Welcome to MACOM's Third Fiscal Quarter 2022 Conference Call. This call is being recorded today, Thursday, July 28, 2022. At this time, all participants are in a listen only mode. I will now turn the call to Mr. Stephen Ferranti, MACOM's Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.
Thank you, Olivia. Good morning and welcome to our call to discuss MACOM's financial results for the third fiscal quarter of 2022. I would like to remind everyone that our discussion today will contain forward-looking statements, which are subject to certain risks and uncertainties as defined in the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those discussed today. For more detailed discussion of the risks and uncertainties that could result in those differences, we refer you to MACOM's filings with the SEC. Management statements during this call will also include discussion of certain adjusted non-GAAP financial information. A reconciliation of GAAP to adjusted non-GAAP results are provided in the company's press release and related Form 8-K, which was filed with the SEC today.
With that, I will turn over the call to Stephen Daly, President and CEO of MACOM.
Thank you, and good morning. I will begin today's call with a general company update. After that, Jack Kober, our Chief Financial Officer, will review our fiscal Q3 results. When John is finished, I will provide revenue and earnings guidance for fiscal Q4, and then we will be happy to take some questions. Revenue for the third quarter was $172.3 million, and adjusted EPS was $0.73 per diluted share. Gross and operating margins increased sequentially in the third quarter, and we continued to generate strong cash flow, ending the quarter with $536 million in cash and short-term investments. Our financial performance reflects ongoing business improvements along with the growing revenue contribution for new products within our portfolio. The book-to-bill ratio for the third quarter was 1.1 to one, which was the seventh consecutive quarter above one.
Our backlog remains strong, providing us with good near-term visibility. While we are pleased with the bookings, I'll note that it is normal for our book-to-bill ratio to periodically fluctuate below one. Our turns business was approximately 15% of our total revenue during the quarter, which is in line with the last few quarters. Q3 revenue breakdown by end market was as follows. Industrial and Defense was $75.5 million, Telecom was $62 million, and Data Center was $34.8 million. I&D revenue was up 12.5% sequentially, while Telecom and Data Center were relatively flat following a strong Q2. These results were mostly in line with our expectations. Industrial and Defense remains a key area of opportunity for MACOM. We believe this market has the potential for significant revenue growth over the next few years.
Within Aerospace and Defense applications, we expect growth to be driven by radar modernization programs, Electronic Warfare applications, Unmanned Aircraft Systems, Avionics, secure communication networks, and SATCOM applications. All of these areas are priorities within the broader U.S. defense budget and are critical programs within the various branches of the Department of Defense. As a result, we expect opportunities within this market to remain robust for the foreseeable future. Our telecom end market revenue saw a modest sequential decrease in Q3 following a very strong Q2. Telecom is another broad market for MACOM, and it includes broadband access networks, passive optical fiber networks, wireless networks, including 5G, metro long- haul optical networks, and broadband satellite communication applications. The primary driving forces for growth across all of these applications are higher data rates and more bandwidth supporting increased computing power closer to the end users.
MACOM has a very diverse product portfolio to address the telecom markets, including our Monolithic Microwave Integrated Circuits or MMIC product line, coherent drivers and TIAs, small signal RF products, RF power amplifiers, high-performance analog ICs, and lasers to name a few product lines. Our data center end market revenue was relatively flat in Q3 following a strong Q2 performance based on continuing demand for our high-performance analog solutions. We are pleased to see modest revenue contributions from our new 25 G DFB laser portfolio, and our expectation is for continued slow but steady laser revenue growth and market share gains during the remainder of FY 2022 and throughout FY 2023. Customer interest in our recently introduced linear equalizers remains high, and we see growth opportunities in active copper cable applications at both 200 G and 400 G data rates for high-performance computing systems.
I would like to highlight we recently updated our five-year strategic plan. This was the third annual update of our strategic plan, and while we've made great progress executing over the past three years, we are pleased to have further refined and honed our compelling strategy with the goal of creating long-term stockholder value. Our bottoms-up strategic plan includes an in-depth review of all elements of our business and establishes strategic goals and growth objectives through 2026. The foundation of our strategic plan revolves around expanding our Served Addressable Markets, or SAM, by extending existing product lines, introducing new product lines, and raising the bar on semiconductor performance in areas where we choose to compete. Our goal is to provide compelling and differentiated solutions that help solve complex technical challenges for our customers while driving highly profitable growth for MACOM.
An important element of our strategy is to leverage our existing capabilities and technology portfolio to find adjacent opportunities to expand our markets. Some examples of this over the past couple of years have been our 0.14-micron GaN-on-silicon carbide process, our PURE CARBIDE product line, active copper cable ICs, KV CAPS, and RF power amplifier pallets. We believe thus far, these new products have helped us expand our SAM by about $400 million-$500 million. I'll note our market share in these product categories is negligible today, which provides us with a great opportunity for growth. I'll also note a characteristic of our growth strategy is to target market opportunities that support our financial goals of achieving best-in-class profitability. This requires developing many new and oftentimes niche semiconductor product lines to address these requirements.
It might be helpful if I highlight a few recent examples which exemplify MACOM's strategy. First, at this year's International Microwave Symposium, which was held in June, we announced the expansion of our power amplifier product portfolio with the introduction of a 7 kW power amplifier operating in the 960 MHz to 1.2 GHz frequency range. This product is based on MACOM's PURE CARBIDE GaN- on-S ilicon Carbide technology, and we believe it represents the highest power level RF amplifier in the industry. This extremely high power level was achieved by combining novel high voltage circuit topologies with advanced packaging materials for improved thermal performance. This product is ideal for high power and high voltage aerospace and defense applications, including radar and electronic warfare systems. Our goal is to establish ourselves as a leader in RF power.
Second, we are actively expanding our R&D teams in bringing new engineering design capability to MACOM. We recently opened two design centers, one on the east coast of the U.S. and one in Seoul, Korea. These actions of hiring more experts in analog and Digital IC design and adding new Microwave subsystem engineering capability support our future product development plans and initiatives. Hiring best-in-class designers to support organic growth is a strategic priority. Third, we recently introduced a new Optical Time- Domain Reflectometer, or OTDR, photodetector product line to support customers that utilize fiber connectivity in their defense, industrial, telecom systems, or data center networks. An OTDR test instrument is used to measure a fiber optic cable's optical loss and to identify the location of a fiber cable break or performance problem.
Portable OTDR test equipment is used during fiber network installation, and OTDR functionality can be embedded in remote fiber test systems to permanently monitor a live telecom network or an operating system for any changes or failures. We believe the field portable OTDR test equipment market is growing due to the worldwide deployment of PON and 5G optical networks. To be clear, the heart of an OTDR is the Indium Phosphide-based optical photodetector, and our strategy is to be a leading supplier of OTDR photodetector IC-based products. Here, we have utilized our proprietary internal MBE technology and photodetector IC design expertise to achieve industry-leading results. We plan to sell our OTDR products with pigtails fiber for an easy turnkey solution or in a ROSA or chip on carrier format, depending on the customer requirements and desired form factor. In recent months, we received two qualifications from leading OTDR equipment manufacturers.
The three examples I just discussed show how MACOM is addressing small and medium-sized high-performance applications with solutions that rely on our internal semiconductor process expertise and/or our IC and system design and application expertise. We believe more and more customers are viewing MACOM as a strategic supplier of high-performance analog, RF, Microwave, and light wave semiconductor solutions, and we believe this is directly attributable to the strengthening of our product portfolio. Today, we focus our budgets on R&D, product development, and then engaging customers face to face with our regional and technical sales staff, design engineers, and technical leadership. I'll note a key element of our strategy is strengthening and expanding our relationships with Tier I and Tier II OEMs, and we are making good progress in this area.
To a certain degree, our strong bookings for the past seven quarters is in large part due to the outstanding execution and collaboration between our sales, operations, and business development teams and our customers. Today, we see a growing trend of Tier I and Tier II customers providing us with their latest requirements for Gallium Arsenide and GaN MMICs, BAW filters, diodes, lasers, and analog and mixed signal ICs. These development projects with our customers across all markets validate that our design capability, products, and new technologies are compelling. Before I turn it over to Jack, I would like to highlight we are cognizant of the uncertainties around the broader global macroeconomic environment, and we do not presume to think our business would be immune from a global recession.
Our long-standing posture has been to run the business in a way which enables us to remain both profitable and cash flow positive during all parts of the business cycle. As such, given the heightened economic uncertainty, we have and will continue to manage the business, particularly the capital investments and spending budgets very carefully. I'll highlight, however, that we have very little consumer market exposure, and we believe our defense business is typically decoupled from near-term negative economic trends. Additionally, we believe our business is relatively small compared to the semiconductor industry at large, and growth can be supported by market share gains as we expand and ramp our latest products and technologies. At a higher level, we believe the semiconductor industry growth over the long term is supported by secular growth trends.
More specifically, the drive towards more bandwidth, faster data speeds, higher frequencies, and higher power levels, whether in radar, electronic warfare, broadband access networks, 5G or the data center, play to MACOM's strength in RF, Microwave, and optical. In many cases, addressing these markets requires advanced semiconductor technologies like GaN, Bulk Acoustic Wave or BAW filters, advanced lasers and detectors, high-speed analog ICs, and high voltage capacitors. In summary, we believe our position within the industry is improving due to our strengthening portfolio. We have many compelling new process technologies underway, a growing team of world-class IC designers, and unique manufacturing and packaging capabilities. I am confident we will continue to push the boundaries of semiconductor engineering and gain market share. Jack will now provide a more detailed review of our financial results.
Thank you, Steve, and good morning, everyone. Financial results for our third fiscal quarter ended July 1st, 2022 remained strong, and MACOM's team continues to strongly perform in executing toward our business strategy. Revenue for the fiscal third quarter was $172.3 million, up 4.3% quarter-over-quarter and exceeded our guidance range based on strength in the Industrial & Defense market. On a geographic basis, revenue from U.S. domestic customers represented approximately 45% of our fiscal Q3 results, with continued diversity across our customer base. Adjusted gross profit was $107.2 million, or 62.2% of revenue, up 50 basis points sequentially. Exceeding 62% gross margin represents another major milestone in improving our profitability.
Total adjusted operating expense was $53.1 million, consisting of research and development expense of $34 million and selling general and administrative expense of $19.1 million. As anticipated, total operating expenses were sequentially up by $2.1 million from fiscal Q2 as we continue to expand our R&D team and their capabilities. We continue to carefully manage administrative spending as we support growth-related investments across the business. Adjusted operating income in fiscal Q3 was $54.1 million, up from $50.9 million in fiscal Q2. Adjusted operating margin increased 60 basis points sequentially, crossing the 31% threshold to 31.4% for fiscal Q3. Depreciation expense for fiscal Q3 was $5.9 million, and Adjusted EBITDA was $60 million.
Trailing-twelve-month Adjusted EBITDA was approximately $224 million as compared to $214 million in our prior fiscal quarter. Adjusted net interest expense for fiscal Q3 was $433,000, down approximately $500,000 from fiscal Q2, primarily driven by higher short-term investment balances and the associated interest income. With increases in interest rates, we anticipate higher net interest expense during our next fiscal quarter ending in September. Our adjusted income tax rate in fiscal Q3 was 3% and resulted in an expense of $1.6 million. Our net cash tax payments were approximately $1.1 million for the third quarter, up $600,000 from fiscal Q2, primarily based on our increases in profitability. We expect our adjusted income tax rate to remain at 3% going forward.
Fiscal Q3 Adjusted Net Income was $52.1 million compared to $48.4 million in fiscal Q2. Adjusted earnings per fully diluted share was $0.73, utilizing a share count of 71.1 million shares, compared to $0.68 of adjusted earnings per share in fiscal Q2. Now, moving on to operational balance sheet and cash flow items. Our Q3 accounts receivable balance was $106.6 million, up from $100.6 million in fiscal Q2, reflecting our $7.1 million increase in revenue over the prior period. As a result, days sales outstanding as of the end of June were 56 days. During the past three quarters, our quarterly revenue has increased by $17 million, which is the primary driver for the fiscal 2022 year-to-date increase in our accounts receivable balance of $22 million.
Inventories were $110.2 million at quarter end, up from $93.4 million sequentially. Inventory turns were 2.4 x, down sequentially in Q3 from 2.7 x in the prior quarter. During fiscal year 2022, we have made strategic investments in various inventory items such as manufacturing consumables, substrates, precious metals, as well as critical wafer stocks and finished goods. This strategic increase in inventory is expected to support our growing backlog, which we feel will provide additional stability in the current supply environment. Fiscal Q3 cash flow from operations was approximately $40.4 million, down $2.1 million sequentially, primarily from increases in working capital. Capital expenditures totaled $6.6 million for fiscal Q3, with additional investments in fab capabilities and R&D equipment.
We expect our fiscal year 2022 capital expenditures to now be in the range of $25 million-$30 million due to the timing of receipt of certain CapEx items. Next, moving on to balance sheet items. Cash, cash equivalents, and short-term investments for the third fiscal quarter were $536.3 million, up $33.3 million sequentially. With our continued cash generation and 5% increase in trailing twelve-month EBITDA, our third quarter gross leverage is 2.7, down from 2.8 in Q2. Our net leverage remains below one, and our net debt is now $67 million. We recognize that we are still in a net debt position. However, we are pleased that the increases in our cash and short-term investment balances will provide us with new and expanding strategic options for future growth.
Finally, I would like to also note that this week we published an updated environmental, social, and governance report, which can be found in the investor relations section of our MACOM website. The report highlights progress we have made in improving our ESG reporting metrics. I will now turn the discussion back over to Steve.
Thank you, Jack. MACOM expects revenue in Q4 to be in the range of $175 million-$180 million. Adjusted gross margin is expected to be in the range of 61.5%-63.5%. Adjusted earnings per share is expected to be between $0.74 and $0.78 based on 71.4 million fully diluted shares. In Q4, when compared to Q3, we expect revenue for industrial and defense and data center to increase by mid-single-digit percentages sequentially, and telecom to be relatively flat. In summary, we stand in front of a multi-billion-dollar SAM with a unique and growing technology portfolio. Our strategy is to further diversify our products, customers, and end markets. We maintain a long-term perspective on executing our strategy, and we will work to manage our business to be profitable throughout all business cycles.
We are confident we can continue to improve our financials and take market share in the months and years ahead. I would now like to ask the operator to take any questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, you will need to press star one one. In the consideration of time, we ask that you please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. Now first question coming from the line of Tom O'Malley with Barclays. Your line is open.
Good morning, and thanks for taking my questions. My first one's just related to the segments. It looks like with your guidance for September, the data center business is declining slightly for the year, but the telecom business is looking a lot stronger than you initially expected. Could you just walk through the puts and takes of what's going on between those? You mentioned some of the data center lasers ramping, but any more color on what you saw a little bit weaker in data center and what you're seeing a little bit stronger in telecom?
Sure. Good morning, Tom. You're correct in terms of the trends that you outlined. I'll just also note that on a year-over-year basis, all three of our end markets were up. I&D was up 6%, data center was up 5%, and telecom almost 30%. On a relative basis, we think for the full year, you know, two possibly three of the markets will be up. We think the strongest market on a full year comparison will be our telecom business, again, about 29% year-over-year growth. Industrial and defense, mid-single digits, around 5% year-over-year growth. Data center right now is trending to low single digit or flat performance on a year-over-year basis.
Given the variety of the products that we're selling, of course, and the diversity of our revenue, there are a lot of puts and takes. I think one thing to highlight inside the data center is that during the course of this year, we've seen significant movement of our 100G CWDM4 business from U.S.-based customers over to Asia-based customers. That trend is a favorable trend, and it continues. On the telecom side, I would highlight that tremendous growth from telecom coming from access markets, including 10G PON, and also a lot of strong growth in metro long haul. I think those are, you know, just a few key items that I would probably highlight as it relates to the three markets.
That's helpful. In your preamble, you talked about your lack of consumer exposure and how the defense business is relatively protected from what you think would be a macro downturn. Could you talk about the broad-based industrial business? When you look at that business, do you think that that should track relative to GDP? Or do you think there's areas within the industrial business? I think you've broken it out like 60% Defense, 40% Industrial in the past. In that 40%, could you just talk about any areas that, you know, may outperform GDP and how you think that market, how you think that segment may perform in a down market? Thank you.
Sure. So, first, I'm not sure if our growth rate will or will not track GDP, so I can't really address that. But I would point towards some of the products that we're introducing for the industrial and defense markets. This past June at the International Microwave Symposium, we went through a whole range of product demonstrations and product announcements. I think I'll highlight a few of these because they demonstrate the focus of the company. For example, we launched a new SOI switch product line for test instrumentation. We launched our 0.14 GaN- on-S ilicon Carbide MMIC process. This is the process we've been working on now coming up on two years. That is focused on a wide range of SATCOM and in industrial and defense applications.
We demonstrated a 7W Ka-band MMIC there. We also demonstrated a 10W E-band amplifier, again, focusing on satellite communications, ground to satellite communications. Just some real interesting technology there. We also announced our new BAW filter line. We demonstrated a switch filter bank at L-band, really targeting defense, the defense industry and some of the next generation switch filter banks that customers are looking for. A lot of the focus and a lot of the work that we've been doing has really been targeting telecom at large, a lot of the wireless standards that are out there, as well as high-performance defense applications. When we think about our future growth coming from the defense industry, it will be radar-based platforms. It will be communication-based platforms.
It will be handheld and mobile radio, high-power radios. It will be Jammers and UAV. This is a very diverse application set for our defense business. On the industrial side, we've been making tremendous progress penetrating the medical market. We've been doing some next generation functions, both on the discrete diode-based technology, as well as on our analog and mixed signal technologies. Over the past year, we've been focusing some of our analog designers more and more on industrial applications. That's been doing quite well. The last thing I'll add is on the test and measurement industry. This is an industry that needs to support the higher data rate applications and higher speed applications, whether it's in the compute market or the telecom market.
MACOM is doing a tremendous amount of chip development for applications like memory testers or high-speed analog testers or even optical testers. The industrial market for us is really a target-rich environment, and there's certainly a lot of diversity there.
Our next question coming from the line of CJ Muse with Evercore ISI. Your line is open.
Yeah, good morning. Thank you for taking the question. I guess wanted to focus first on data center. I think your outlook for September is a little bit worse than what you thought three months ago. When I look at kind of the growth trajectory over the last three years, it's about running at about a 4% CAGR. Would love to hear your thoughts as we move into fiscal 2023 and beyond, whether we should start to see a re-acceleration in growth there. If so, what are the key drivers that you're pointing to, as well as, do you already see some of that business in your extended backlog?
Yeah. Thanks for the question, CJ. We have definitely seen revenue numbers that are below what our previous expectations were for the full year. Even as we've looked at the business, we've seen shifts within our business there. I'll just first, before I talk about the moving parts within the market segment, I'll just highlight two things for investors to remember. We did announce about a year ago that there would be about a $15 million decrease in our data center business due to legacy programs falling off, which included platforms like PowerPC and some of our networking products that were legacy AMCC product lines. When you add back that $15 million to our current run rate, you would have over 10% growth.
The second thing I would highlight is that this is the one market of the three for MACOM that has been more challenged with supply constraint issues. Those challenges have been opening up. We saw some nice growth in Q3 and also we're seeing good performance in Q4. So that's improving. In terms of looking forward and where we think the growth will come from, going, you know, looking into fiscal 2023, certainly our 400G PAM4 business will be strengthening. We like the fact that there's more and more work at 800G. And so again, we will address these markets with multi-channel TIAs and drivers for very high-speed applications. We also see tremendous opportunities with coherent light.
As our customers are looking to extend the high speed reach, you know, they do see limitations with PAM4. There is sort of a bit of a migration over to an NRZ in a coherent application. The last thing I'll add is there's some product lines that are just beginning to blossom within the data center market. That would be our linear drivers, which are going to put a lot of pressure on DSPs for short reach applications and our lasers. This year we have been very, very active with design wins not only for telecom markets, meaning PON and 5G markets, but also the data center.
What we were surprised to see this year is many of the module manufacturers or pluggable module manufacturers were interested in bringing our lasers into the data center. As we think about the long-term growth and some of the new technologies we'll bring to the data center, I think I announced on the last call that we've had actually some early successes with our new EML laser technology. This is you know the price points and the market for EML's lasers is very strong, and we're very excited to start to introduce that technology in the back half of 2023 and as we enter 2024. I do think there's tremendous opportunities there within the data center. I will highlight we are absolutely staying in our lane and playing to our strengths.
We have, you know, we are not interested in developing DSP chips, for example. We're very focused on providing customers analog chips that are high speed components that help them solve various problems and potentially be an alternative to DSPs. I'll maybe add one other point. We've also noticed as more and more of our customers are working on co-packaged optics, we're actually finding lots of interesting opportunities on the analog and on the optical side, including our photodetectors and our laser arrays. We've been demonstrating single chip eight laser devices, which are getting a lot of interest in the market, and we're also increasing the power levels of our CW laser products. There's just a lot of interesting things going on.
We are quite bullish on the long-term prospects for the data center.
Very thoughtful and thorough answer. Thank you. As my follow-up, just a quick modeling question. How should we be thinking about OpEx beyond the September quarter? You talked about interest expense ticking higher. How should we model that into September and beyond?
Yeah. Good morning, CJ. This is Jack. You know, as we've discussed in the past, and as you may have seen, here in our June quarter, you know, there was a bit of an uptick in our operating expenses as we continue to invest primarily in R&D activities across the organization. You know, depending on growth from a revenue perspective, as we work our way out into the future, you'll see a bit of an uptick in our sequential operating expenses on a go forward basis. From an overall interest point of view, obviously interest rates are on the rise.
You know, what we're seeing here going into the fourth fiscal quarter or September quarter, you know, that will include basically the full quarter impact of the rate adjustment we had seen back a month or so ago. Then obviously we'll have some of the impacts from the rate increase that that was announced yesterday. That will drive some of the interest rates up from an expense point of view. Some of that will be mitigated as we go forward, depending on short-term investment returns.
Our next question coming from the line of Quinn Bolton with Needham. Your line is open.
Hey, guys. Congratulations on the nice results. Steve, you mentioned, you know, sort of acknowledging the more challenging economic conditions. I'm wondering, are you starting to see any changes in your customers' order patterns? Are weekly orders becoming more variable on a week-to-week basis? Are you seeing any pushouts or adjustments to delivery schedules, any cancellations, anything like that yet?
Thanks for the question. This is something we've been very focused on in trying to look for, let's say, early trends of possible future softness. You know, at the end of the day, we're not seeing that. We're actually seeing continued strong bookings across all of the different end markets. That's the good news. As I think we mentioned in the early remarks, this was our seventh consecutive quarter of having a greater than one book-to-bill. I'll just also note one thing we have seen improvements on are some of the availability and lead times for our third-party foundries. We're seeing some of the process nodes that we use come down in lead time, and we think that would suggest that there's capacity opening up.
We actually think this is a good thing. It will allow us to bring some of our manufacturing cycle times down. I would say that's the only noteworthy item. Some of our third party large silicon fabs are quoting slightly shorter lead times, and we see that as a benefit. In terms of the day-to-day business and the bookings, I can say that, you know, we're not seeing any indications, and we're keenly sensitive to the daily booking trends, and we do keep a close eye on it.
Perfect. Thank you. Thank you for that color. Wanted to also know, just ask on the laser opportunity. You've got lasers for PON, lasers for 5G backhaul, and now starting to emerge into the data center. Can you give us a, you know, just of those three opportunities, maybe relative size or rank order, you know, is one significantly larger than the others? Or, you know, how do you sort of see those three opportunities for lasers ramping over the next couple of years?
You know, it's an interesting part of our portfolio. The thing about our lasers, as you highlighted, we are actually focusing on three different markets. Now sort of four as LIDAR is starting to emerge, where we are seeing requirements for very high-powered lasers. Of course, you've got the data center, you've got access, and then you have telecom. In terms of our portfolio, as you know, we have the Fabry-Perot lasers, which are good for the short distances. We have the DFBs, which are for longer distances, and now we're working on EMLs, which are for the very long distance applications. MACOM does not today produce VCSELs, and that is a large part of the market.
I can tell you from a customer base point of view, we have approximately 20-25 customers that we are engaged on that are qualifying various types of lasers depending on the application. We're seeing qualifications with LR4. We're seeing qualifications in Korea for WDM 12 for 5G. We're seeing CWDM six for 5G, and certainly 5G for BiDi and also different data rates applications for 5G, actually higher data rates for mid-haul. My point being is we have a lot of qualifications going on. We have very few customers today that are actually in production. We see many customers beginning to ramp. If I were to pick one market which is the largest market of the three, I would say the PON market is actually a very interesting market.
You know, at 2.5G PON, the annual laser consumption was about 80 million lasers at its peak. We're going through a period today where MACOM is one of the largest producers of 2.5G PON lasers for the market. Over the next two to three years, there's gonna be a shift from 2.5G to 10G. This is actually being driven in not only by the China market, but also the global expansion of passive optical networks for fiber to the home. We plan on being a major participant in that market. I can tell you today our 10G PON laser revenue is almost zero. We're only in qualification phases. We think that market will turn on sometime in 2023.
I haven't sort of directly answered your question about which is the largest. I think there's tremendous opportunities within each of the segments. As some of the markets adopt silicon photonics or co-packaged optics, they're gonna want high-power CW lasers or they're gonna want laser arrays, and we are actively engaged with customers in both those applications. The last thing I'll add about our laser portfolio is we expect the profitability of this product line to be accretive to our margins. We have an advantage of being on four-inch indium phosphide. Our edge faceted technology allows us to do on-wafer testing, so we believe we have a cost advantage when we go into high volume markets.
Our next question coming from the line of Tore Svanberg with Stifel. Your line is open.
Yes, thank you, and congratulations on the record operating margin. Steve, when you talked about PAM4, you said you're happy to see 800 Gig activity. I was just wondering, does that mean some customers will be skipping 400, meaning going straight from 200 to 400, 200 to 800? Or is this more of a timing thing where, you know, the market is actually already starting to do some 800 Gig designs?
I think it's very early, Tore Svanberg, for 800. We are engaging customers with not only 800, but 1.6 Tb. We're addressing the highest speeds, and customers are coming to us for analog solutions, and so that's the point I wanted to make there. I don't believe customers will be skipping 400G. In fact, 400G is becoming or is the majority of our revenue today within the data center, and that's across a wide range of sub-segments. We actually divide internally our data center revenue into about nine different categories depending on the distance, the length, and the speed.
When we look at our 400G platforms, whether it's short reach DR4 or FR4 or active copper cables even, in all cases, we see the 400G revenue growing. We do have a very strong position from our product standpoint of view to address the market. I think that, no, I'm not suggesting that there are customers that are skipping the 400G.
Very good. Thanks for clarifying that. My follow-up, either for you or for Jack. MACOM is in striking distance now from no longer being in a net debt position. I was just wondering, you know, once we get to that level, which will be very soon, will the company's capital management plans change?
Yeah. Tory, this is Jack, and good morning. So, yes. Yeah, as we look at our cash position and our net debt position, as you highlighted, and as I had indicated on the prepared remarks, you know, we do view ourselves as still being in a net debt position. You know, we'll have to see how things go as we move forward. We continue to make investments, you know, internally throughout the organization. We believe our cash balance and where we sit today is a strategic asset that, you know, provides us with a number of different options as we go forward. Steve, I don't know if you've got any other thoughts. Yeah.
I think that's exactly right, Jack, and I'll just add that we do recognize that a growing cash position is a strategic advantage, and as that cash position grows, it will allow us to have more options as we look forward. Given the fact that we are either in or maybe soon to be in a recession, having a large cash position also you know allows us to sleep well at night.
Excellent. Thank you.
One moment for our next question. Our next question coming from the line of David Williams with Benchmark. Your line is open.
Good morning, David, are you there?
Okay. One moment for our next question. Our next question coming from the line of Matt Ramsay with Cowen. Your line is open.
Yeah. Hi, guys. This is Ethan Potasnick on for Matt. Congrats on the great results and guide here. I was wondering if you guys could discuss on gross margins. Things are still progressing really incredibly. I was wondering if you could dive into, you know, where you see levels from here. Is the strength sort of being driven by timing or product mix? Wondering if you guys could explore that dynamic.
Yeah, sure, Ethan, and good morning. This is Jack Kober. As we look at our gross margins, you know, we have been pleased with the progress that we've made over the past couple of years in terms of those improvements. As we've also discussed, we have a continuous improvement culture here at MACOM, so we're constantly striving to make improvements across the organization. There's been a number of different things that we've done in terms of reducing scrap and waste and trying to improve yields across many, if not all, of our different product lines that we have, and that's both internally manufactured products as well as things that we go to the outside folks on. We keep picking away at this and making those improvements.
You know, we continually say we'd like to see incremental improvements over time, but we know, you know, things don't always occur in a straight line. As our gross margins get up to this higher than 62% range, you know, we understand that it can be a little bit more challenging as we go forward. You know, as we look out over the longer term, you know, slow and steady sequential improvement is our goal, but it's not always gonna be heading in that consistent direction. One of the other things to think about as well is some of the new product introductions that we have.
That's a core element of our strategy is to introduce more products and at higher gross margins that specify to some of our customer needs. As we feather in some of those new products looking out over the longer term, we hope that'll also be additive to our gross margins.
Understood. I was pretty intrigued by some of the commentary in the script on the OTDR product line. You know, given some of the recent qualifications, as deployments of PON 5G optical networks continue, I was wondering any insight into time to revenue there?
Yes. We just introduced the products recently. We actually had to go through about three different iterations of the photodetector to meet customer requirements. Qualifications, as I highlighted in my script, are starting now. We should expect a slow ramp, like all of our different product lines, over the course of the next 12 months. We would expect at, you know, contribution in the near term and ramping up over time. I'll just also note there that there are multiple markets that would use this type of functionality, including PON, like you mentioned, but also metro long haul. There's also various military applications, whether it's underwater cables or systems that are in active platforms that need to monitor electronics.
It's a fundamental feature that's necessary in a lot of different optical fiber applications, and MACOM wants to be a leader in this area. We have some outstanding packaging technology. We have dialed in the performance of these detectors. They have to be very fast speed, that way it can identify if there's an issue on a fiber that's close to a, you know, a break or a bend in the cable of the fiber that is near itself. You need to have a fast, effectively a fast switching photodetector to identify the distances between these these type of events. It is also, I'll just highlight, a niche market. This is not a multi-hundred million dollar market.
You know, from our point of view, we think the SAM is somewhere between $20 million and $40 million. Over the next few years, if we can win a reasonable portion of that market, I think we'll be doing well. Just as Jack highlighted, it was your question about gross profit margins. I think this is a perfect example of going into a niche market with a customized product and becoming a dominant supplier, and the product line will meet MACOM's goals of increasing gross margins over time.
Our next question coming from the line of Mark Lipacis with Jefferies. Your line is open.
Hi, thanks for taking my question. Steve, I had a question on the defense commentary you made. I think you've always talked about it as a growth sector for MACOM. Maybe I'm reading too much, but it seemed like you highlighted it in particular this quarter. I'm wondering, is there particularly good visibility or improving visibility in that sector now? Maybe as part of that, if you could just step back, since you have decades of experience in the defense market, do events like the Ukraine War or Desert Storm typically lead to increased demand or visibility for component suppliers like MACOM? Thank you.
Thank you. We are very pleased with the performance of our defense business across a lot of different applications. Historically, MACOM was known to be a supplier of discrete diodes, and in some instances, MMICs, which were mostly for RF and Microwave applications. What we've been doing over the past three years is really branching out and introducing all the different technologies to our defense customers and absolutely getting well received. We're very excited about it. As I highlighted in my script, we're also bringing in new design capability to allow us not only to provide components, but also modules and multi-chip assemblies or subsystems. I think about six months ago, we highlighted a 45kW contract, a multimillion-dollar contract from the Navy.
We expect more of these type of activities over the next few years, winning and getting involved in very large programs. This is something that MACOM was not doing four or five years ago. The other thing I'll highlight since you talked about sort of general trends is I think it's warranted to bring up the CHIPS Act, which as everybody knows, the Senate passed this week, and it looks like it should be signed into law sort of imminently. That provides about $53 billion to the semiconductor industry. CHIPS stands for Creating Helpful Incentives to Produce Semiconductors, and that's exactly what we do. We are really an ideal candidate to win funding. The funding will flow through, in many cases, DoD agencies or sponsors.
As we've been for the last few years, reestablishing and building new relationships with the major agencies, that will help us as these CHIPS dollars start to flow, because they're gonna be looking to not only build out and improve and expand manufacturing, but they're also gonna be providing about $13 billion for semiconductor R&D. We wanna be a major beneficiary of those funds. We're very focused on defense. We have outstanding technology across many different technology areas, whether it's RF, optical, high speed analog, or RF power. We're certainly very excited about the market. We've been able, over the past three years, to take a market that had been stagnant and running in about $40 million a quarter, and now we're approaching $80 million a quarter.
That is certainly due to just market share gains and going after new programs. I wouldn't specifically relate any of this to any particular skirmishes like the Ukraine that you mentioned. Certainly the world is not a safer place today, and so as the challenges emerge for the U.S., that generally drives electronics to higher frequencies and higher power and higher data rates. These trends play to our strengths. The fact that we are moving ourselves to the edge of performance should drive our DoD business.
Very helpful. Thank you.
Thank you. One moment for our next question. Now our next question coming from the line of Harlan Sur with J.P. Morgan.
Good morning. Thanks for taking my question. As a follow-up to that, Steve, so several of your fabs are AS9100D. They're aerospace qualified. I think your Lowell facility has ITAR sort of trusted fab status by the Department of Defense. You've also got a number of standard products and custom programs for defense initiatives, as you outlined in your prepared remarks. As you just mentioned, I mean, you guys are clearly an important partner to the U.S. defense and aerospace industry. As you combine this with the high probability of the passing of the CHIPS Act bill, it does seem very likely that you guys are gonna get access to the associated subsidies. I know that proposals were requested by the Department of Commerce a few months back.
Can you guys just give us a sense, sort of base case, how much is the team requesting in subsidies?
CapEx right now is about 4%-5% of your revenue, so any subsidies will be a good boost to your free cash flows.
Yeah. I just think it's probably a bit too early to get to that level of detail, or for us to share that level of detail. It is still certainly early in the process. I think instead I can just highlight that as we think about how we can help and where we would wanna drive funding, it would be certainly towards supporting our manufacturing facilities. But it's also equally we're interested in working with different agencies to develop technologies for new programs. It's that semiconductor R&D piece, which can come in a lot of different forms. It can come in the form of process development, circuit design or package technologies.
You know, we wanna make sure that we use this vehicle to help in many ways subsidize our advanced R&D. I think you're right in your comments about us being AS9100. We have a trusted foundry facility, and we have a growing capability in this area. It's just too early for us to talk about specifics until we have a better understanding of how the dollars will flow.
Maybe a good example of the, you know, access to R&D dollars. I mean, I think a good example of that, right, is your 0.14 micron GaN-on-Silicon Carbide MMIC process that was transferred from the Air Force Research Laboratory. You also characterized this technology as one of the key emerging growth drivers for the team. Is the manufacturing process fully qualified? I know it's running in your Lowell facility. Is the manufacturing process fully qualified? Given that this was a technology that was transferred from AFRL, are you guys limited to just doing custom and standard products purely for defense-related initiatives, or are you guys allowed to use this process for non-defense-related standard and custom products and maybe even also offer the process to non-defense-related foundry customers?
Yes. A great series of questions. I'll try to answer all of them. Just to highlight the 0.14 GaN-on-Silicon Carbide process that we transferred from the Air Force was paid for by MACOM. We used MACOM R&D dollars. There was no government subsidies or funding for that. That was a commitment we made to the Air Force because we felt it was strategic in nature. We wanted to build relationships, we wanted to begin a working relationship, and that has been an absolute success. This is a transfer of technology that's royalty-free. We're not paying the Air Force, and there's no royalties associated with it.
The second thing I'll highlight, we are not constrained by how we use the process. We can sell it into the commercial markets. In fact, that's exactly what the Air Force wants. They wanna see the process go to volume production. It can also be used, of course, for DoD applications. You generally start to get into limitations when you start to do particular circuit designs, which could create limitations on applications. In terms of the qualification status, the process is not yet qualified. We expect to be qualified by year-end or early Q1 of 2023. However, what we have qualified is our PDK, which is the design tools necessary to start making chips.
Our designers and our business development staff are off collecting requirements and designing devices because effectively the process is frozen. That's the status. We've been doing demonstrations, we've been engaging customers, we've been sharing all our data. I wanna highlight that this technology is really a launching point for future technologies. As the chip dollars start to flow, we wanna use some of those future dollars to go to shorter gate lengths and create, you know, new capabilities within high frequency GaN. It's really just step one in a long-term program. We know there's U.S. competitors, two major competitors, that are producing hundreds of millions of dollars of revenue within this technology set. Today we have zero revenue.
Our goal is to very clearly step into the market, win market share, and drive growth.
Thank you. One moment for our next question. Now our next question coming from the line of Richard Shannon with Craig-Hallum. Your line is open.
Hi, guys. Thanks for taking my question. I just had one and it kind of covered a few of the comments you just made here in the last couple minutes, Steve. I'll take a phrase you used earlier in the call here about staying in your lane. I think in reference to you know not going after DSPs, which I think most people would make sense. You've also talked about a lot of the opportunities that you have in new markets, you're being kind of niche-y. It seems like with the potential from the CHIPS Act that this might allow you to go after you know a little bit bigger markets here.
You just described, I may have missed some of it, the detail here about, you know, markets where the revenues are well into the $100s of millions. I guess my question to you, Steve, to maybe expand on just your last answer here, is that could staying in your lane allow you to or allow you to go after much bigger markets in the past, especially with the CHIPS Act money? Maybe just expand on the last answer, and I'll leave it at that. Thanks, Steve.
Yeah. I do think that. Well, first of all, we have a long-term strategic plan, as we talked about, and that plan is a self-funded plan. We are not, you know, betting our future strategy on winning dollars from the CHIPS Act. For us, this is an accelerator. It will allow us to do things faster, and it will provide financial benefit, you know, in cash flow benefits, of course. It helps solidify long-term relationships with major agencies and customers. To the extent that we are successful winning funding, it will be an accelerator. It, you know, we don't typically talk about our future plans or when we do decide to jump lanes, what lane we'll jump into. That will come later.
There is potential certainly for us to continuously expand our SAM, and that is a key part of our growth strategy. Today, we estimate our SAM to be about $5 billion, and we wanna push that to about $8 billion or $9 billion over the next few years. By only spending $130 million or $140 million a year in R&D, you know, you can only do so much. We have a very methodical and measured approach to stepping into markets we know we can be successful in. Again, I'll just highlight that the CHIPS Act would only be an accelerator, but it won't change our fundamental strategy.
Okay. Appreciate those comments, Steve. That's all for me.
Thank you.
Thank you. I will now turn the call back over to Mr. Stephen Daly for any closing remarks.
Yes. Thank you. In closing, we'd like to thank our employees, our customers, and our suppliers for their continued support. Have a nice day.
Ladies and gentlemen, that does end the conference call for today. Thank you for your participation. You may now disconnect.