MACOM Technology Solutions Holdings, Inc.

Good afternoon and welcome to MACOM's fourth fiscal quarter 2020 conference call. This conference call is being recorded today, Thursday, November 5th, 2020. At this time, all participants are in a listening mode. I will now turn the call to Mr. Steve Ferranti, MACOM's Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.

Thank you, Shannon. Good afternoon. and welcome to MACOM's fourth fiscal quarter 2020 earnings conference call. 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 8K, which was filed with the SEC today. With that, I'll turn over the call to Steve Daley, President and CEO of MACOM.

Thank you, and good afternoon. I will begin today's call with a general company update. After that, Jack Kober, our chief financial officer, will provide a more in-depth review of our fourth quarter and full-year financial results for fiscal year 2020. When Jack is finished, I will provide revenue and earnings guidance for the first quarter of FY21, and then we will be happy to take some questions. Before I start my review, I would like to acknowledge the amazing work and contributions of our employees who make these results possible. Revenue for the fourth fiscal quarter was $147.2 million and adjusted EPS was 40 cents per diluted share. This was the highest EPS performance in 12 quarters. I'll note that our fiscal year 2020 had multiple financial highlights, including 6% year-over-year revenue growth, 440 basis points of improved gross margin, and operating income that grew by a factor of eight, which generated over $150 million in free cash flow. Jack and I, along with the entire management team, are pleased with the progress to date, and we remain focused on further improving our financials. The secular trends associated with our three core end markets, data center, telecommunications, and industrial and defense, provide us significant opportunities for growth. We estimate our serviceable available market, or SAM, is approximately $5 billion. To maximize our market share, we are working to establish Macom as a leading supplier of LightWave, RF, and high-speed analog solutions. It is our goal that these technologies will be supported with best-in-class customer engagements, manufacturing, and quality. New products are our growth engine, and as I've stated in the past, our future performance will be based in part on our ability to introduce more innovative products at a faster pace. In support of our growth strategy, we are focused on execution and fast time to market. I see meaningful progress here, and as an example, I am pleased that our engineering teams have more than doubled the number of product introductions in fiscal year 20 versus fiscal year 19. Further, I am pleased the competitiveness and the uniqueness of our new products continues to improve. As we start our new fiscal year, I would like to share some of our top priorities. Above all else, we seek to maintain a safe and healthy work environment for our employees. I'll note we are in our third month of a program which offers voluntary, daily, on-site COVID-19 screening to any employee working at our largest manufacturing sites. Easy access and fast COVID test results help support a safe work environment. Our first priority is to continue to improve our profitability. Strategies underpinning this effort include maximizing the efficiency of our R&D investments, developing high-margin differentiated products, improving factory utilization and yields, optimizing sales strategies, and maintaining OPEX disciplines. We are pleased that our operating margin is currently greater than 23%, and we are confident we can do even better. Second, we want to expand our presence in 5G utilizing RF, high-speed analog, and lightweight solutions. Today, MACOM is present across the 5G network with product content in the antenna systems, as well as in front-haul, mid-haul, and metro long-haul optical systems. Today we are only delivering a fraction of our potential, and we believe our best performing products for some of these applications will come to market over the next six to 12 months. Third, we will use our high speed analog and connectivity design capabilities to expand deeper into our target end markets. Our data center growth strategy includes working closely with worldwide cloud service providers to ensure our technology roadmaps are aligned with their future needs. Roadmap alignment is critical, whether working on current 100G, 200G, or 400G systems, or disruptive future generation architectures. Included in this effort is supporting emerging applications, such as Next Generation PON. Our high-speed analog and optical design capability is compelling, and we will build upon this strength. Fourth, we are focused on leveraging the manufacturing capability of our Lowell, Massachusetts and Ann Arbor, Michigan wafer foundries. This is critical for our long-term industrial and defense and market growth. We have revamped our process technology roadmaps for each FAB and we expect to make some exciting announcements on new initiatives throughout our fiscal 21. Investing in our FAB infrastructure and process technologies enables differentiation which ultimately supports unique products that may drive highly profitable growth. And fifth, our priority is to take market share with best-in-class lasers and photo detectors in and around the data center and 5G telecom systems. We believe that our newest laser and APD products will set the standard for performance. We have a broad technology portfolio, and each one of our engineering organizations now has detailed product roadmaps and refreshed market positioning strategies. It is exciting to see our engineers and sales teams working in a collaborative way with customers to win market share. Let me highlight one example of improving our position in the emerging 10 GPON market. Today, Macom is a leading supplier of 2.5 GPON lasers. Historically, we have supplied two GPON products in volume production, lasers and laser drivers. As 10 GPON emerges and ramps up, we expect to provide up to five products across four product families. namely high and low power lasers, laser drivers, transimpedance amplifiers, and photo detectors. PON networks are deployed globally, and we believe the work-from-home trend across Europe, Asia, and the U.S. will accelerate the deployment of next-generation PON systems because the systems operate at higher speeds. This trend has the potential to benefit MACOM. Our Q4 revenue by end market was as follows. Data center was $43.9 million. Telecom was 55.4 million and industrial and defense was 47.9 million. Data center had sequential growth of 35% while our industrial and defense business was essentially flat and telecom declined by 2%. We had an exceptional year in bookings and we are pleased to start our fiscal year 21 with a near record backlog. Our Q4 book to bill ratio was approximately 0.8. However, I will note our book to bill for the full year was 1.1 to 1. I'll also note in FY20, we had periods of exceptional bookings driven by healthy underlying demand across our end markets, augmented at times by long lead time IND orders, and customer pull-ins driven by concerns about supply chain disruptions due to COVID-19. Our Q4 turns business was approximately 13% of total revenue. I'll highlight in Q4 we ceased shipping and canceled certain customer backlog in order to remain compliant with the expanded U.S. export restrictions announced in August. We estimate the year-over-year impact of the expanded restrictions is approximately $20 million of lost revenues. We do expect to offset this lost revenue with growth from new products and market share gains at other customers. We track channel inventory and long-term demand forecasts from our largest customers, and I would characterize the new orders environment in October as improving when compared to our fourth quarter. Now turning to the markets. Our data center and market revenue was driven by strong cloud data center demand for both domestic and international deployments. Our 100G high-performance analog products and our emerging 200 and 400G analog products are supporting this growth. I'll note that our international data center growth is driven by Asia-based data center expansion where we sell both 25G and 100G analog products. Our telecom market demand was primarily driven by 5G products and to a lesser extent GPON products. We believe the near-term demand for our 5G products will temporarily slow before it begins to accelerate again when the next round of 5G bids is released. We also expect near-term delays in global deployments of 5G due to COVID-19 and the Huawei business impact. Nevertheless, the secular growth opportunity in 5G remains intact as worldwide demand for improved connectivity at higher data rates will continue to grow. Our industrial and defense end market revenue performed as we expected, with general weakness in testing measurement as well as avionics. However, in the coming quarters, we anticipate the negative trends will be offset by strengthening demand from a variety of U.S. defense programs some of which are already in backlog. Each of our six engineering teams has tremendous growth potential. Notably, we have a tremendous growth opportunity with our RF power business. Our efforts include, one, taking market share on legacy silicon bipolar business, two, expanding our MACOM pure carbide GAN product portfolio with compelling new products, three, partnering with major OEMs across the industrial and defense markets, and four, participating in the 5G power amplifier opportunity. As you may remember, we launched two flagship general-purpose pure carbide GAN products last quarter. Since then, we have expanded our pure carbide GAN portfolio to a total of five products, including 25-watt, 65-watt, 85-watt, 150-watt, and 2.6 kilowatts. Our 2.6 kilowatt product is truly unique and represents Macom's highest power product ever. And it achieves industry leading power levels, making it ideal for certain defense applications. We plan to grow our pure carbide portfolio significantly over the next 12 months with additional high performance products. In summary, we stand in front of a multi-billion dollar SAM with a strengthening technology portfolio. We maintain a long-term perspective on executing our strategy. We are excited with the pace of innovation that we are achieving. We are confident we can continue to improve our financials and take market share in the months and years ahead. Jack will now provide a more detailed review of our financial results.

Thank you, Steve. Fiscal Q4 was another period of solid financial performance. We posted sequential improvements in revenue, margins, earnings, and cash flow. Revenue for the fourth fiscal quarter of 2020 was $147.2 million, up 7% from Q3. The sequential improvement in revenue was driven primarily by positive trends in the data center and market. For fiscal year 2020, revenue was $530 million, up 6% from $500 million in fiscal 2019. On a geographic basis, approximately 36% of fiscal Q4 revenue was from domestic customers and 64% was from international customers. And for the full fiscal year 2020, 41% was domestic and 59% international. Adjusted gross profit in fiscal Q4 was $83 million, or 56.4% of revenue. Adjusted gross margin was up 90 basis points sequentially. From an operational perspective, we remain focused on many continuous improvement initiatives that we believe will support improvements to gross margins going forward. These initiatives include improving the efficiency of our manufacturing, supply chain, and other operations, as well as the continued management of our inventory. Adjusted gross margin for fiscal year 2020 was 55%, up 440 basis points from 50.6% in fiscal 2019. Total adjusted operating expense was $48.9 million, consisting of R&D expense of $32.1 million and SG&A expense of $16.7 million. Operating expenses were up approximately $2 million sequentially, as we anticipated, primarily due to the timing of certain R&D expenses. We continue to manage our operating expenses closely. we have instilled a corporate-wide focus on expense management in order to create ongoing opportunities for savings, which helps support our new product development and growth initiatives. Looking ahead, we expect operating expenses to increase modestly from Q4 levels. As noted in the past, we will continue to carefully balance investments in new product opportunities while managing our discretionary spending. Adjusted operating income in fiscal Q4 was $34.1 million. up from $29.3 million in fiscal Q3. Adjusted operating margin was 23.2% for fiscal Q4, sequentially up from 21.4% in fiscal Q3. For fiscal year 2020, adjusted operating income was $96 million, compared to $10.9 million in fiscal 2019. We expect the combination of top-line growth, improving gross margins, and stable operating expenses to provide continued operating leverage over the course of fiscal 2021. Depreciation expense for fiscal Q4 was $6.7 million, and adjusted EBITDA was $40.8 million. For fiscal 2020, our last 12 months adjusted EBITDA was $124.5 million as compared to EBITDA of $40.6 million in fiscal 2019. a year-over-year improvement of more than 200 percent. Fiscal Q4 adjusted net interest expense was approximately $4.2 million, down approximately $500,000 from fiscal Q3 2020. The decline was primarily driven by the reduction of LIBOR rates on our floating rate term loan and higher interest income on our short-term investments. Looking ahead, we expect net interest expense to remain roughly at these levels. Our adjusted income tax rate in fiscal Q4 continued at 8% and resulted in an expense of approximately $2.4 million. We expect our adjusted income tax rate to reduce to 5% for fiscal Q1 and the remainder of fiscal 2021, as we expect to continue to have relatively low cash tax payments. Fiscal Q4 adjusted net income was $27.6 million compared to $22.7 million in fiscal Q3. Adjusted earnings per fully diluted share was 40 cents in fiscal Q4, utilizing a share count of 69.3 million shares compared to 33 cents of adjusted earnings per share in fiscal Q3. For fiscal year 2020, adjusted net income was $67.1 million and adjusted EPS was 98 cents as compared to a net loss of $19.2 million and a loss of 29 cents in fiscal 2019. Now, moving on to cash flow and balance sheet items. Fiscal Q4 was an exceptional quarter for cash flow. Q4 cash flow from operations was $74.4 million. Improvements in operating income and strong accounts receivable collections helped to enable strong cash generation for the quarter. During Q4, we received payments of approximately $18 million associated with prior years United States tax return receivables. These cash receipts are considered one time in nature and are not expected to recur in the future. Cash receipts are considered one time in nature and are not expected to recur in the future. Capital expenditures totaled $4.9 million for fiscal Q4. For fiscal 2020, CapEx came in at $17.6 million as compared to $38 million in fiscal year 2019. Free cash flow was $69.5 million for the fourth fiscal quarter. For fiscal year 2020, we generated $153.8 million in free cash flow versus negative free cash flow of $17.3 million in fiscal 2019. This year-over-year cash flow improvement was driven by the numerous structural improvements we've made to the business, working capital improvements, as well as the one-time collection of prior year tax receivable I noted earlier. We feel the ongoing operational and financial improvement initiatives will continue to help drive positive cash flow going forward. Our Q4 accounts receivable balance was $45.9 million, down from $60.5 million in Q3. As a result, Day sales outstanding were 35 days. As I've noted in the past, we've made many operational improvements within the business, including our sales, inventory, and operations planning, or SIOP, process. These improvements have allowed us to better control our production processes and manage shipment linearity during the quarter. During Q4, we were pleased that we were able to ship more of our revenue earlier in the quarter, which helped to drive the exceptional cash generation and lower DSO during the quarter. Inventories were $91.6 million at quarter end, down another $4 million sequentially. Inventory turns improved to 2.8 times during the fourth fiscal quarter, which is the highest inventory turns we've achieved since 2015. Inventory management remains an area of emphasis, and we see ongoing opportunities to further improve these metrics going forward. Cash, cash equivalents, and short-term investments for the fourth fiscal quarter were $333 million, up $68 million from Q3. In total for fiscal year 2020, our cash and investment balances increased by $156 million. As a reminder, our short-term investments are comprised of corporate bonds and commercial paper and are classified as held for sale. Long-term debt of $659 million is covenant light and has minimal annual principal repayments until its maturity in May 2024. In addition, we have $30 million of finance leases. our trailing 12-month EBITDA increased again in fiscal Q4. With the increase in our cash position and the improvement in trailing 12-month EBITDA, we exit fiscal 2020 with a net leverage ratio of around 3.4 times. We feel Q4 was another solid quarter and concludes a year of sequential financial and operational improvements in many areas across the company. We are pleased with our recent progress and believe there continues to be more for us to do to continuously improve the business and achieve our longer term objectives over the course of fiscal 2021 and beyond. I'll now turn the discussion back over to Steve.

Thank you, Jack. Macomb expects revenue in Q1 ending January 1st, 2021 to be in the range of $146 to $150 million. which is approximately 24 percent year-over-year growth at the midpoint. Adjusted gross margin is expected to be in the range of 56 to 58 percent, and adjusted earnings per share is expected to be between 41 and 45 cents, based on 69.8 million fully diluted shares. In Q1, we expect industrial and defense revenues to grow approximately 20 percent sequentially. and data center and telecom to be down approximately 10%. In a year-over-year comparison at the midpoint of our Q1 guidance, data center and telecom are expected to be up approximately 70% and 10% respectively. I'll also note we expect strong full-year performance from these two end markets. We are excited about the multiple growth opportunities in front of us, and I would now like to ask the operator to take any questions.

Ladies and gentlemen, as a reminder, to ask a question, you will need to press the star and the one key on your touch-tone telephone. In the consideration of time, we ask you that please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. And our first question, coming from the line of Harsh Kumar with Piper Sandler, your line is open.

Yeah, hey, guys. Solid performance. Congratulations. You know, just a set of impressive numbers. Steve, first question for you. Industrial and defense turning up, I think you said 20% sequentially, so I'm curious what is happening there, if some of that is one time in nature or do you, you've been counting on sort of the turn in industrial or is that turn, you know, for good to growth is finally starting to happen and we should expect sustained growth here?

So thanks for the question. I would say that there's a few things happening in our IND and market going into Q1. The first is our U.S. defense business is improving. We've got a very solid backlog. The type of products we're selling into this market are typically for ground-based and airborne radars as well as mobile radios. And I would just also note that's being supported by an uptick in some of our automotive radar products that we sell into that market as well. In terms of the long-term trend for industrial and defense, I think our fiscal 21 is going to be a very good year. We have done a really nice job setting ourselves up for growth, mostly in the back half and mostly going into our fiscal 22 with winning some significant new business. So we do believe there is kind of a turning point here where we should start to deliver growth on this end market. And I'll just highlight that this is a market that we've struggled with over the last three to four years. It's actually our largest market, but it just hasn't been growing. And the growth that you're going to see is really going to be product-driven and market penetration strategies-driven. whether it be asking our team in the LightWave business unit to enter the defense industry with some of their technologies, or whether it's bringing our pure carbide products, the GaN and silicon carbide, to this end market. So there's really a tremendous opportunity in this end market, and we'd like to think that this level of growth will continue. I'll just caveat my comments with the fact that You know, we do believe our fiscal 21 is going to be a good year, top-line growth. We're certainly targeting more than 10%, so our IND business will help that tremendously.

Hey, for my follow-up, Steve, when you say fiscal 21 will be a 10% growth, did you mean that, and this is just a clarification, do you mean that for the industrial business or do you mean for the overall company?

Yeah, I was meeting year-over-year company growth.

Okay. And then for my follow-up, Steve, historically, in a few years, around December timeframe, the channel inventory, particularly in optical in Asia, sort of starts to adjust and create some fluctuations in business. I was curious how you feel about your channel situation for the optical parts, particularly for data center and long haul, and what you are seeing there.

I don't think we're going to have those same issues this year in terms of things you've seen in the past. Our channel inventory is actually quite healthy. I think we will see a bit of a slowdown, as I commented in my prepared remarks, regarding 5G, specifically front-haul related. So there is a bit of a slowdown there. But it's not channel inventory related. We think it's really, let's say... we're waiting for the new round of tenders to come out, which will spark new demand. So we are pretty comfortable with our inventory positions, not only here at, you know, inside of MACOM. Jack commented that our inventories have been coming down. We're very happy about that. Certainly record turns, as he pointed out, since 2015. And we think our channel is in a reasonable spot, not only to manage, you know, their inventories, but also to react to the turn-on when 5G begins, specifically front-haul, where, you know, our customers are demanding, you know, fast delivery of products when they want to build their modules.

My next question, coming from one of Thor's wagon with Spiegel, your line is open.

Yes, Tori Svanberg here. Congratulations on the strong quarter. Um, uh, Steve, you talked about in 10 gig pond, uh, you're really adding some content. I believe you said from two, two products to five is, is that, uh, just the result of the architecture, uh, or, or are you basically introducing new parts that would gain share? And, and when do you expect 10 gig in earnest to become more material?

Yeah. So, uh, Tori, historically we've, service 2.5G PON, as I highlighted. As the newer next generation systems are emerging, there's really three different versions that we're interested in. XG PON, which is an asymmetrical system that has 2.5 and 10G data rates, then XGS PON, which is basically 10G both ways, and then EPON. We see and we've been developing products to support each of these really for the past year, year and a half. So it's really new content. It's recognizing that essentially these systems are at the terminal level or taking electrical signals and turning them into optical and pushing them down the fiber. So this is an area where customers are looking for very cost-effective products easy-to-implement solutions, and we're very good at working with customers to give them these turnkey solutions. And so our approach here is really to try to maximize the content, so bringing in TIAs, something we've not shipped into this market before, or the APDs, the photodetectors. So that's brand-new content. And then when you add on top of that certainly the laser content, The lasers are a little bit more difficult. They're different wavelengths. There's different environments on them. We think we're in a pretty good spot. It is emerging. I will caveat my comments with that. In terms of the volumes, people talk about different levels of volumes. We think over the next 12 months, it's probably in the range of maybe somewhere between 5 and 10 million ONUs, which are the user premise, and But we think in the out years, in the peak years, that could be 30 to 40 million units a year. So when you multiply that by four parts, it gets quite interesting. So this is what we're working on. The good news is it's an emerging market, and we think our timing will be lined up with the ramp. And I'll also highlight that Macom has a tremendous reputation in this market for being able to deliver very high-volume products. And so we're bringing with us a very strong reputation into the market for being able to deliver in the, you know, we have direct customer access and engagement. So we're actually quite excited about the, you know, the next gen pond systems.

Yeah. Thank you for all that color, Steve. My followup is for Jack. You know, even when adjusting with the tax attorney, your operating cashflow was 38% of revenue. How should we think about cash flows going forward on a normalized basis as a function of revenue? I know it moves around from quarter to quarter, but if you have sort of a number in mind that you can share with us, that would be great.

We did have a very good cash generation quarter here in the way we look at it. Our free cash flow is really trying to look at that in terms of a percentage of our non-GAAP net income. And we believe that can be a one-to-one. It's going to bounce around. Some quarters might be a little bit better, depending on what we do from a balance sheet perspective. And this past year has obviously been tremendous in terms of what we've been able to do with the balance sheet from an inventory and from a receivables perspective. Also, that tax item, which was about $18 million, was another benefit here in the year. So, you know, as we go forward, our target is really to try and get our free cash flow to essentially equal our non-GAAP net income.

And our next question coming from the line of Tom O'Malley from Blacklist. The line is open.

Good evening, guys. Thanks for taking my question. My first one is really about the September quarter. Clearly, you saw some additional strength in data center than when you initially set out during the quarter. Can you talk about where you saw that additional strength that got you to that really robust quarter, particularly if it's strength in a certain geography or in a certain product type?

Yes, certainly. And so we actually saw strength pretty much across the board with our 100G products, whether it's CWDM4, DR1. We actually, as we announced a quarter ago, we began initial shipments with our 100G PAM4 products. DSP, so that began to contribute in a modest way, but it was contributing to the growth. And also, we were seeing an uptick in some of our short-reach platforms that we service. Most of those platforms are U.S.-driven demand, data center demand from the U.S. side. And then on the international side, we saw improved revenues or increased revenues from some new customers, mostly on 25G and 100G analog solutions, also for Asia-based data centers. So we're very happy about that. I mean, our data center and market has been growing for five sequential quarters. It is an area that, you know, it's a very interesting area for MACOM. I can tell you that the growth areas over the next two to three years will include not only the next generation products on the analog side, but we also have set our targets on supporting the data center with our next generation lasers. We've made tremendous progress on our laser development technology, and I'll maybe take a moment to explain. As everybody knows, we announced about two quarters ago our 25GFP laser. which was really the first next-generation laser that our team had developed. And the back story on that work is that we actually have been reengineering our entire laser design so that it would be more manufacturable, it would be a platform-based design, And we, while doing this, improved the overall performance and robustness and reliability of the laser platform. And the 25G FP laser was really the first product, really the flagship product out the door, which we're targeting front haul, 5G front haul with. Now, why is that part important? Because it validated our approach to move towards 25G DFB lasers. And so as you may have seen in one of our announcements back in September, we demonstrated at CIOE a whole family of 25G DFB lasers. And we began to introduce our platform to not only 5G customers, but also we started to gain interest from our data center customers at the same time. What's interesting here is the platform that we've developed is scalable. So as you start to look at the 5G networks, each one of the operators that's rolling out these networks is certainly using a different modulation scheme. Some use CWDM6, some use MWDM12, or DWDM16 if you're in Korea, for example. And so what all that means is there's a lot of different wavelengths that need to be created to support 5G. And so the work we did, which allows us to have a scalable platform to address all these different wavelengths, has been done. And we are in the process of working through the qualification and starting to do our initial sampling with our customers so that we can capture some of the 5G opportunity. But what's most interesting is some of these wavelengths, specifically the CWDM6 wavelengths, also have the same wavelengths that you see in the data center. And it's the same device. And so we are really excited to finish the work that we're doing, which we'll be talking about more on our next conference call and really into the spring. But I have to say that the team here has done just a phenomenal job putting together a platform that we believe is scalable, not only for 5G, but also it will allow us to reenter the data center with very compelling product. Great.

That's a really helpful color. My next one's for Jack. I'm looking at the margins here, and you guys haven't touched these levels really since the end of December 18. And along with the gross margin ramp, you've really seen some nice revenue growth as well. But looking into December from a sequential basis, you're not seeing as much revenue growth as you've seen over the past couple of quarters, but you're seeing that expansion in gross margins. And you're also kind of guiding to more industrial defense, which is traditionally a little lower gross margin than your other segments. Can you walk us through how you're getting that gross margin incremental improvement quarter over quarter when you have two pieces that are kind of not going in your favor?

Sure. Thanks for that, Tom. So in terms of our gross margin expansion that we've got going into our December quarter, You know, there's a number of things that come into play, and a lot of the improvement that we've seen over the past year has really been a lot of operational efficiencies that, you know, that have been taking place throughout the organization that have been contributing to that improving margin. You know, we've talked about some of the scrap processes that we've put in place to monitor and to reduce variances. So there's things that are happening across the organization that are driving that. And I know you had touched upon the improvement in the IND revenue going into our December quarter. I wouldn't read too far into that in terms of that driving the margin mix. It's really a combination of a number of different things that we've got going on throughout the organization that have allowed us to improve those margins. And, you know, as we look at this, you know, looking longer term, we want to get back to some of those higher gross margins that we had, which were in the high 50s, you know, going back a few years. And, you know, once we get to those higher levels, the goal is to eventually exceed those. Steve, I don't know if you've got any further comments on our margin improvements.

Well, I'll just make a couple comments. I think people are starting to notice the improvements, and the team here has really done just a phenomenal job, as you pointed out. I'll also just add that... Inside of engineering, we are really raising the bar on overall performance. And I highlighted one of the parts that's really a best in class part, which is our 2.6 kilowatt device. And so there's not many companies that, A, can work with products at such high power levels. And so when you walk into a defense OEM and you put a product like that on the table, it creates all sorts of interest in and around the things you're doing. And ultimately, that drives very high-end opportunities that command very strong pricing. And so you'll certainly start to see more and more of that. Part of our strategic plan is to raise the bar and to go after high-performance, non-commodity-type applications. And by the way, I'll just add to that, a lot of the business that we've had this past year regarding our 5G front-haul products, these are very high-end products. You're talking about extremely... high-speed, complex devices, dual CDRs, power management, all sorts of diagnostics, built-in testing capabilities. These are fairly sophisticated devices that have very strong price points. And so it really is a testament to the work that our team in engineering is doing to develop chips that can demand higher prices. I'll also add to that that our MIMIC and DIODE teams have also been taking a critical look at the sales strategies in and around some of the legacy business, and they've come to recognize that there are opportunities to expand and do a little bit better job with the pricing, and some of that will certainly contribute. But we also think we have a fair way to go on the gross margin. We are delighted that it's moving in the right direction. Certainly, once you get above 60% gross margin, it becomes more about running an efficient operation with products that can be in very high price points. And to do that, you have to rely on either proprietary processes, which we can do because we have two foundries, or best-in-class design talent using third-party foundries, which we also can do. So I do think there's opportunities to grow on the gross margin side. And certainly, I'll just sort of coming back to my commentary on the lasers, these are generally dye sales that are in very high volume. And so, there's tremendous opportunities for gross margin expansion as these products start to come to production.

Our next question coming from the line of Carl Ackerman with Column. Your line is open.

Good afternoon, gentlemen. Two questions, if I may. Jack, one for you. How should we think about how the $20 million headwind from Huawei abates on a linear basis throughout the fiscal 2021? And I have a follow-up.

Thanks for that. In terms of how that's going to play out, I mean, it's pretty much linear throughout the year. I mean, I wouldn't think it's going to be that much linear. too lumpy as you look back over the past year. And once again, that may include some others that were on the entity list. It's not just limited to Huawei, but Huawei would probably represent a majority of that $20 million that Steve referred to earlier. Got it.

Yeah, the only thing I'll add to that is, and I'll come back to our underlying theme, which is we plan to outgrow, you know, the loss of that $20 million of revenue by introducing more new products faster and winning market share. So we think we have a good plan for this year to kind of push right through that. The loss of those revenues are obviously baked into our Q1 numbers today. And all of those customers have been driven to zero. So we're not expecting any upside from any of those companies. So it really comes back to our ability to launch more products faster. Uh, and by the way, there may be, uh, in some, some instances where other OEMs pick up some of that market share. And so to the extent that happens and we're able to support them, uh, you know, maybe, uh, there's an opportunity there, but the real growth story for Macon is new products and our six engineering organizations are really just doing a super job pushing products out the door. engaging the customers. And so I would just not focus on the loss of the $20 million. I would really focus on what are the new things coming out, are the products competitive, and I think that will really make you understand why we're going to grow through it.

Sure. No, helpful color. Steve, previously you mentioned that while you completed your PAM-4 100-gig DSP design project, you still need to intersect a design cycle until you receive revenue from that. One of your peers tonight just spoke about how PAM4 demand has been pushed out a bit, which I think should help you now bring up your design capabilities and kind of intersect that market. Is there a way to think about the cadence of your DSP roadmap that could perhaps increase your competitive capabilities and also substantiate your long-term value to that customer base? Thanks.

Sure, and I'm glad you asked that question, so I want to be clear on a few points. So we are not investing in new DSP designs. We announced that strategy about a year ago when Jack and I took over. And so what we communicated was that we would finish some of the projects that were in flight and bring them to conclusion and then bring them to market if they would be competitive. We do have an instance where we have 100G PAM4 DSP, where we have direct relations with the major OEM, and we are in production with them on that part. We will have some sister parts. We call them PRISM. We have essentially another part that we will use and bring to market to try to capture some market share. These are generally for 100G DR1 applications. And by the way, when there's the 400G breakout, it should actually help drive some of the 100G DR1 volume for MACOM. And then the other thing I'll highlight is we will be taking the platform that we have today and we'll be targeting mid-haul for 5G, which is running at 50 gigs per second. So I just want to be clear that we're not going to continue to develop new silicon and We are going to productize and create derivative products in and around the technology we have. And what we'll do with those design resources and the IP around the PAM4 universe, let's say, is we'll apply it to other areas where we can be very successful. And so we're actually quite excited to do that.

Our next question coming from the line of CJ News with Epico. Your line is open.

Yeah, good evening. Thank you for taking my question. I guess first question, Steve, you talked about wanting to grow more than 10% in fiscal 21. I'm just curious if you could shed some light on where you see, you know, greater growth on a segment basis and then also within that on the telecom side. What kind of assumptions are you making in terms of the timing and magnitude of a 5G recovery?

So I think all three of our end markets will grow this year, number one. And we are being cautiously optimistic with when 5G comes back online for us. We think that's most likely sometime late in Q2 or early Q3 when things start to really move. Because of that and because of the backlog and some of the other markets that are reasonably strong right now, primarily IND and some other parts of the data center market that are still doing quite well, we think the first half will still be very strong and we think we'll end or start to accelerate on the back half of 21 when the 5G market kicks into gear. And by the way, when it does kick into gear, as I highlighted, we hope to have additional new content in some of the platforms, primarily on the optical side.

Very helpful. If I could follow up on Tommy's gross margin question, you know, you had been kind of suggesting, you know, at least externally, maybe not internally, trying to hit 57% in the back half of fiscal 21, and here we're seeing that you know, in the December quarter. So I guess should we be thinking an exit rate that's now higher than this level? And I guess is there anything mix-wise that is a benefit in the December quarter that we should be thinking about?

Yeah, maybe we should try to answer that in two parts. I'll say a few words and then Jack can help. So our gross margin very much depends on mix. So There is always uncertainty around mix as you enter the forward quarter. So we can't say with specificity exactly what our margins might be in Q3 or Q4. With that said, we like the trends. We like the things that we're doing. We talked about the strength of the product line improving. Our operations team has done a phenomenal job with yield enhancement programs. The SIOP program that Jack mentioned is actually driving costs down as well. And we're getting better efficiency out of our FAB. So when you line all these things up, you see improvements. And we would much rather deliver improved gross margins than give you a number that we might fall short of. So, Jack, maybe you can add to that.

Yeah, CJ, so obviously going back to kind of that 57 number, that is at the midpoint of our guide going into Q1. So with some of the sequential improvements that we're looking for and also depending on mix, that would obviously take that exit rate for fiscal year 21 up a notch or two.

My next question is coming from the line of Ruben Moore with Benchmark. Your line is open.

Thanks very much. Jack, maybe we could just continue on that line of questioning and maybe just move down to the OpEx. You guys did a great job, and you talked about, you know, a lot of the strategic initiatives you're taking to manage expenses. In the context of looking out towards 10% plus growth in fiscal 21. Can you give us a little bit of an idea of how you're thinking about your spending with that type of growth in mind?

Sure. We've been very disciplined, as I've mentioned, in terms of looking at all of our OpEx spending throughout the organization and trying to balance the R&D investments that go along with that within the R&D section of our operating expenses. So, You know, it's been a very rewarding progress that we've gone through over the past year in terms of the improvements that we've made. We forecasted here in the fourth quarter that there'd be a bit of an uptick just based on the timing of some of those R&D expenses and those investments that we were making. So that will work its way through some of the operating expense items that we've got out there. But same thing with some of the things that we've been doing from an operational perspective in terms of continuous improvements. We're looking to do some of those same things within our G&A and sales and marketing areas to help try and make sure we're doing things more efficiently, which are in turn supporting some of those R&D expenses that we have going forward. But having said all that, there is that natural tendency for operating expenses to creep up. Obviously, things have been a little bit dampened down by some of the COVID restrictions that are out there from a travel point of view. So hopefully over time, we'll be able to travel a bit more. So that might cause some of those operating expenses to creep up as we work our way throughout the year. The other area that we've been focused on, not only from an operating expense perspective, is also some of our capital investments. If you look at where we were for the year, fiscal year 20, we came in around $18 million of CapEx. Going back to prior years, we were way in excess of $30 million. So we've been very focused on all of our spend throughout the organization and making sure we're doing it prudently and making sure any dollars that we're investing in the business, we're getting the appropriate returns.

If I may just make one comment, especially on the capital side. So as we talked about on the prepared remarks, we are very much focused on maximizing the utilization of our FAB and making it run more efficiently and having newer and better equipment in the FAB. So as part of our planning process for this year, we've certainly earmarked a capital for our FABs. And that shouldn't scare people because in our, you know, we're not talking about tens or hundreds of millions of dollars. We're talking about, you know, this year probably a capital investment for our LOLFAP here in the range of, you know, $5 to $8 million, which will certainly keep us in line with reasonable overall CapEx spending. But it's such an important point to make because one thing that Jack and his team have done quite well is focused on return of capital employed, and that is absolutely something we look at, whether it's buying test equipment, whether we're looking at changing out a piece of equipment in the fab. And so we have really instilled a very nice discipline in and around the business units, as well as the operations, to look at the overall returns on some of these big investments.

Thanks, Steve. Thanks, Jack, for all the detail. It's very helpful. If I could ask a quick follow-up. Steve, you had a lot of commentary around PON and sort of the additional products that you guys have worked on. Is there a way to think about the content opportunity or maybe even higher level, the TAM opportunity? I forget what 2.5G PON was at its peak, maybe $100 million to $200 million market. Do you have an idea if we get to $10 million, GPON units, 10-gig GPON units with four or five parts in the box, what could the market opportunity look like?

Well, at a very, very high level in the range of $200 million a year. Okay. And that assumes somewhere in the range of $5 million optical line terminals, or what they call OLTs, and maybe about $25 million ONUs, which are the customer premise end. So it sounds like a very big and attractive number, right? But today, we have little or no market share, and this is what we're aiming at. And we think it's in our wheelhouse. We have the technology. We have the customer relationships, and we're working on the designs. So it's a great market. It's a MACOM market. It's something that we think we can be very strong on. And by the way, I'll point out there are other, there's really one other U.S. competitor that we deal with here that's been very successful in this market. And, you know, we plan on moving in with better products and winning market share. So we still have a lot of work to do, but we are, we're making slow progress bit by bit.

My final question coming from the line of Lynn Balsam from New England Company. Your line is now open.

Thanks, guys, for taking my question. Steve, I wanted to come back to the guidance you gave sort of for the December quarter with the industrial business up and telecom and data center both down about 10%. I know you're not going to give guidance for March, but do you think that, you know, is the data center sort of a one, two-quarter thing, trajectory digestion? Do you think it's a fairly temporary pause? Just wondering, you know, Davis Telecom was probably a kind of end of the second quarter, fiscal second quarter, I assume, before you might see that recovery. But just wondering any thoughts on data center, how long that period of digestion might last?

So, yeah, It's a very difficult question to answer. And we certainly, for our largest customers, have very good visibility. And by the way, typically the lead times in the manufacturing, I should say the manufacturing times for these products is, you know, extends over one quarter. So we have to make certain assumptions about where we think the market will be before we start inventory. But I really can't answer your question. It's very difficult to say what might happen to the data center market and let's say in Q3 or Q2 or even Q4. So I want to sort of not answer that question right now. With that said, I think it's going to be a good year for the overall market. And we are, as I pointed out, picking up new customers in Asia. It's a new line of revenue. We are starting to ship our PAM4 DSP. So that's a new color of revenue there. And clearly there's an increasing demand for data due to COVID, and there's a secular tailwind that we're seeing and enjoying. So when we now layer on top of that some of the new products, including some of our 400G products that are in some instances best in class, when we start to introduce our lasers towards the back half of calendar 21, I think we're setting ourselves up for some good growth.

Okay, and the same question is just a follow-up on the lasers. Are most of the 5G front-haul lasers the FP lasers, or are you going to need the DFB lasers also for some of those front-haul applications? It sounded from your comments in the script that it was going to be a mix of both FP and DFB lasers and front-haul, but I just wanted to clarify that.

Well, I would say that you're going to need both, and in fact, the DFB lasers are more important because they handle, you know, they have better overall temperature performance. They're allowing you to run higher distances, and they're also, there's new requirements that have come out, you know, so CWDM-6 and MWDM-12, these really need to be DFB lasers, and so the work and the platform that we've established will allow us to be successful there. Remember that our 25GFP laser is a single wavelength laser for a very particular application. And so we'll be successful there. But I would say that on balance, the work that we're doing to create this platform is more important, and it opens up more of the market for us.

I'm not sure any further questions at this time. I would now like to turn the call back over to Steve Bailey for closing remarks.

Thank you. In closing, Jack and I would like to thank our employees for their extraordinary efforts and accomplishments throughout the past quarter and fiscal 2020. Thank you and good evening.

Please hang on when that doesn't call conference for today. Thank you for your participation. You may all disconnect.