Credo Technology Group - Q4 2023

Transcript

Operator (participant)

Good day. Thank you for standing by. Welcome to the Credo Q4 Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to go ahead and turn the call over to Dan O'Neil. Please go ahead.

Dan O'Neil (Treasurer and VP of Investor Relations)

Good afternoon. Thank you all for joining us today for our fiscal 2023 fourth quarter and year-ending earnings call. Joining me today from Credo are Bill Brennan, our Chief Executive Officer, and Dan Fleming, our Chief Financial Officer. I'd like to remind everyone that certain comments made in this call today may include forward-looking statements regarding expected future financial results, strategies and plans, future operations, the markets in which we operate, and other areas of discussion. These forward-looking statements are subject to risks and uncertainties that are discussed in detail in our documents filed with the SEC. It's not possible for the company's management to predict all risks, nor can the company assess the impact of all factors on its business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement.

Given these risks, uncertainties and assumptions, the forward-looking events discussed during this call may not occur, and actual results could differ materially and adversely from those anticipated or implied. The company undertakes no obligation to publicly update forward-looking statements for any reason after the date of this call to conform these statements to actual results or to changes in the company's expectations, except as required by law. Also, during this call, we will refer to certain non-GAAP financial measures, which we consider to be important measures of the company's performance. These non-GAAP financial measures are provided in addition to, and not as a substitute for or superior to, financial performance prepared in accordance with US GAAP.

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

Bill Brennan (President and CEO)

Thanks, Dan. Good afternoon, everyone. Thank you for joining our Q4 fiscal 2023 earnings call. I'll begin by providing an overview of our fiscal year 2023 and fiscal Q4 results. I will then highlight what we see going forward into fiscal 2024. Dan Fleming, our CFO, will follow my remarks with a detailed discussion of our Q4 and fiscal year 2023 financial results and share our outlook for the first quarter. Credo is a high-speed connectivity company delivering integrated circuits, system-level solutions, and IP licenses to the hyperscale data center ecosystem, along with a range of other data centers and service providers. All our solutions leverage our core SerDes technology and our unique customer-focused design approach, enabling Credo to deliver optimized, secure, high-speed solutions with significantly better power efficiency and cost.

Our electrical and optical connectivity solutions deliver leading performance with port speeds rangixng from 50 gig up to 1.6 terabits per second. While we primarily serve the Ethernet market today, we continue to expand into other standards-based markets as the need for higher speed with more power-efficient connectivity increases exponentially. Credo continues to have significant growth expectations within the accelerating market opportunity for high-speed connectivity solutions. In fact, the onset of generative AI applications is already accelerating the need for higher speed and more energy-efficient connectivity solutions. This is where Credo excels. I'll start with comments on our fiscal 2023 results. Today, Credo is reporting results from our first full fiscal year as a public company. In fiscal 2023, Credo achieved just over $184 million in revenue, up 73% over fiscal 2022. We achieved non-GAAP gross margin of 58%.

Product revenue increased 87% year-over-year, primarily due to the ramp of our Active Electrical Cable solutions. License revenue grew 28% year-over-year from $25 million to $32 million. Throughout fiscal 2023, we had several highlights across our product lines. For Active Electrical Cables, or AECs, we continued to lead the market Credo pioneered during the last several years. Our team continued to quickly innovate with application-specific solutions, and we've been successful in expanding our engagements to include multiple data centers and service providers. Our customer-focused innovation has led to more than 20 different versions of AECs shipped for qualification or production in the last year, and we remain sole sourced in all our wins. While our significant power advantage was a nice-to-have a couple years ago, it's increasingly becoming imperative as our hyperscaler customers are pushed to lower their carbon footprint.

For optical DSPs, Credo continued to build momentum by successfully passing qualification for 200 gig and 400 gig solutions at multiple hyperscalers with multiple optical module partners. In addition, Credo introduced our 800 gig Optical DSPs, Laser drivers, and TIAs, and we announced our entry into the coherent optical DSP market. For line card PHYs, we continued to expand our market leadership. In particular, Credo built upon our position as the leader for MACsec PHYs, with over 50% market share. We also extended our performance and power efficiency advantages for 100 gig per lane line card PHYs, with the introduction of our Screaming Eagle family of retimers and gearboxes, with up to 1.6 terabits per second of bandwidth. For IP licensing, we continue to build on our offering of highly optimized SerDes IP.

In the year, we licensed SerDes IP at several process nodes, from 4 nanometer to 28 nanometer, with speeds ranging from 28 gig to 112 gig, and reach performance ranging from XSR to LR. We believe our ability to innovate to deliver custom solutions remains unparalleled. We maintain very close working relationships with hyperscalers, we'll continue to collaborate with them to deliver solutions that are optimized to their needs. Despite recent macroeconomic headwinds in the data center industry, we believe the need for higher speed with better power efficiency will continue to grow. This plays perfectly to Credo's strengths, which is why we remain optimistic about our prospects in fiscal 2024 and beyond. I will now discuss the fourth quarter more specifically. In Q4, we delivered revenue of $32.1 million and non-GAAP gross margin of 58%.

I'll now provide an overview of key business trends for the quarter. First, regarding AEC, market forecasters continue to expect significant growth in this product category due to the benefits of AECs compared to both legacy direct attached copper cables and compared to Active Optical Cables, which are significantly higher power and higher cost. With our largest customer, we're encouraged by our development progress on several new AEC programs, including an acceleration in their first 100 gig per lane AI program, where they intend to deploy Credo AECs. We saw the initial ramp of a second hyperscale customer, which we expect to grow meaningfully throughout the year. We're ramping 50 gig per lane NIC to TOR AEC solutions for both their AI and compute applications, and I'm happy to report that Credo has been awarded this customer's first 100 gig per lane program.

We're also actively working to develop several other advanced AEC solutions for their next-generation deployments. We continue to make progress with additional customers as well. We remain in flight with two additional hyperscalers and are also engaged in meaningful opportunities with service providers. We've seen momentum building for AEC solutions across AI, compute, and switch applications, and we continue to expect to benefit as speeds move quickly to 100 gig per lane. Regarding our progress on optical solutions, in the optical category, we've leveraged our SerDes technology to deliver disruptive products, including DSPs, Laser drivers, and TIAs for 50 gig through 800 gig port applications. We remain confident we can gain share over time due to our compelling combination of performance, power, and cost.

In addition to the hyperscalers that have previously production qualified Credo's optical DSPs, we started the production ramp of a 400 gig optical DSP for a U.S. hyperscaler as the end customer. At OFC in March, we received very positive feedback on our market solutions, including our Dove 800 products, as well as on our announcement to enter the 100 gig ZR coherent DSP market. We're well positioned to win hyperscalers across a range of applications, including 200 gig, 400 gig, and 800 gig port speeds. We're also engaged in opportunities for Fibre Channel, 5G, OTN, and PON applications with optical partners, service providers, and networking OEMs. Within our line card PHY category, during the fourth quarter, we saw growing interest in our solutions, specifically for our Screaming Eagle 1.6 terabit per second PHYs.

We've already been successful winning several design commitments from leading networking OEMs and ODMs for the Screaming Eagle devices. Credo was selected due to our combination of performance, signal integrity, power efficiency, and cost effectiveness. We also made significant development progress with our customer-sponsored next-generation 5-nanometer, 1.6 terabit per second MACsec PHY, which we believe will extend our leadership well into the future for applications requiring encryption. Regarding our SerDes IP licensing and SerDes chiplet businesses, our IP deals in Q4 were primarily led by our 5-nanometer and 4-nanometer, 112G SerDes IP, which, according to customers, offers significant power advantage versus competition based on our ability to power optimize to the reach of an application. Our SerDes chiplet opportunity continues to progress. Our collaboration with Tesla on their Dojo supercomputer design is an example of how connectivity chiplets can enable advanced next-generation AI systems.

We're working closely with customers and standard societies, such as the UCIe Consortium, to ensure we retain leadership as the chiplet market grows and matures. We believe the acceleration of AI solutions across the industry will continue to fuel our licensing and chiplet businesses. To sum up, the hyperscale landscape has shifted swiftly and dramatically in 2023. Compute is now facing a new horizon, which is generative AI. We expect this shift to accelerate the demand for energy-efficient connectivity solutions that perform at the highest speeds. From our viewpoint, this technology acceleration increases the degree of difficulty and will naturally slim the field of market participants. We remain confident that our technology innovation and market leadership will fuel our growth as these opportunities materialize. We expect to grow sequentially in Q1 and then continue with sequential quarterly revenue growth throughout fiscal 2024.

We believe our growth will be led by multiple customers across our range of connectivity solutions, which will result in a more diversified revenue base as we exit fiscal 2024. I'll now turn the call over to our CFO, Dan Fleming, who will provide additional details. Thank you.

Dan Fleming (CFO)

Thank you, Bill, and good afternoon. I will first provide a financial summary of our fiscal year 2023, then review our Q4 results, and finally, discuss our outlook for Q1 and fiscal 2024. As a reminder, the following financials will be discussed on a non-GAAP basis, unless otherwise noted. Revenue for fiscal year 2023 was a record at $184.2 million, up 73% year-over-year, driven by product revenue that grew by 87%. Gross margin for the year was 58.0%. Our operating margin improved by 13 percentage points, even as we grew our product revenue mix. This illustrates the leverage that we can produce in the business. We reported earnings per share of $0.05, an $0.18 improvement over the prior year. Moving on to the fourth quarter.

In Q4, we reported revenue of $32.1 million, down 41% sequentially and down 14% year-over-year. Our IP business generated $5.7 million of revenue in Q4, down 55% sequentially and down 49% year-over-year. IP remains a strategic part of our business. As a reminder, our IP results may vary from quarter to quarter, driven largely by specific deliverables to pre-existing contracts. While the mix of IP and product revenue will vary in any given quarter over time, our revenue mix in Q4 was 18% IP, above our long-term expectation for IP, which is 10%-15% of revenue. We continue to expect IP as a percentage of revenue to come in above our long-term expectations for fiscal 2024. Our product business generated $26.4 million of revenue in Q4, down 37% sequentially and flat year-over-year.

Our team delivered Q4 gross margin of 58.2%, above the high end of our guidance range, down 94 basis points sequentially due to lower IP contribution. Our IP gross margin generally hovers near 100% and was 97.4% in Q4. Our product gross margin was 49.7% in the quarter, up 245 basis points sequentially and up 167 basis points year-over-year, due principally to product mix. Total operating expenses in the fourth quarter were $27.2 million, within guidance, up 6% sequentially and 25% year-over-year. Our year-over-year OpEx increase was a result of a 36% increase in R&D, as we continue to invest in the resources to deliver innovative solutions. Our SG&A was up 12% year-over-year as we built out public company infrastructure.

Our operating loss was $8.5 million in Q4, a decline of $10.7 million year-over-year. Our operating margin was -26.4% in the quarter, a decline of 32.2 percentage points year-over-year due to reduced top line leverage. We reported a net loss of $5.7 million in Q4, $8.3 million below last year. Cash flow used by operations in the fourth quarter was $11.8 million, a decrease of $14.2 million year-over-year, due largely to our net loss and changes in working capital. CapEx was $3.9 million in the quarter, driven by R&D equipment spending, and free cash flow was negative $15.7 million, a decrease of $8.4 million year-over-year.

We ended the quarter with cash and equivalents of $217.8 million, a decrease of $15.2 million from the third quarter. This decrease in cash was a result of our net loss and the investments required to grow the business. We remain well capitalized to continue investing in our growth opportunities while maintaining a substantial cash buffer for uncertain macroeconomic conditions. Our accounts receivable balance increased by 14.6% sequentially to $49.5 million, while day sales outstanding increased to 140 days, up from 72 days in Q3 due to lower revenue. Our Q4 ending inventory was $46.0 million, down $4.3 million sequentially. Turning to our guidance.

We currently expect revenue in Q1 of fiscal 2024 to be between $33 million and $35 million, up 6% sequentially at the midpoint. We expect Q1 gross margin to be within a range of 58%-60%. We expect Q1 operating expenses to be between $26 million and $28 million. We expect Q1 basic weighted average share count to be approximately 149 million shares. We feel we have moved through the bottom in the fourth quarter. While we see some near-term upside to our prior expectations, we remain cautious about the back half of our fiscal year due to uncertain macroeconomic conditions. In summary, as we move forward through fiscal year 2024, we expect sequential revenue growth, expanding gross margins due to increasing scale, and modest sequential growth in operating expenses.

As a result, we look forward to driving operating leverage as we exit the year. With that, I'll open it up for questions. Thank you.

Operator (participant)

Thank you. As a reminder, if you have a question, please press star one one on your telephone. Please wait for your name to be announced before you proceed with your question. One moment while we compile the Q&A roster. The first question that we have is coming from Tore Svanberg of Stifel. Your line is open.

Tore Svanberg (Managing Director and Senior Analyst)

Yes, thank you. In regards to the Q1 guidance, as far as what's driving the growth, you know, given your gross margin comment, I assume that, you know, AEC will probably continue to be down with perhaps the growth coming from, you know, from PAM4 DSP and IP. Is that sort of the correct thinking, or if not, please correct me.

Dan Fleming (CFO)

Hi, Tore, this is Dan. You're correct in that. If you look at the sequential increase in gross margin from Q3 to Q4, while our product revenue was down, that's really reflective of a favorable product mix, where AEC, as we all know, which is on the lower end of our margin profile, was contributed less of the overall product mix. That trend will continue in Q1. I would characterize that really as broadly across all of our other product lines, not really singling out one specific product line that's taking up the slack from AEC, so to speak.

Tore Svanberg (Managing Director and Senior Analyst)

Sounds good. As my follow-up question for you, Bill, with generative AI, as you mentioned in your script, you know, things are clearly changing. I was just hoping you could talk a little bit more granular about how it impacts each business. I'm even thinking about sort of the 800 gig PAM4 cycle. I mean, is that getting pulled in? Yeah. I mean, if you just give us a little bit more color on how, you know, generative AI could impact, you know, each of your four business units at this point. Thank you.

Bill Brennan (President and CEO)

Sure. Sure, absolutely. I think generally, I think that AI applications will create revenue opportunities for us across our portfolio. I think the largest opportunity that we'll see is with AEC. However, optical DSPs, there will definitely be a big opportunity there. Even LineCard PHYs chiplets, even SerDes IP licensing will get an uplift as AI deployments increase. Maybe I can start first with AECs. Now, it's important to kinda identify the differences between traditional compute server racks, which is kind of commonly referred to, you know, uses the front-end network, so basically a NIC to TOR connection, the TOR up to the leaf and spine network. You know, the typical compute rack would have 10-20 AECs in rack, meaning in-rack connections from NIC to TOR.

you know, you highlight that leading-edge lane rates today for these connections with compute servers is 50 gig per lane. Within an AI cluster, in addition to the front-end network, which is similar, there's a back-end network referred to as the RDMA network. That basically allows the AI appliances to be networked together within a cluster directly. you know, if we start going through the math, this back-end network has 5x-10x the bandwidth as the front-end network. The other important thing is to note, within these RDMA networks, there are leaf-spine racks as well.

If we look at the, if we look at one example of a customer that, you know, we're working with in deploying, the AI appliance rack itself will have a total of 56 AECs between the front-end and back-end networks. Each leaf spine rack is a Clos rack or a disaggregated chassis, which will have 256 AECs. When we look at it from a, you know, an overall opportunity for AECs, this is a huge uplift in volume, and the volume coincides with the bandwidth. Now, lane rates will quickly move. Certain applications will go forward at 50 gig per lane, others will go straight to 100 gig per lane.

We see a, you know, probably a 5x+ revenue opportunity difference between, you know, if you were to say apples to apples with the number of compute server racks versus an AI cluster. To kind of extend the, to kind of extend in the optical, there's typically a large number of AOCs in the same cluster. You can imagine that the short in-rack connections are gonna be done with AECs. These are, you know, three meters or less. These appliances will connect to the, you know, to the back-end leaf-spine racks, these disaggregated racks, all of those connections will be AOCs. Those are connections that are greater than three meters.

If we look at this is all upside to, you know, say, a traditional compute deployment, where there's really no AOCs connecting rack to rack. When we look at, you know, the overall opportunity, we think that the additional AEC opportunity within an AI cluster is probably twice as large, as twice as many connections as AOCs. The AOC opportunity for us will be significant in a sense that AOCs represent the most cost-sensitive portion of the optical market. It's, you know, it's also a lower technology hurdle since the optical connection is, you know, is well defined and it's within the cable. This is a really natural spot for us to be disruptive in this market.

We see some of our planning on deploying with 400 gig AOCs, others are planning to go straight to 800 gig AOCs. We view, you know, AECs as the largest opportunity, optical DSPs for sure will get an uplift in the overall opportunity set. Also, I think that if we look at Tesla as an example, that's an example of where as they deploy, we're gonna see, you know, really nice opportunity for our chiplets that we did for them, for that Dojo supercomputer. You know, it's an example of how AI applications are doing things completely differently, and we view that long term, this will be, you know, kind of a natural thing for us to benefit from.

We can extend that to SerDes IP licensing. Many of the licenses that we're doing now are targeting different AI applications. Also, don't forget line cards. The opportunity for, you know, for the network OEMs and ODMs is also increasing. You know, of course, line card PHYs are, you know, are something that, you know, go on those switch line cards that are developed. You know, generally speaking, I think that AI will drive faster lane rates. We've been very, very consistent with our message that, you know, as the market hits the knee in the curve on AI deployments, we're naturally gonna see lane rates go, you know, more quickly to 100 gig per lane. That's where we really, you know, we really see our business taking off.

We're getting a really nice, you know, revenue increase from 50 gig per lane applications, but we really see acceleration as 100 gig per lane happens. Especially, you know, when you start thinking about the power advantages that all of our solutions offer, compared to others that are doing similar things. Does that? That might have been more than you were looking for, but.

Tore Svanberg (Managing Director and Senior Analyst)

No, that's a great overview. Thank you so much, Bill. That was great. Thank you.

Bill Brennan (President and CEO)

Sure.

Operator (participant)

Thank you for your question. One moment while we prepare for the next question. The next question will be coming from Quinn Bolton of Needham & Company. Your line is open.

Quinn Bolton (Managing Director, Equity Research)

Thanks very much for taking my question. Bill, maybe a follow-up to Tore's question, just sort of the impact of generative AI on the business. You know, given that most of your AEC revenue today comes from the standard compute racks rather than AI racks, what do you see in terms of potential cannibalization, at least in the near term, as these hyperscalers prioritize building out the AI racks, potentially at the expense of compute deployments, again, at, you know, in the near term?

Bill Brennan (President and CEO)

I feel very good about how we're positioned. It is, you know, it is the case that our first ramp with our largest customer was Compute Rack. I think we're very well positioned with that customer as they transition to AI deployments. We've talked in the past about, you know, two different, you know, types of deployments at the server level. Of course, compute will continue, and we can all guess as to what, you know, ratio it's gonna be between compute and AI. We've got the roadmap very well covered for compute, so I think we're well set. As that resumes at our largest customer, I think we're gonna be in good shape.

I'm actually more excited about the acceleration of the AI program that we've been working with the same customer on, you know, for close to a year. I feel like we're well covered for both compute and AI, and that's really a long-term statement. A little bit of new information I would say, is that with our second hyperscale customer, you know, just to give an update generally on that, and then, you know, relate that back to the same point that I was making about the earlier customer. We are right on track with the AEC ramp. The first program is a compute server rack that we've talked about. We saw small shipments in Q4, and we expect to see a continued ramp through fiscal 2024.

However, during the past several months, a new AI application has taken shape. You know, if we would, if we would have talked 100 days ago, we wouldn't have seen this, we wouldn't have talked about this program. You know, we quickly delivered a different configuration of the AEC that was designed for the compute server rack. If you recall, we did a straight cable as well as an X cable configuration. They asked us to deliver a new configuration that had, you know, specific, changes that were needed for their deployment. We delivered the new configuration within weeks, which is, you know, that's another example of the benefit to how we're organized.

The qualification's underway. We expect this AI appliance rack to also ramp in our fiscal 2024. It's unclear as to the exact, you know, schedule from a time standpoint and a volume standpoint. We feel like, you know, this is gonna be another significant second program for us. I think that, you know, I think that for both our first and our second hyperscale customer, I think we're covering the, you know, the spectrum between compute and AI. I feel like we're really in great shape. Hopefully that answers your question.

If I take it a little bit further and say, okay, long term, let's say it's 80% compute, 20% AI, and you think maybe because the opportunity for us is 5x larger in AI, maybe the opportunity is similar if the ratio is like that. Compute might be equal to AI from an AEC perspective. I think that any way that goes, we're gonna benefit. If it goes 50/50, that's a big upside for us with AEC, given the fact that there's, you know, larger volume, larger dollars associated with an AI cluster deployment. I think that, you know, for us, it won't affect us, you know, one way or another. Maybe in the, in the near term quarters, yeah.

you know, the situation at our first customer really hasn't changed since the last update. We think that, you know, the year-over-year increase in revenue for that customer will happen in FY 2025, as we've discussed before.

Quinn Bolton (Managing Director, Equity Research)

Okay, no further pushout or delay of the compute rack at the first hyperscaler, given the, you know, potential reprioritization to AI in the near term?

Bill Brennan (President and CEO)

Well, the new program qualifications, we've talked about two of them. They're still scheduled in the relatively near future. You know, of course, as those get, you know, qualified and ramped, we'll see benefit from that. You know, it's a little bit tough to track month by month, right? That's a little bit too specific in a timeframe standpoint. We've seen a slight delay, but it's not something that we're necessarily concerned about.

Quinn Bolton (Managing Director, Equity Research)

Hey, got it, Bill. Just a clarification on this second hyperscaler. I think, you know, the last update, you had said you may not yet have a hard forecast for that hyperscaler's needs on the AEC side. Have you received sort of a hard PO or at least a more reliable forecast that you're now sort of forecasting that business from in fiscal 2024?

Bill Brennan (President and CEO)

Yeah, it's coming together. It's coming together, and I think we feel, you know, comfortable saying that the revenue that will be generated by this second customer will be significant. I'm not, you know, exactly able to talk about how significant. I think that we continue to view this through a conservative lens because we really don't know how the, you know, the second half is gonna shape up. All the indicators that we've heard over the last 90 days are quite positive. I think, you know, Dan referenced the fact that in Q2, we expect, you know, significant material revenue as that starts.

Quinn Bolton (Managing Director, Equity Research)

Perfect. Thank you.

Operator (participant)

Thank you. One moment while we prepare for the next question. Our next question will be coming from Suji DeSilva of Roth Capital. Your line is open.

Suji DeSilva (Managing Director, Senior Research Analyst)

Hi, Bill. Hi, Dan. Just want to talk about the AEC, the products. You know, you have multiple products, and I just wanted to know if, are there certain ones that are more relevant to a AI rack versus a traditional compute rack, or are they all applicable across the board?

Bill Brennan (President and CEO)

Well, you know, I would say that I wouldn't classify all of these solutions. I wouldn't lump them together. We're very much looking at the AEC opportunity as, you know, one where we're positioned to implement really customer-specific requests. You know, part of what we're seeing is that most of the designs that we're engaged now have something very specific to a given customer. I can say that we're seeing, you know, that there's a large number of customers moving to 100 gig per lane quickly, but we're also seeing customers that are reconfiguring existing NICs and building different, you know, AI appliances with those NICs, they're gonna be able to ramp with 50 gig per lane solutions.

You know, now, as far as configurations go, you know, we see straight cable opportunities, we see Y cable opportunities. We, you know, we see opportunities where, you know, just recently we had a customer ask us to, you know, have 100 gig on one end of the cable and 50 gig on the other end of the cable. Obviously, that's a breakout cable. It's an interesting challenge because this is the first time we'll be mixing different generations of ICs. You know, again, this is something we're able to do because we're so unique in a sense that we have a dedicated organization internal to Credo that's responsible for delivering these system solutions.

It's, you know, it's really that single party that's responsible for collaborating with the customer, designing, developing, delivering, qualifying, and then supporting the designs with our customers. You know, I can't emphasize enough that, you know, you give engineers at these hyperscalers the opportunity to innovate in a space they've never even thought of. It's something that we're getting really good uptake on. You know, of course, you know, our investment in the AECs, the AEC space is really unmatched by any of our competition. I think we're unique in the sense that we can offer this, you know, this type of flexibility. To answer your question, it's not, I can't, couldn't really point to one type of cable that, you know, that is gonna be leaned on.

Suji DeSilva (Managing Director, Senior Research Analyst)

No, it's helpful. It paints a picture of how the cables are being deployed here. Thank you, guys. Also, I believe in the prepared remarks, Mark, you mentioned, 20 AECs being qualified for shipment, if I heard that right. I'm curious how many across how many customers or how many programs that is, just to understand the breadth of that qualification effort.

Bill Brennan (President and CEO)

Yeah, I would say that, you know, there's a set of hyperscalers that, you know, are really the, you know, the large opportunity within the industry for, you know, for the AEC opportunity. We've also had a lot of success with data centers that might not qualify as capital H hyperscaler, as well as service providers. You know, we can look at the relationships with hyperscalers directly, and there's several SKUs that, you know, that we've delivered, and there's even more in the queue, you know, for these, you know, for these more advanced, next-generation systems.

Even if we look at, you know, I think, you know, we're, you know, if you look at the number of million-dollar per, you know, per quarter or per year customers that we've got, the list is really increasing. The product category, I think, has really been solidified over the last six to nine months, and you see that also because a lot of companies are announcing that they intend to compete longer term.

Suji DeSilva (Managing Director, Senior Research Analyst)

All right. Okay. Thanks, Bill.

Operator (participant)

Thank you. One moment while we prepare for the next question. Our next question will be coming from Karl Ackerman of BNP. Your line is open.

Karl Ackerman (Managing Director, Equity Research, Semiconductors and IT Hardware)

Thank you. I have two questions. Good afternoon, Dan and Bill. I guess, first off, you know, it's great to see the sequential improvement in your fiscal Q1, but I didn't hear you confirm your fiscal 2024 revenue outlook from 90 days ago. You know, I guess could you just speak to the visibility you have on your existing programs that gives you confidence in the sequential growth that you spoke about throughout fiscal 2024? If you just touch on that would be helpful.

Dan Fleming (CFO)

Yep. Thanks, Karl. This is Dan. yeah, generally speaking, you know, as we've described, we see some near-term upside, but we still remain a bit cautiously optimistic about the back half of the year. We're very comfortable ultimately with the current estimates for the back half. We do have certainly increasing visibility as time passes, and we hope to provide meaningful updates in, you know, over the next upcoming quarters. you know, we're working hard to expand these growth opportunities for FY 2024 and beyond, and we remain very encouraged with what we're seeing, especially with the acceleration of AI programs.

Karl Ackerman (Managing Director, Equity Research, Semiconductors and IT Hardware)

Got it. Understood. Thanks for that. I guess as a follow-up, of the DSP opportunity that you've highlighted in prepared remarks, are you seeing your design engagements primarily in fiscal 2024 on coherent offerings, or are you seeing more opportunities in DCI, for your 400 gig and 800 gig opportunities? Thank you.

Bill Brennan (President and CEO)

Yeah. The large opportunities that we're seeing are really within the data center. I can say that, you know, it's across the board, 200 gig, 400 gig, and 800 gig. All of these hyperscalers have different strategies as to, you know, how they're deploying optical. I think, you know, we continue to make progress with 200 and 400, and I think we're in a really good position from a time to market perspective on 800 gig. You know, we can talk about, you know, the cycles that we're spending with every hyperscaler. We're also aligning ourselves very closely, you know, in a strategic go-to-market strategy with select optical module companies.

We think that as it relates to DCI and Coherent specifically, we're in development for that first solution that we're pursuing, which is 100G ZR. We feel like, you know, that development will take place throughout this year, and that we'll see first revenue in the second half of calendar 2024. As far as 400G, that would really be a second follow-on type of DCI opportunity for us. In the ZR space, we're gonna be unique because we'll market and sell the DSP to optical module makers, we intend to engage 3 to 4 module makers in addition to our partner, EFFECT Photonics.

That makes us somewhat unique, in the sense that other competitors are going directly to market with the ZR module. I highlight power is really an enabler here. You know, the key thing is we can do a 100 gig ZR module and fit under the power ceiling for a standard QSFP connector, which is roughly 4 and a half watts. There's a large upgrade cycle from 10 gig modules that will enable, but also there's new deployments in addition. That kind of gives you a little bit of flavor about the coherent, but I really see our opportunities more within the data center.

Karl Ackerman (Managing Director, Equity Research, Semiconductors and IT Hardware)

Understood. Thank you.

Operator (participant)

Thank you. One moment while we prepare for the next question. Our next question will be coming from Vivek Arya of Bank of America. Your line is open.

Vivek Arya (Managing Director)

Thanks for taking my question. Bill, I'm curious to get your perspective on some of these technology changes. One is the role of InfiniBand that's gaining more share in these AI clusters. What does that do to your AEC opportunity? Is that a competitive situation? Is that a complementary situation? The other technology question is, some of your, you know, customers and partners have spoken about their desire to consider co-packaged optics and, you know, linear direct drive type of architectures. What does that do, right, to the need for standalone pluggables?

Bill Brennan (President and CEO)

Thanks. I appreciate the opportunity to talk about Ethernet versus InfiniBand, there's been a lot said about that. Generally, we see coexistence. I think, you know, depending on how you look at the market forecast information, there is a point soon in the future where Ethernet exceeds InfiniBand for AI specifically. Beyond AI, I think it's game over already. Whether you measure the TAM in ports or dollars, you know, Ethernet is forecasted to far exceed InfiniBand in the out years, so calendar 2025 and beyond. If we think about, you know, from an absolute TAM perspective, you know, forecasters are showing Ethernet dollars perspective. They're showing that Ethernet surpasses InfiniBand by 2025.

The forecasts show a CAGR for Ethernet of greater than 50%, while InfiniBand, they're showing a CAGR of less than 25%. You know, you can also look at this from a port cost perspective, where InfiniBand is 2x-4x the ASP per port compared to Ethernet, depending on who you talk to. In a sense, it's, you know, it's no secret that you know, the world will continue to do what the world does. They'll pursue cost-effective decisions, and we think from a technology standpoint, they're very similar.

If you think from a cost perspective, if you look at apples to apples, and you think that an InfiniBand port is 2x-4x, the cost of an Ethernet port, in a sense, you could justify that 1-3 of those ports of Ethernet are free in comparison to InfiniBand. I think that, you know, that our position here is that we really believe that Ethernet is going to prevail. We're working on so many AI programs. Every single one of them is Ethernet.

Vivek Arya (Managing Director)

Bill, anything on the move by some of your customers to think about co-packaged optics and direct drive? While I'm at it, maybe let me just ask, you know, Dan, a follow-up on the fiscal 2024. I think, Dan, you suggested you are comfortable with where, I think, expectations are right now. That still implies a very steep ramp into the back half. I'm just trying to square, you know, the confidence in the full year with some of just kind of the macro caution that came through in your comments.

Dan Fleming (CFO)

Yeah, we are confident in how we have guided, as I mentioned, we're very comfortable with the current estimates. If we look at FY 2024, as you allude to, Vivek, you know, we see strong sequential top-line growth throughout the year, in order to achieve those numbers. you know, it's kind of well documented, what's happened at Microsoft to us for this fiscal year. If we exclude Microsoft, what that means is we have, you know, in excess of 100% year-on-year growth of other product revenue from other customers, which again, we're very confident, based on all of the traction that we've seen recently, that we'll be able to achieve that.

Of course, I'll just reiterate, one of the key drivers is AI in some of those programs. Hopefully that gives you some additional color on our confidence for FY 2024.

Bill Brennan (President and CEO)

Yeah, regarding your question about the linear direct drive, that was, I think, this year's shiny object at OFC. I do think that, you know, the idea that it's really... You know, the idea is really to how to address the power challenges, you know, basically move away from the optical DSP. I think that, you know, this is not a new idea. There was a big move towards this linear direct drive in the 10 gig space when that was emerging. You know, I think the fact that there is really none in existence, I think that the DSP was chosen then, it was really critical to close the system. Our feeling is that, I think we'll see much of the same this year.

I think Marvell did a great job in, you know, kind of setting expectations correctly. You know, they did a long session, you know, right after OFC that I think addressed it quite well. I think you'll see small deployments where every link in the system is, you know, very, very controlled. These are typically, you know, very, very small in terms of the overall TAM. Now, we're fully signed up. If the real goal is power, that's exactly where we play. We're fully signed up to looking at unique approaches in the future to, you know, to be able to offer compelling things from a power perspective.

It's not like I'm completely dismissing, you know, the concept that was really behind the idea of linear direct drive. We're actually viewing that as a potential opportunity for us in solving the problem differently. Generally speaking, I don't think you'll see in the future a world where linear direct drive is, you know, is measured in any kind of, you know, significant way. It's not to say that people aren't spending money trying to prove it out right now, you know, that is happening. Regarding CPO, I think that was, yes, like that was kind of a, you know, that was something that was talked about, you know, for many, many years prior.

I think also on that, you'll see smaller deployments if, you know, that's ultimately the, you know, something that, you know, that some customers embrace. I don't think you'll see it in a big way. That's simply not what the customer base is looking for.

Vivek Arya (Managing Director)

Thank you, Bill. Thank you, Dan.

Operator (participant)

Thank you. One moment for the next question. Our next question will be coming from David Liu of Mizuho.

David Liu (Sr. Research Associate, Equity Research, Semiconductors)

Call me.

Operator (participant)

Please go ahead.

David Liu (Sr. Research Associate, Equity Research, Semiconductors)

Hi. Yeah, thanks. This is David on for Vijay at Mizuho. My first question is: assuming that if in fiscal 2025, data center demand for general compute improves and you see the continued new AI ramps, can you provide any more color on the puts and takes there and, you know, the type of operating leverage you can improve?

Dan Fleming (CFO)

Well, we're not, we're not giving specific guidance yet to fiscal 2025. You're right in that the ingredients certainly exist where, you know, operating leverage. We should exit FY 2024 with pretty robust operating leverage, and that we would expect, based on what we know now, to carry forward into FY 2025. We haven't framed yet, of course, what that's going to ultimately look like.

David Liu (Sr. Research Associate, Equity Research, Semiconductors)

Okay, sure. I guess for my second question, when you're talking with, hyperscalers on these new AI applications, you know, how important is sort of your TCO advantage when they're exploring a solution? Or are they currently kind of just primarily focused on time to market and, maximum performance and just getting their AI deployments out there?

Bill Brennan (President and CEO)

I just wanna make sure you said Total Cost of Ownership?

David Liu (Sr. Research Associate, Equity Research, Semiconductors)

Yes, yes.

Bill Brennan (President and CEO)

It's, you know, I think it's hands down in favor of AEC. If we look at 100 gig lane rates, I think the, you know, the, you know, the conclusion throughout the market is that there's two ways to deploy short cabled solutions. It's really AEC or AOC. If we look at it from a CapEx standpoint, AECs are about half the cost. If we look at it from an OpEx standpoint, also about half the cost, about half the power, you know, half the ASP for an apples-to-apples type solution. I think the TCO benefit is significant.

The other thing you've got to consider is that, especially when you're down in server racks, you know, these are different than switch racks in a sense that having a failure with your, you know, your cabled solution it becomes a very urgent item. When we think about AOCs and the reliability in terms of number of years, it is probably, you know, anywhere from one third to one tenth. The AECs that we sell are, we talked about a 10-year product life, and so kind of matches or exceeds the life of the rack that it's being deployed in. The same cannot be true for, you know, it cannot be said for any kind of optical solution.

I think across the board, it's hands down, the TCO is much more favorable for AEC.

David Liu (Sr. Research Associate, Equity Research, Semiconductors)

Okay. Thank you.

Operator (participant)

Thank you. One moment for the next question. Our next question will be coming from Quinn Bolton of Needham & Company. Your line is open.

Quinn Bolton (Managing Director, Equity Research)

Hey, guys. Thanks for the quick two follow-ups. One, Dan, was there any contra revenue in the April quarter?

Dan Fleming (CFO)

That's an excellent question, Quinn. I'm glad you caught that. Actually, there was, and you'll see that when we file our 10-K. In the past, you've been able to see that in our press release, in our GAAP to non-GAAP reconciliation. From Q4 and going forward, we're no longer excluding that contra revenue from our non-GAAP financials. This really came about through a comment from the SEC, not singling out Credo, but actually all of Amazon's suppliers who have a warrant or Amazon has a warrant with them. The positive things of this change are, you'll still be able to track ultimately what that warrant expense is, but when we file our 10-K. You know, looking historically, there's not really it doesn't really make a reporting difference on a non-GAAP basis.

It was not material, the difference.

Bill Brennan (President and CEO)

... it just makes, you know, calculation, a little bit more straightforward going forward. Our only non-GAAP reconciling item, going forward, or at least for the foreseeable future, is really just share-based compensation.

Quinn Bolton (Managing Director, Equity Research)

Got it. The revenue doesn't change, you'll just sort of you won't be making the adjustments for the contra revenue and the non-GAAP gross margin calculation going forward?

Bill Brennan (President and CEO)

Correct.

Quinn Bolton (Managing Director, Equity Research)

Got it.

Bill Brennan (President and CEO)

That's exactly correct, yeah. Revenue is still revenue. It has a portion of it, which is contra revenue, which obviously brings down the revenue a little bit.

Quinn Bolton (Managing Director, Equity Research)

Got it. Okay. Then for Bill, would you expect in fiscal 2024, you know, a meaningful initial ramp of the 200 or 400 gig optical DSPs? Would you continue to encourage investors to sort of think that the optical DSP ramp is really beyond a fiscal 2024 event at this point?

Bill Brennan (President and CEO)

I think that, when we think about significant, we think about crossing the 10% of revenue threshold. We don't see that until fiscal 2025. We do see signs of life in China. As I said, we're shipping 400 gig optical DSPs to a U.S. hyperscaler now. My expectation is throughout the year, we're gonna have a lot more success stories to talk about, but those ramps will most likely not take place within, you know, the next three quarters. It's really a fiscal 2025 target at this point.

Quinn Bolton (Managing Director, Equity Research)

Got it. It starts this year, just you're.

Bill Brennan (President and CEO)

Yeah

Quinn Bolton (Managing Director, Equity Research)

... calling it meaningful because it doesn't hit 10% threshold.

Bill Brennan (President and CEO)

Right. Exactly.

Quinn Bolton (Managing Director, Equity Research)

Got it. Okay. Thank you.

Operator (participant)

Thank you. One moment. While we have a follow-up question, and that question will be coming from Tore Svanberg of Stifel. Your line is open.

Tore Svanberg (Managing Director and Senior Analyst)

Yes, Tore here. Bill, maybe a follow-up to the previous question about 200 and 400 gig. I was a little bit more curious about 800 gig. You know, are you seeing any changes at all to the timelines there? I think the expectation was that the 800 gig market would, you know, maybe take off second half of next calendar year. You know, with all these new AI trends, just wondering if you're seeing any pull-in activity there or maybe even seeing some cannibalization, you know, versus 200 gig and 400 gig.

Bill Brennan (President and CEO)

I think that. You know, my expectation is that, you know, this is really a calendar year 2024 type of market takeoff. Whether it's the second half or first half, we, of course, would like to see it in first half, given the fact that, you know, that would imply that there would be success in pulling in AI programs. There's a lot of benefit that comes with 800 gig modules and the implication that it has on our AEC business. I definitely see it kind of in that timeframe. I don't really see it as cannibalization of the 200 and 400 gig. It's really unless you look at it, that these new deployments are in lieu of the old technology.

Like I said before, every hyperscaler has their own strategy related to the port size that they plan on deploying. Everybody's got a unique architecture, and where we see optical is typically, you know, typically in the leaf spine network for, you know, anything above the TOR. In AI, I think the real opportunity is gonna be with AOCs, and, you know, that I think is gonna be a very large 800 gig market when, you know, when those AI clusters really begin deployment. Which again, I think could be, yeah, could be in calendar 2024. Appreciate the question, though.

Tore Svanberg (Managing Director and Senior Analyst)

Great. Thank you.

Operator (participant)

Thank you. That concludes the Q&A for today. I would like to turn the call back over to Bill Brennan for closing remarks. Please go ahead.

Bill Brennan (President and CEO)

Really appreciate the participation today, and we look forward to following up on the call backs. Thanks very much.

Operator (participant)

This concludes today's conference call. Thank you all for joining, and everyone, enjoy the rest of your day.