings a tremendous amount of industry experience, and we are looking forward to working with him and his team. We have already integrated roadmaps to create a very compelling end-to-end Ethernet connectivity portfolio. And in fact, the combined Marvell and Aquantia team have already secured their first major design win together. This win was for a multi-gig Ethernet PHY in a Tier 1 networking OEM's campus switch platform, and we expect to start ramping production in the second half of next fiscal year.

In addition, the response from multiple automotive customers to the combined company roadmap has been very strong, and we are jointly working on additional opportunities to add to the 16 design wins Marvell has already won across a broad range of OEMs. From a revenue perspective, macroeconomic uncertainty impacted Aquantia's revenue in the first half of Aquantia's fiscal year as their key customers reduced purchases to better match their inventory with demand. With the acquisition now complete, we expect to grow this business to approximately $100 million in annualized revenue in fiscal 2021. In fact, Aquantia's revenue has already started to recover from their June quarter on a run rate basis.

Turning now to the growing ecosystem for ARM-based compute in the data center. At the Supercomputing Conference in Denver, we announced the availability of NVIDIA GPU support for ThunDERX2 based server platforms to provide HPC and cloud customers with a powerful solution for exascale computing.

In addition, we recently announced that Microsoft has started to deploy servers based on Marvell's ThunderX2 server processors for internal Azure development workloads. We believe that this is an important milestone on the path to the broader adoption of ARM-based servers across the Azure platform. The progress of ThunderX adoption at our cloud and HPC customers gives us confidence in expecting revenue growth next fiscal year from our server processors, starting from a base of low initial volumes and then continuing to ramp in the second half. As we look beyond the data center server market, we are also seeing multiple opportunities to leverage our ThunderX processor cores in SoC or ASIC solutions, for applications requiring embedded high-performance compute engines.

Moving on to our outlook for the fourth quarter for our networking business. Driven by -- primarily by full quarter contributions from Avera and Aquantia, we expect an approximate 25% sequential increase in networking revenue. We are expecting revenue from Aquantia products to continue to recover from the low point they reported earlier this year. For the rest of Marvell's networking business, we expect 5G shipments to remain strong, while demand from the enterprise end market remains weak, including a decline from a number of Chinese customers.

As you may recall, in prior quarters, we had indicated that these customers appear to be building inventory to guard against any future potential supply chain disruptions. As a result, in the fourth quarter of fiscal 2020, we are anticipating a sequential decline from that elevated run rate in addition to general end market softness. We are also projecting the Wi-Fi business to decline seasonally in the fourth quarter.

Turning to our storage business. Storage revenue for the third quarter was $288 million, growing 5% sequentially. As expected, this growth was driven primarily from the enterprise and data center market. However, we did experience weaker-than-expected revenue from the edge market, with a softening in demand from gaming and video surveillance. We also continue to see a rapid conversion from HDDs to SSDs in the PC market, which presents a headwind for our client business. Despite challenges from current trends in the client and edge markets, our strategy to focus on the enterprise and data center market, including a strong position in high-capacity cloud drives, continues to pay off to drive growth for the overall storage business. Last quarter, we introduced the industry's first PCIe gen 4 SSD controller based on a 12-nanometer process. This product delivers higher performance within a lower power envelope in a space-optimized package to enable our customers to develop smaller form factor solutions.

In addition, our solution also allows customers to eliminate DRAM from their SSDs which also reduces size and power while lowering their bill of material. Multiple customers, including several NAND OEMs are deeply engaged in evaluating our product as it uniquely addresses a number of their emerging mainstream SKUs where they need to balance performance and power in a small form factor solution. This PCI gen 4 architecture is also the basis for our customized SoC flash controllers for embedded and do-it-yourself applications. Our first major DIY design at a Tier 1 system-level OEM is in the final stages of development. We expect a sharp ramp in revenue from this product in the third quarter of next fiscal year when our customer begins mass production of their system.

Turning to the fourth quarter for our storage business, we project revenue to be flat to up slightly on a sequential basis. We expect our revenue from the data center and enterprise end markets to continue to grow from a strong third quarter and offset weaker trends in the edge and client markets.

In closing, we continue to win new designs and position ourselves for solid growth with strong execution on new product introductions. Our 5G products have started shipping in volume, helping us offset macro weakness in other end markets such as enterprise. We expect 5G base station deployments to expand into multiple geographies later next fiscal year, which we anticipate will drive a substantial increase in revenue. In addition, we continue to expand our engagement with a broad set of Tier 1 5G customers. Our storage business has stabilized, benefiting from our growing exposure to enterprise and data center applications and grew appreciably in the third quarter.

The acquisitions of Aquantia and Avera meaningfully increased our addressable market opportunity and add to Marvell's infrastructure capabilities to create a very unique technology platform. I'm looking forward to an exciting fiscal 2021. With that, I'll turn the call over to Jean for more detail on our results and outlook.

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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 a review of our financial results for the third quarter, which include a partial quarter of results from the Aquantia acquisition, which we closed on the 19th of September. As a reminder, the guidance provided on the 29 of August for the third quarter did not include any contribution from the pending Aquantia acquisition. Revenue in the third quarter was $662 million versus our guidance of $660 million at midpoint.

Networking represented 50% of our revenue in the third quarter, with storage contributing 43%. Revenue from our other business was $45 million in the third quarter, below expectations and declined 14% sequentially. Other products accounted for 7% of revenue. GAAP gross margin was 51.3%. Non-GAAP gross profit was $421 million or 63.5% of revenue, at the mid point of our guidance range.

GAAP operating expenses were $402 million. Non-GAAP operating expenses were $283 million, slightly above the mid point of guidance due to the closure of our Aquantia acquisition within the quarter. Without the impact from the Aquantia, acquisition, non-GAAP operating expenses would have been below the low end of guidance.

Our current level of OpEx reflects a lower level of [bonus accrued.] GAAP operating loss was $62 million. Non-GAAP operating profit was $138 million or 21% of revenue. GAAP loss per diluted share was $0.12. Non-GAAP earnings per diluted share was $0.17, at mid point of guidance.

Now turning to the balance sheet. In the third quarter, we returned $40 million to shareholders through dividend, and then we exited the quarter with $438 million in cash and cash equivalents. Long-term debt was $2 billion, an increase of approximately $350 million from prior quarter. The increase was from drawing down on our revolving credit facility for funding the acquisition of Aquantia.

Inventory increased to $68 million from the prior quarter. $31 million of the increase was from the Aquantia acquisition, including accounting fair value step-up. The balance of the increase was to support the expected growth of our 5G business.

Let me now move on to our current outlook for the fourth quarter of fiscal 2020, which include expected results from the Aquantia and Avera acquisitions for the full quarter.

This guidance also includes expected results for the full quarter from the Wi-Fi business. Once the sale of the Wi-Fi business is completed, we'll update the revenue portion for our guidance for the fourth quarter. We continue to expect our revenue in the current quarter to remain impacted by the U.S. government's export restrictions on certain Chinese customers.

Specifically, we expect revenue to be in the range of $750 million plus or minus 3%. We anticipate our GAAP gross margin will be approximately 45.5%, and our non-GAAP gross margin will be approximately 62%. Avera is a carve out from GlobalFoundries. And we have such onetime transition costs that are expected to negatively impact our gross margin in the fourth quarter. We expect gross margin return to more than 63% once we complete the divestiture of Wi-Fi business and fully integrate Aquantia and Avera into Marvell supply chain.

We project our GAAP operating expenses to be in the range of $445 million to $455 million. We anticipate our non-GAAP operating expenses to be in the range of $315 million to $320 million. We expect net interest expense to be approximately $26 million.

As a reminder, at the beginning of our fourth quarter, we financed the acquisition of Avera with $600 million bridge loan. And this increase in debt is reflected in our guidance for interest expense. We anticipate GAAP loss per diluted share in the range of $0.17 to $0.23 and the non-GAAP income per diluted share in the range of $0.15 to $0.19.

Before we open the line for questions, let me make a couple of longer-term comments on operating expense expectations given we have a few moving parts from 3 transactions: First, due to the typical seasonality in payroll taxes, merit increases and the reset of bonus accruals from the current low level, we expect our non-GAAP OpEx in the first quarter of the next fiscal year to grow by approximately 5% on a sequential basis. Second, we have quickly started to integrate both Aquantia and Avera and the ERP integration had been largely completed, enabling a faster start toward the synergy achievement. We'll continue to drive the remaining synergy achievement and the operating efficiency improvement through fiscal 2021 while investing in growth initiatives to position us to deliver long-term profitable growth. Once we complete the divestment of our Wi-Fi business and fully integrate Aquantia and Avera, we expect OpEx to decline through the rest of fiscal 2021 from the Q1 high point I just outlined.

As a result, we project our non-GAAP operating expense in Q4 next fiscal year will be approximately $300 million. Operator, please open the line for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Vivek Arya of Bank of America.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [2]

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Matt, a few quarters ago, you gave a $600 million long-term opportunity in 5G. What is the confidence in achieving that? And just what does that number look like now that Avera is in the mix? And I think you highlighted some additional opportunities also in massive MIMO.

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

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Yes. Great. Thanks, Vivek. So I think to answer your first question, we -- you're right, a couple of quarters ago, we articulated the $600 million number, which was really the business that we had already secured design wins for. We still feel very good about that opportunity. And in fact, as we indicated in the prepared remarks, there's even been some incremental change to that on the positive side as we transition at least one of our customers to a higher ASP product in the massive MIMO area. So that tends to be tracking well in terms of the design opportunities and our customer positioning. So we're quite confident there.

On Avera, what we said was about half their revenue was from the wireless infrastructure market and base stations, of which a portion of that is tied to 5G. And certainly, we see that contributing as well. And that would be on top of the $600 million. And I look forward to completing a full quarter with Avera under our belt and then articulating the combined opportunity in the future, but it's definitely above $600 million, just given the fact that Avera is bringing in pretty significant revenue in the base station market.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [4]

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All right. And for my follow-up, Jean, thanks for giving us the gross margin and the OpEx puts and takes. I was hoping you could -- just for clarification, give us just contributions of the different M&A moving pieces in your Q3 and Q4, so that we can align the models accordingly?

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Jean Hu, Marvell Technology Group Ltd. - CFO [5]

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Yes. Vivek, it's actually quite straightforward if you think about our operating expense guidance for Q4, which include both Aquantia and Avera for the full quarter, which also include the Wi-Fi business. So moving forward, if we end up closing the Wifi sale in our Q4, the way -- the best way to think about it is I also guided you Q4 next year, that OpEx is going to be $300 million without Wi-Fi business. So a simple way to think about it is that how we are going to migrate. We're going to have a merit and bonus increase reset in Q1, but we're going to absorb those increases by improving efficiency and achieving additional synergies. So you can actually view the difference between Q4 this year and the Q4 next year is the difference is the WiFi business getting out.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [6]

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I meant on the sales side, Jean, if you could give us the puts and takes in Q3, Q4 from -- you completed Aquantia in Q3, which added probably some small amount. And then in Q4, right, you have the 2 acquisitions, but then WiFi goes out, but it's down seasonally. I think just -- I'm just trying to contrast the outlook that you gave versus what people's expectations were going into the quarter.

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Jean Hu, Marvell Technology Group Ltd. - CFO [7]

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Okay. Great. So Q3, Q4 is actually -- when you think about Q3, our OpEx is about $280 million without any acquisitions. We actually achieved a significant amount of the synergies right at the beginning of the 2 acquisitions. So the 2 acquisitions probably add about $37 million of OpEx. That's why the Q4 midpoint for OpEx guidance is the current level. So the way to think about it is the $280 million step-up because of the 2 acquisitions. And then when you get into Q1 next year, of course, we're going to have the Wi-Fi business coming out if we close the transaction, but at the same time, the OpEx will stay around the same level because that 5% sequential increase from the merits and the bonus reset.

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Ashish Saran, Marvell Technology Group Ltd. - VP of IR [8]

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Vivek, this is Ashish. So I think from -- I think your question was also on the top line side. So I think for Q3, again, Aquantia was there for a fairly small period, and it's a fairly small number. So the Q3 revenue is pretty much -- you should assume it's really Marvell with a very small help from the Aquantia side. I think on Q4, again, I think what we can do is remind you of kind of what we expect on a full year basis. So as we said, Avera is a $300 million business, right, for next year. Aquantia, next year, we believe, is about $100 million. But as we said, it's still recovering towards that number, right, as you remember, from where they were originally. Wi-Fi, again, if you remember, when we said the divestment, it's a $300 million business, right. So you can do the quarterly number, and it's on the low end of that number, given we're at a seasonally low point. I think that's how you can think about revenue for Q4.

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Operator [9]

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Our next question comes from Blayne Curtis of Barclays.

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Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [10]

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I was just kind of curious. I mean, you've obviously had, you've talked about more opportunities on the wireless side, you can deal with. You haven't had ASIC capabilities. Just kind of curious of the timeline to kind of combine these roadmaps and scale of Avera and kind of if you just talk about the pipeline as you look forward, opportunities that you've looked at with your customers that you could potentially move over with those capabilities?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [11]

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Sure. Great question. So a couple of things. So one is -- I talk about in 2 dimensions. The first is we've already had hit the ground running on the customer side. So there's been a pretty extensive global roadshow with the combined Marvell and Avera team to articulate our strategy for both 7 and 5-nanometer in our technology platform. We're doing this in a very targeted manner and really think about it as we're going to address -- we're going to line up our IP roadmap that we've had inside the company with the end customer orientation. So we're going to go more narrow and go much bigger with a handful of large customers across those end markets, I mentioned, which is cloud, enterprise, automotive and also base stations, and that's gone extremely well.

The second is we've done already a very good job of the team, integrating the IP team from Avera and also the back-end teams into one consolidated central engineering effort. So when we hit the ground running on our next-generation process technology platform, we're going to have one platform that we can leverage for our ASIC business, for our semi-custom business and for our standard product business. And that's resonating very well with the customer base. I think they wanted to see us actually bring the team together quickly and have one integrated offering. And I would say the feedback has been phenomenal from the roadshow in terms of interest from all those end markets that I mentioned.

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Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [12]

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And then maybe if you could just talk about the ramp of your lead base station customer, you said you shipped it early, you've been hitting these aggressive timelines. Obviously, they need to deploy those, get them quality carriers and ramp. I think you were looking for a contribution in January. Can you speak to whether that's still on track in your guidance? And then if there's any visibility, you mentioned some regions. But in terms of the traction, they're getting and your visibility into getting those targets for that customer?

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

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Sure. Yes. No. It ramped up and it ramped up fairly steeply, which was positive. It's going to probably remain -- certainly from a Korea standpoint, it will keep deploying at that level. And then we see continued momentum as our customer deploys in other regions and within those other regions, other carriers within those regions. And certainly, even in the Korea market, I think the best is still in front of us if you look at subscriber penetration which has been very fast in Korea. I think to date, it's around 15% of total subscribers around 5G. And certainly, that's going to trend significantly higher next year. So I think -- think of it as sort of the first step as Korea has ramped, and it's going to stay strong for the next few quarters, and then we anticipate additional regions kicking in in the outer quarters with what looks to be a very strong second half as 5G really picks up momentum and our design position should enable us to participate in that.

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Operator [14]

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Our next question comes from Ross Seymore of Deutsche Bank.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [15]

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Matt, I want to focus more on the enterprise side of things. In your preamble, you talked a little bit about the China inventory digestion. But last quarter, you also talked about some of the big customers that hit you with some order cancellations relatively close to your call. So overall, I just wanted to see, how long do you think that inventory burn in China is going to last? And did the weakness that you saw from that large customer continue into the fourth quarter guidance? Or is that kind of plateaued?

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

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Sure. Thanks, Ross. Let me talk about them in 2 distinct pieces because they're a little bit different. I think on the China side, what we signaled was we did see inventory being built, I think, primarily due to concerns about restrictions from an entity list point of view, and we had signaled that over the last couple of quarters, we saw it happen, and we called out that we now see the -- we see that reflected in our Q4 outlook, which is that inventory had been built in Q3 and that was not going to continue into Q4. So that's sort of a separate geopolitical issue on the enterprise market relative to the broader enterprise market. We certainly were impacted last quarter. We did signal that we had a slowdown in the outlook fairly close to the call. That's continued. And I think if you just look at the commentary in general, out of the market, I think most of the large companies selling into the enterprise, are continuing to have a weaker outlook, primarily due to the macro.

And I think the way we look at it is -- certainly, there's some -- well, the -- looking at the United States while the consumer is strong, I think the business environment tends to be fairly cautious. And until there's maybe more clarity on some of the trade-related issues or there's some conclusion, it's going to continue to remain choppy. And so that's what we're seeing currently. I'd say -- I'd end this whole thing by saying, at the same time, because of our -- the investments we've made in some of these new emerging areas and candidly, the team's very strong execution on our new product development, we've been able to offset some of this weakness. And 5G was one example this past quarter, which we expect to continue. But we also -- as we said in our prepared remarks, we see multiple growth drivers heading into next year, which even with a weaker macro, we think our product cycles will carry us through.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [17]

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That's great. And as my follow-up one for you, Jean. I guess, maybe a clarification then the question. The clarification. On the OpEx, does it go up 5% sequentially in the first quarter for all the reasons you described before, but then comes back down when the Wi-Fi comes out? So that nets out kind of flat?

And then the question behind that would be on the gross margin side, I think you gave great color about what it would do once you get the integration done. Would you care to give us any idea on exit rates? Like you said, on OpEx being $300 million next fiscal year. What the gross margin might be? Is that about when you get over the 63% again? Or is there some different timetable we're talking about?

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Jean Hu, Marvell Technology Group Ltd. - CFO [18]

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So if you think about gross margin, right, the 2 major drivers are revenue level and product mix. We are quite confident once we complete the Wi-Fi divestiture and fully integrate the 2 acquisitions that we should get to about 63% very quickly. But then beyond that, really, it's going to be driven by revenue level. When our revenue level recover it helps to improve our gross margin further above that level. And of course, your product mix is another one. Typically, we'll see how the product mix goes each quarter. But we are quite confident we'll be able to drive the gross margin above 63% quickly, probably in Q1 next quarter -- next fiscal year and then go beyond that.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [19]

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And the OpEx side?

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

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On the OpEx side, I think, really -- you're absolutely right, is when you look at the bonus reset and the merit increase, the payroll tax, all added together in Q1, that's the 5% sequential increase that we discussed. But then we'll take down that OpEx to the $300 million level exiting Q4 fiscal '21.

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Operator [21]

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Our next question comes from Gary Mobley of Wells Fargo.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [22]

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Let me apologize in advance if there's any background noise. I wanted to ask about sort of the revenue breakdown post sale of the Wi-Fi and bluetooth business. It sounds like the baseline there for that business in the fourth quarter is -- excluding that business is $675 million. And how should we think about the seasonality off of that as we start out fiscal year '21 and progress through that fiscal year?

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Jean Hu, Marvell Technology Group Ltd. - CFO [23]

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Yes. Okay. Gary, I'll try to give you some color. We're certainly not guiding next fiscal year. But typically, the way to think about our revenue seasonality without Wi-Fi business is Q1 sequentially versus Q4, there will be slightly low single-digit decline. That's just regular seasonality. And then when you migrate into Q2 will increase slightly. I think that's the most important thing in the second half, as Matt mentioned, we have some very significant revenue drivers. That's related to our old product cycle [despite] normal seasonality or macroeconomic situation. Those drivers are coming from 5G, from DIY, SSD solutions. So those things are probably to drive our revenue significantly higher in second half. So that's the only color I can give you right now.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [24]

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Okay. Well, that's helpful. And just to confirm some of the stats for the connectivity business, with it being down seasonally in the fourth fiscal quarter, presumably somewhere in the ballpark of $65 million, can you confirm that this business is still 50% gross margin business and more than likely operating breakeven in the current quarter?

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Jean Hu, Marvell Technology Group Ltd. - CFO [25]

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I think the right way to think about this what we give to you guys before, right. This business operated around the $300 million revenue with some seasonality and gross margin around 50%. So that's what we've provided in the past.

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Operator [26]

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Your next question comes from C.J. Muse of Evercore.

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Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [27]

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I guess as you learn more about the plans for your lead customer on the 5G side and you gain a better understanding of kind of geographically outside of Korea, the build plans, can you speak to how you think about your market share there as well as content as we push forward?

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

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Yes. Just to make sure I got this. You're really saying, hey, beyond Korea for our lead customer, what is the deployment look like? And then what is our content relative to maybe some of those different regions? Did I get that right, C.J.?

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Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [29]

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Yes. Exactly.

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [30]

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Yes. So I think the way to think about it is, first, just on the content side, this tends to be one platform. The only difference is I would note is, to the extent that in certain regions that massive MIMO is deployed more extensively, then that's certainly a positive thing for us because we have more content in those radio heads. And as I mentioned, we already have some content today in radio heads. And in the future, we would have more customized purpose-built solutions.

Beyond Korea, we see, certainly, Japan deploying next year. A lot of that's driven by the country hosting the Olympic Games. Certainly, for those of us here in the United States, you can see the pretty strong momentum among the various carriers of their plans to deploy 5G, that's probably more robust later in 2020. I think there's certainly with respect to the device side, there's a slew of devices out there, but sort of the holy grail that people have in mind is when there's an iPhone 5G. And to the extent of that, the timing of that product becomes clear. I think we certainly think that will help overall adoption of 5G and drive demand for the service, probably very similar to when the product initially came out and made the transition to 3G, that drove a big cycle. And we've seen cycles subsequently from 3G to LTE to 5G. So I think there's a number of positive data points. Certainly, we get more and more encouraged about the adoption of the technology.

And then there are other things going on. There is spectrum licenses in India and other countries. And I think we're just going to see a continued sort of evolution of various countries around the world deploying. But for us, it's really Korea, Japan, United States and then to some extent, depending on when India decides to kick in, our lead customer has always had a strong presence in that region. But again, content, you should assume, unless there's some very high adoption of massive MIMO in a particular region, should be very similar to the numbers we've been talking about.

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Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [31]

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Okay, very helpful. I guess as my follow-up, now that Avera is closed, can you talk a bit about the strategy to try to bring their -- I guess, your #1 customer there in-house on the ASP side?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [32]

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Well, what I'd say is in what's resonating well is that the -- across all of, quite frankly, our combined Tier 1 5G customers and base station customers is that our end-to-end portfolio, our offering is second to none, okay. I mean, there's not another company that has all of these various pieces under one roof, right, from baseband IP to transport processing IP, fronthaul connectivity, obviously, DET and now we're getting very strong DFE experience and capability from Avera and plus some of the massive MIMO efforts we're putting in.

So that I would say, across the board, has resonated extremely well, that entire data chain being able to be provided by Marvell. And so certainly, we're engaged both with the Avera customer base as well as the Marvell customer base and presenting it as one unified strategy. There's no specific update on an existing customer. But I will say, just having brought Avera on board recently, I mean, we've already gotten RFQs from several customers that were new customers for Avera, right, and we're bringing those Marvell relationships in. So we're still early days, but certainly, to be effectively a month in and be already engaged in these types of discussions is very encouraging to me.

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Operator [33]

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Our next question comes from Joe Moore of Morgan Stanley.

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Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [34]

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I wonder if you could talk a little bit about the Thunder opportunity. You talked in the main remarks about the update for Microsoft, which was good to see. How do you size that potential? And what are the prospects for other customers, both with domestic cloud and also in China for that.

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

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Sure. So let me give a big picture first, and then we can frame our opportunity. So I think one positive thing, certainly out of the supercomputing conference [this year], and you can even look as recently as the last couple of days with Amazon's events. It's pretty clear that the ecosystem for ARM-based server-class CPUs continues to grow. I mean, certainly, in the couple of years we've had the business or even less, there's been tremendous progress there. And so we look at it, one, as a positive that there's a number of different solutions now that are coming to market. The partnership with NVIDIA. It's been significant. And I think the ability to go work, interoperate with them, certainly in the exascale type of opportunities is a big deal. We were pleased to announce that we -- progress on the Microsoft front and that we put out the joint press release. And we certainly see that -- those deployments starting initially in the early part of next year and ramping in the second half. I think it's a little bit early to call the size and the slope.

But clearly, we're encouraged that we've gone through the gauntlet of qualifications and joint development there over the last couple of years, it's been a great partnership, and we're looking forward to this ramping into production in the second half. And I think everybody knows the sort of size of the server CPU market is deca billions of dollars. I mean, at our own Analyst Day, we said the subset of that, that we were going after was probably in the range of $4 billion or so of SAM just as a subset. So still remains a big opportunity, still lucrative, but we'll probably give more color as we approach production ramps to be able to give you a sense of what that should look like.

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Operator [36]

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Our next question comes from Harlan Sur of JP Morgan.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [37]

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On your second Fusion customer for 5G base stations, they've made some commentary in wanting to pull in their development schedules and accelerate their time to market with their 5G platforms.

The Fusion program is a semi-custom program. So I think that there's only so much that you guys can do to kind of pull in these type of products. But do you see the potential for possibly pulling in the production ramp into fiscal Q3? And then on future programs with this customer, which you already seem to be engaged with, what's the potential of increasing your dollar content to include things like OCTEON embedded for control and data plane, your Ethernet products, your radio head content from both core Marvell and Avera.

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

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Sure. Well, thanks for the question. So I think the way I'd frame it at a high level is, if you look at our lead customer, and I noted some of the statistics about how fast we were able to bring them to production and just the overall development cycle time. I think that was one compelling reason why we were chosen. And the second opportunity was really the confidence in the team's ability to dramatically improve the historical cycle times of getting types of ASICs out in general in the base station market. And so we've got some really strong proof points. I think -- and we're executing extremely well to the aggressive schedule that we had committed to upfront for the second customer. We certainly have proved our team's capability to the extent that if people want to try to go earlier then we would certainly do everything we could. We're currently on track to sample the product, tape-out sample production in line with what we've been saying and that's currently the plan of record. But we're always very sensitive when our customers want to go faster and the extent that they -- we could mutually align on that we would. But at this point, we are committed -- we already committed a pretty aggressive schedule, to begin with. And so that's what we're sticking to.

On the second part of the question, at least so far, because the partnership has been strong and the engagement -- and we've been delivering to what we said. Any time you do that with a customer, it opens up opportunities. And so again, you kind of nailed it between OCTEON for the transport, full ASIC capability for DFE and the ability to add even some Marvell IP in there massive MIMO, Ethernet, fronthaul connectivity, it's a pretty compelling portfolio. So we're hopeful to continue to win more business across the board. And certainly, the best way we can do that is live up to our promises and execute really thoroughly to what we commit to, and that's what we're intending on doing, at least with this current opportunity.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [39]

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And then on storage. Last quarter, I believe you guys were still shipping under consumption in the storage business. And so still some room to get back to normal consumption levels.

On top of that, I think that you're ramping pretty strongly into your 2 customers, nearline 16-terabyte HDD programs, and that's looking to be a pretty strong tailwind for them in the first half of next year. Your enterprise SSD platforms are doing well. Cloud spending is accelerating. So help us understand why the business on a sequential basis, doesn't seem to be growing in the January quarter?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [40]

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Sure. Yes, I think you nailed the growth drivers pretty well. And certainly, I think the effort, candidly, that we put in over the last 3 years to really repivot this storage business and focus on the cloud and enterprise and get those design wins and get the products developed and get them ramped, that's all starting to play out, and that's helping offset what we see as pretty continued weakness both in the client side, I think there's been some pretty well-telegraphed challenges on the CPU front in terms of ability to build enough notebooks. That hasn't helped anybody. Certainly, the drive companies and the end OEMs. I think also the export restrictions in the bands relative to some of the Chinese OEMs in the video surveillance area. Clearly, those video surveillance cameras and devices have a tremendous amount of storage attached to them and that's [-- although] it got some impact. That's a derivative impact. We don't sell directly into those companies, but we sell to drive companies that may or may not have business there, and that's certainly a weakness, too.

So I think we see these edge and client markets being fairly soft and then offsetting it or even in the case of Q3 more than offset it was strong growth on these product cycles and the tailwinds that you mentioned.

And so what we're going to continue to do is continue to execute our strategy. We've been putting all of our R&D efforts into the markets that are growing today. And where we can control our destiny on research and development and product execution, we will. Some of these other things like PC CPU shortages or government bans on -- it's hard for us to influence those. All we can do is manage around it and where we can control our destiny.

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Operator [41]

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Our next question comes from Timothy Arcuri of UBS.

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Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [42]

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I guess the first question, Jean, is maybe, if not, some qualitative, at least some quantitative commentary around what the long-term financial model will look like for the new company. You were saying before you could get about 66% gross margin and sort of 30% to 32% OpEx target. I know gross margin, you said it will be back above 63% exiting fiscal 2021. But where should we kind of think about sort of the upside beyond the 63% and sort of where OpEx can go in with sort of the new company here?

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Jean Hu, Marvell Technology Group Ltd. - CFO [43]

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Yes, Tim, thanks for the question. I think in the longer term, we're quite confident it will continue to drive the gross margin expansion with the combined portfolio, especially, we are very much focusing infrastructure market, as Matt mentioned, we have a very broad portfolio. Overall, as I said earlier, gross margin are impacted by both level of revenue and product mix. When we recover from the current revenue level and continue to expand, especially with the 5G ramp and other new product cycles unique to Marvell in the second half next year, we do see with the revenue level going up, that will help improve our gross margin and the progress is [toward] that target level.

On the operating margin side, we continue to focus on operating margin expansion. So our focus is definitely is the same operating margin target like before. We continue to manage the SG&A cost to make sure it's below 7% of revenue. And R&D, that's -- the investment is very important for us to drive the longer-term profitable growth. And so we continue to invest in our business. So once our revenue level going up, our model is highly leverageable, we'll get to our operating model quickly.

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Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [44]

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Got it, Jean. And then, I guess, Matt, maybe can you give us some sense, I know maybe you don't want to give us a number. But of the $288 million in storage, can you give us a sense of how much is SSD sort of on a relative basis? And maybe from a competitive point of view, how much do you worry about the threat of your customers who continue to try to actively displace you there? I mean, how real is that?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [45]

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Sure. Yes, Tim, I think the way to think about our storage business is, in we actually -- I think you've followed this. We made the pivot, which we thought was more appropriate. Back when we closed Cavium, we added fiber channel in. We did our Analyst Day, and we really decided to talk about the business more in terms of end market orientation, enterprise and data center versus client just because from an R&D standpoint, that's where we invest. We look at it from an end market application point of view, not so much how much do we want to spend in x, y, z product line. So again, I think the commentary I gave to Harlan, a few questions ago was probably the way you should think about it, which is we're executing well to our strategy on the enterprise and the data center, so -- and that continues to grow as a percentage of our total storage which is encouraging.

On the competitive threat side, I'd say a couple of things. One is, at the Analyst Day, we did about a year ago, what we said was look, we acknowledged that verticalization is occurring, in particular, in client area, and in particular, in the -- we believe that the low end portion of the PC market was probably the place where we would see the most traction from our NAND customers who wanted to go vertical. And we've seen that play out. Now we weren't necessarily putting much, if any, R&D in that area. And so we've just been managing that trend.

What we're encouraged by, and that's actually why we purposely called out, the product we just introduced our first 12-nanometer product is it's a standalone controller, and I would call it, for the higher end of the market. But really, what we are able to leverage is for the DIY opportunities. It's the same process nodes, same IP set just customized very specifically for an application. And that market, that business, that -- this DIY concept, which was really more of a concept actually when we first talked about it in 2017, that's become real. And now we're even saying in Q3 of next year, we expect a sharp revenue ramp as a result of that business model catching on in the cloud and beyond. And I think that trend, we're going to continue to see.

And we look like a really good choice there because the end customers want a supplier who actually has deep experience working with other people's NAND. And so when you -- if you were an end OEM, and you wanted to get a NAND supplier with their own controller team to go start working with everybody else's NAND, that probably isn't going to happen because nobody really wants to share their inner workings of how their product interoperates.

So we think the DIY trend is real, it's growing in importance to us, and so we're going to take a standard product approach that gets us the IP we need, so we can go do that. But to the extent we can produce a standard product out of it, that's got broad market appeal that can fit certain swimlanes or SKUs of our end customers, where they don't have the capability or the capacity of the design team internally to do it, then we would be a good supplier.

So the bottom line is we see our SSD business growing through DIY and others on an ongoing basis from starting at this point going out through next year and beyond, driven by some of these trends that I articulated.

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Operator [46]

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Our last question comes from Chris Caso of Raymond James.

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Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [47]

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The first question is regarding the Fusion radio headwind that you talked about. If you could give a little more color on that? And assuming that's incremental to the revenue run rates you're running in 5G right now? And perhaps talk about some timing and magnitude of when that ramp occurs?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [48]

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Yes. Sure, Chris. So the way to think of it is we have a customer take our prior generation fusion and because of the architecture and the scalability of the programmability, right? They were actually able to implement it and go into production fairly quickly. And so that's in our current run rate model today.

Just to clarify, the next-gen that we won

adds more functionality. And so as a result, actually, the higher ASP -- so when that product kicks in, which would be in the early part of 2021 in production, I mean we're going to get the whole development done in calendar '20. So when that ramps in calendar '21, certainly, that's some incremental revenue to us.

What I would say is that the dark horse is what's the adoption of massive MIMO going to be. And I think to the extent that massive MIMO does better, that's certainly going to be an opportunity. And then beyond that, this is a trend we see. So this wasn't just one customer who has their own kind of concept about how to do this. We very much see the trend of purpose-built optimized silicon in the radio head, not only at the customer that we're engaged with today. But at multiple other customers and including a very strong engagement we have already with a second customer today to do something very similar. So it's a trend, we see it, and we think we're very well positioned to take advantage of it with future design wins beyond our lead customer with this type of architecture.

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Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [49]

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And as a follow-up on the Aquantia business, you talked about getting back to $100 million revenue run rate in that business. Is that just a function of customers burning off inventory and getting back to normal shipments? And what are the prospects of growing that business beyond the $100 million level?

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Matthew J. Murphy, Marvell Technology Group Ltd. - President, CEO & Director [50]

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Yes. Yes, Chris, I think it's a combination. One is inventory digestion and getting back to a normalized run rate. And then the second is, new design wins that Aquantia had already secured prior to us -- prior to the acquisition, their pipeline was pretty strong when we acquired them and certainly, I think it goes without saying what the reception for the combination has been very strong, both by the enterprise customer base as well as the automotive customer base.

I mean on the enterprise side, the view is it creates a much stronger scaled up Fi team with best-in-class technology from both Marvell and Aquantia, and we've got that team fully integrated now under Faraj's leadership. And on the automotive side, where we have really, by far, the most compelling end-to-end portfolio from all the way from 100 megabit Fis to roadmap at 10-gig and beyond over copper with switches and multiple configurations, port counts and a substantially scaled up R&D team to go deliver to what that market needs.

So I think I'd just say it's a combination of wins that they already had, new wins we're getting. And then certainly, the inventory correction that a lot of folks went through from the first half to the second half. That's starting to play itself out as well as we head into the end of the year here.

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Operator [51]

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At this time, I'd like to turn the call back over to Ashish Saran for closing remarks. Sir?

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Ashish Saran, Marvell Technology Group Ltd. - VP of IR [52]

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Thank you, everyone, for joining us today, and we look forward to seeing you at the upcoming Barclays Technology Conference in San Francisco.

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Operator [53]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.