MACOM Technology Solutions Holdings, Inc. (MTSI) Earnings Call Transcript & Summary

[Audio Gap] [Operator Instructions] 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 morning, and welcome to MACOM's conference call to discuss the financial results for our first fiscal quarter of 2021. 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 a 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's 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. And with that, I'll turn over the call to Steve 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 provide a more in-depth review of our first quarter results for fiscal year 2021. When Jack is finished, I will provide revenue and earnings guidance for the second quarter of FY '21 and then we will be happy to take some questions. Revenue for our first fiscal quarter was $148.5 million and adjusted EPS was $0.46 per diluted share. Our book-to-bill ratio was 1.1:1, and our turns business was approximately 15% of our total revenue. Overall, we are pleased with the continued improvements in our financial results, which are made possible by the tremendous work of our dedicated employees. Our Q1 revenue by end market was generally as expected and included Industrial & Defense at $61.6 million, Telecom at $51.5 million and Data Center at $35.4 million. Industrial & Defense was up 29% sequentially. Telecom was down 7% sequentially and Data Center was down 20% sequentially. As indicated by our positive book-to-bill ratio, the demand for our products has strengthened. As we look forward, we believe that our I&D business will continue to perform well, that our Telecom business will begin to benefit when China's telecom carriers resume their 5G build-outs and that our Data Center business will begin to steadily improve as cloud service providers and enterprise demand increases. Q1 was a positive start to our fiscal 2021, and we believe we are on plan to meet our financial and technical objectives. Our goals for the fiscal year include: at least 10% year-over-year revenue growth, expanding our product and technology portfolio to drive long-term growth, improving our sales strategies to win market share, focusing on engineering excellence and ramping new product introductions and optimizing the efficiency of our operations to improve profitability and cash flow. The semiconductor industry has recently seen a broad increase in demand. We believe this is causing higher-than-normal levels of utilization within some portions of our supply chain, particularly at external foundry partners as well as our assembly and test suppliers in Asia. We do not expect this temporary tightening to have an impact on our ability to service customers. Our operations team does an excellent job working with our key suppliers to ensure our goals are met. We manufacture a portion of our semiconductor product portfolio internally. In fact, we believe our wafer foundries in Massachusetts and Michigan provide us a competitive advantage. These facilities manufacture differentiated compound semiconductor process technologies that are at the foundation of some portions of our broad product portfolio. Our long-term strategic plan includes continuous development of compelling semiconductor process technology and installing best-in-class infrastructure at each of our fabs. This strategy enables differentiation, which ultimately supports the creation of unique products that can drive highly profitable growth. As part of our strategic review, we have concluded that a high-performance microwave and millimeter wave GaN on Silicon Carbide mimic process is a critical must-have technology. On Monday, we announced that MACOM has entered into a cooperative research and development agreement, or CRADA, with the United States Air Force's Research Laboratory, also known as AFRL. MACOM will collaborate with AFRL to transfer their production-ready 0.14 micron GaN on Silicon Carbide semiconductor process into our fab in Massachusetts. This production-ready process has exceptional performance, and as an example, the process achieves industry-leading power density. This technology is ideal for very high-frequency, very high-power amplifiers. We will use this process to develop unique products that target high-performance noncommodity applications. Specifically, this new capability will enable us to expand our product offerings to customers in the aerospace and defense, test and instrumentation and satellite communications industries. Based on customer engagements, competitive analysis, benchmarking and industry reports, we believe the demand for this technology is rapidly expanding. This effort is expected to be additive to our SAM and complementary to our existing RF, power and gas mimic growth strategies. Simply put, this effort establishes a new growth opportunity for MACOM based on a proven best-in-class millimeter wave GaN on Silicon Carbide mimic process. MACOM is already actively supporting this project, and we expect to launch our first products in calendar 2022. Now turning to more specifics in our 3 end markets in Q1. Our industrial and defense end market revenue was driven in part by strengthening demand from a variety of U.S. defense programs. Over the past few quarters, we have implemented new strategies to initiate growth, including increased cross-selling of all our technologies into the market, improving our sales channels, refocusing on key accounts and developing additional standard and custom products, which will appeal directly to current and potential customers. As a reminder, this market consists of a variety of end applications, including long-term U.S. defense programs, satellite communication applications, MILCOM and public safety handheld radio applications, test and measurement equipment and other industrial applications. We believe that it will take time to grow our business in I&D given the long design and cycles in these markets, but we are pleased to see the early signs of traction in Q1. Based on program wins and backlog, we see our Industrial & Defense business remaining strong over the course of fiscal year 2021. Longer term, we view this end market as having tremendous growth potential for MACOM. Our telecom end market revenue was down in Q1, driven by softness in 5G, and we expect weakness to remain throughout Q2. We anticipate our Telecom business will begin to improve when the China carriers begin their 2021 5G deployments. We believe we have a strong and expanding position in 5G with our high-performance analog ICs, front-end modules and emerging laser portfolio. While we still have limited visibility as to the exact timing of the resumption of China's 5G deployments, current indications are that tender activity will start to pick up in March or April after Chinese New Year. Nevertheless, we feel the long-term secular growth opportunity in 5G remains intact as worldwide demand for improved connectivity at higher data rates will continue to grow. We continue to view global 5G infrastructure deployments as a key growth driver for MACOM revenue in the coming years. MACOM is present across the 5G network with wireless RF products and antenna systems as well as high-performance analog products in fronthaul and mid-haul and coherent driver in TIAs in metro long-haul optical systems. Today, we are only delivering on a fraction of our potential, and we anticipate further expanding our current 5G portfolio with 25G FP and DFB lasers; 25G Avalanche Photodiodes, or APDs; and more discrete RF components; and more high-performance analog and mixed-signal ICs. Outside of 5G, certain portions of our telecom product portfolio performed well in Q1, including 2.5G PON products, telecom mimics and crosspoint switches, which address submarkets like cable TV and video broadcast. I will highlight that our 10G PON -- that 10G PON is an area of focus for MACOM engineering, and in the future, we expect to offer more products for this application. Our Data Center end market revenue was down in Q1 as our customers continued to consume inventory following a period of multiple quarters of strong sequential revenue growth. We expect future growth to be supported by our 100G high-performance analog products and our emerging 400G analog products. I'll note that our international data center growth has been driven by Asia-based data center expansion, where we sell both 25G and 100G analog products. I would next like to update investors on our Data Center growth strategy. I'll start by noting that we typically target short-reach applications inside the data center, ranging from 50 meters to 5 kilometers. These applications are generally the highest volume applications, and we find that customers are very supportive of evaluating MACOM's high-performance analog solutions. Example applications include 100G CWDM4 and 100G SR4. We believe CWDM4 and SR4 production volumes will continue to grow over the next 5 years. Some industry reports predict 2024 volumes will be 2 to 3x higher than today's volumes. Therefore, it is a priority to service these short-reach applications with current and new products. We also believe there is an opportunity to gain market share in CWDM4. Further, we note that short-reach 400G and 800G applications are now emerging and will grow over the next 5 years. To participate, we are working on next-generation analog solutions, which, when combined together, can support these higher data rates. We have tremendous high-performance analog CDR design capability. However, there are other product areas which are generating growth potential for MACOM in the data center. First, we will continue to develop advanced high-speed TIA and laser driver products. I'll note some customers have expertise in DSP and/or silicon photonics, and they seek to work with us to develop customized, best-in-class TIA and driver solutions as we are a merchant supplier with leading TIA and driver technology. Second, we are developing a broad portfolio of laser products, including 25G DFB lasers for use in PAM4 applications. In addition, we will offer low, medium and high-power CW lasers to customers who wish to use their own silicon photonics. Third, we will leverage our silicon photonic technology into the Data Center, first, for 400G DR1 and DR4, where today we have limited exposure. Our initial product launches will be photonic ICs. Fourth, we will continue to look for ways to gain market share, and we seek new applications inside the Data Center. As an example, we see customers considering to use -- considering use of copper cables in very, very short-reach applications, which might be a new opportunity for MACOM. And last, we will continue to ramp production on our existing 100G PAM4 DSP, which is targeting DR1 applications. We believe our lead customer will continue to increase production volumes over the next few years. Aside from that program, we will pursue new opportunities to gain market share with our existing PRISM DSP. In summary, given our unique technology portfolio and design capability, we believe we have tremendous growth opportunities inside and around the Data Center. Jack will now provide a more detailed review of our financial results.

Thank you, Steve. We had another sound quarter of financial performance for our first fiscal quarter of 2021, posting sequential improvement in revenue, margins and earnings per share. Revenue for our first quarter ended on January 1, 2021, was $148.5 million, up approximately 1% from our fiscal Q4. The sequential improvement in revenue was driven by strength in the industrial and defense end market, which more than offset anticipated declines in Data Center and Telecom. On a geographic basis, approximately 43% of our Q1 revenue was from domestic customers, sequentially up from 36% in Q4. Adjusted gross profit in fiscal Q1 was $85.4 million or 57.5% of revenue. Adjusted gross margin was up 110 basis points sequentially. The sequential improvement in gross margin was supported by ongoing continuous improvement initiatives that we have underway at MACOM. These include increased manufacturing efficiencies around production cycle times, utilization and scrap reduction as well as supply chain and logistics enhancements. We feel there will be additional opportunities for us to continue improving our gross margins as we move forward. Total adjusted operating expense was $47.6 million, consisting of R&D expense of $31.8 million and SG&A expense of $15.8 million. Operating expenses were down $1.2 million sequentially, primarily due to our ongoing company-wide focus on expense management. One area of focus for us has been the optimization of our worldwide office lease footprint. Over the last several quarters, we have continued to consolidate offices, implement subleases in space that was underutilized and also exit facilities that were no longer needed. The net result of these actions has been around a 10% reduction in square footage, which helps drive savings well beyond rent expense. These efforts are ongoing, and we are continuously looking for innovative ways to improve the efficiency of our facilities. This is just one example of the many internal initiatives we have in place. Our operations and administrative teams remain highly focused on the details of our operations to find ways to manage our discretionary spending. I would like to note that we do maintain a long-term perspective on our R&D spending, and we will carefully continue to balance the management of our discretionary spending with investments in new product development and other growth opportunities. Looking ahead to Q2, we expect operating expenses to increase modestly from Q1 levels. Adjusted operating income in fiscal Q1 was $37.8 million, up from $34.1 million in fiscal Q4. Adjusted operating margin was 25.4% for fiscal Q1, sequentially up from 23.2% in Q4. We are pleased to note that it's been more than 13 quarters since we have recorded adjusted operating margin in excess of 25% of revenue. We expect the combination of top line growth, improving gross margins and/or stable operating expenses to provide continued operating leverage over the remainder of fiscal 2021. Depreciation expense for fiscal Q1 was $6.2 million, and adjusted EBITDA was $44 million. We posted another increase in trailing 12-month adjusted EBITDA, which came in at approximately $148 million as compared to last 12-month EBITDA of $124 million for fiscal fourth quarter. Fiscal Q1 adjusted net interest expense was $4.2 million, roughly in line with fiscal Q4 2020. Looking ahead, depending on interest rates, we expect adjusted net interest expense to remain roughly at this level. Our adjusted income tax rate in fiscal Q1 was 5%, in line with our expectations, and resulted in an expense of approximately $1.7 million. We expect our adjusted income tax rate to stay at 5% for at least the remainder of fiscal 2021, and we expect to continue to have relatively low cash tax payments. Fiscal Q1 adjusted net income was $32.2 million compared to $27.6 million in fiscal Q4. Adjusted earnings per fully diluted share was $0.46, utilizing a share count of 69.8 million shares compared to $0.40 of adjusted earnings per share in fiscal Q4. Now moving on to cash flow and balance sheet items. I would like to note that in November, we issued approximately 850,000 shares of stock related to a cashless exercise of warrants. The warrants dated back to the time of our IPO in 2012 and were primarily held by Summit Partners. These warrants were scheduled to expire in December 2020. The warrants had historically been carried on our balance sheet as a liability at their fair value. Each quarter, we recorded increases and decreases in the value of the warrants on our GAAP income statement as noncash gains or losses below operating income. This was historically one of the larger items in our reconciliation of GAAP to non-GAAP financial metrics. Based on the accounting treatment of these warrants, the November transaction had no impact on our non-GAAP income statement, our cash flows and substantially no impact on our diluted share count. Fiscal Q1 was another strong quarter for cash flow. Q1 cash flow from operations was $34.8 million, driven primarily by the improvements in operating profit. Cash flow from operations represented just over 100% of our adjusted net income. Directionally speaking, over time, as we go forward, we believe cash flow from operations should run at a comparable amount of our adjusted non-GAAP net income. Capital expenditures totaled $2.9 million for fiscal Q1, and free cash flow was $31.9 million for the first fiscal quarter. We do anticipate higher quarterly capital expenditures during the remainder of our fiscal year as we continue to make investments in our R&D and fab infrastructure, inclusive of the 0.14 micron GaN on Silicon Carbide program Steve noted earlier. Our Q1 accounts receivable balance was $55.2 million, up from $45.9 million in Q4. As a result, days sales outstanding were 34 days. I would note that we had an exceptional quarter for collections in fiscal Q4. And while our Q1 accounts receivable balance was up around $9 million sequentially, our DSO has been improving over the past few quarters and in line with industry metrics. Inventories were $89 million at quarter end, down another $2.6 million sequentially. Inventory turns were 2.8x during the first fiscal quarter. 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 first fiscal quarter were $355 million, up $22 million from Q4. Our short-term investments are comprised of liquid, high-quality corporate bonds and commercial paper and are classified as held for sale. Long-term debt of $658 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. With the increases in our cash position and the improving -- improvements in trailing 12-month EBITDA, we exit the quarter with a net leverage ratio of around 2.8x. In summary, we would like to thank all of the hard-working MACOM employees who continue to help drive these operational and financial improvements. We believe that fiscal year 2021 is off to a solid start. As I've previously noted on numerous occasions, we 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 will now turn the discussion back over to Steve.

Thank you, Jack. MACOM expects revenue in Q2, ending April 2, 2021, to be in the range of $148 million to $152 million, which is approximately 18% year-over-year growth at the midpoint. Adjusted gross margin is expected to be in the range of 57% to 59%, and adjusted earnings per share is expected to be between $0.46 and $0.50 based on 70.2 million fully diluted shares. In Q2, when compared to Q1, we expect Industrial & Defense to grow around 10%, Data Center to be flat and Telecom to be down approximately 10%. In summary, we stand in front of a multibillion-dollar SAM with a unique technology portfolio. In any given quarter, we expect some end markets will experience periods of high growth and periods of low growth and possibly even negative growth, which is normal for our industry. For these reasons, our strategy is to establish a diverse portfolio of 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.

[Operator Instructions] And our first question coming from the line of Harsh Kumar with Piper Sandler.

First of all, huge congratulations, tremendous execution. And Steve, boy, you weren't kidding when you said you guys were focused on supply chain and operational enhancements. So a tremendous move there. I just had a couple of questions. So revenues are going up. Your largest end market, telecom is -- sorry, industrial and defense is starting to move. Your OpEx is coming down. You mentioned some real estate type benefits where you consolidated some facilities, but was there any operational stuff that was done relative to people or other measures in that?

Harsh, thank you for those comments. So no, nothing particular to call out regarding staffing levels. In fact, we're in the mode of hiring, and we would expect to continue to hire throughout the year. You are correct, though, to point out that we have been very focused on controlling costs. If we look at our overall OpEx from our fiscal '19 to fiscal '20, it came down about 20%. As we exited our fiscal '20, we feel that our OpEx level is at the right level, let's say. We're able to execute our R&D plans. We're looking at investing in new technologies, as we highlighted, with our GaN on Silicon Carbide project. And we are also, at the same time, very focused on running a more efficient business, and maybe Jack can comment on some of the programs in more detail.

Thanks, Steve. Harsh, as Steve noted, we do have a number of initiatives. In my prepared remarks, I did talk about some of the office lease initiatives that we have underway, but there's numerous items that we have that continue beyond operating expenses, and operating expenses comprises both R&D and SG&A. We are in that hiring mode that Steve had noted, but we're also in the mode of making sure we can focus on our operating expenses and reduce unnecessary costs where possible. There probably is some bit of a reduction that we've seen over the past year as a result of COVID, primarily on the travel front. But that's, I'd say, in the noise levels, but something that would be a headwind once we emerge from the COVID time.

Understood, guys. And for my follow-up, Steve, a question for you. One question that we get a lot from investors is, how do you size the new markets that you're going to enter in second half, call it, lasers and silicon photonics. So a, what is the size? And then what is your available opportunity within that? And then maybe you could update us on timing as well, and then I'll be done with my questions.

Sure. Well, first of all, I think it's very difficult to size the overall laser market because we are in 3 very different end markets, including access infrastructure, mobile fronthaul infrastructure and even backhaul infrastructure and then also the data center. And so depending on what you include in terms of the overall SAM for those 3 large markets, the number will vary quite a bit. So I would be hesitant to, first of all, size that SAM for you. And by the way, by extension, I would almost apply the same logic to silicon photonics. It really depends on what we include in those end markets. I will say, regarding the timing, I'll say a few words about each. We have made tremendous progress on our laser development. And if you remember, at CIOE, back in September, we actually demonstrated to the market a 25G DFB for very specific 5G applications, where we demonstrated that we had product that worked in CWDM6, MWDM12 and a variety of other standards. The reason why this is important is, as the fronthaul infrastructure is being developed in China, specifically, we see that the operators are using different wavelengths and different modulation schemes. And when you add up all the different wavelengths for all the different modulation schemes, you literally get dozens of wavelengths. And I'll highlight that some of these lasers are operating at different temperature ranges, including what they call itemp or etemp or gtemp. So it's a very complicated matrix. And the good news is since September, when we made those demonstrations, we went through a phase of sampling customers really over the past 6 months. We've had very positive feedback on the performance of our lasers. I would say that we are now moving into that phase where customers are more seriously looking at the product and going through a selection process. And we think that overall, we will have very favorable results as we get to -- we start to get qualifications. I can tell you that just generally speaking, in terms of 5G fronthaul modules, there's roughly 8 million to 10 million modules manufactured a year, and that's sort of based on 600,000 base stations. That number will change. We think over time, it will go up. And then if you look at how the operators are laying down their fiber, we'll see that some of those modules might have 6 different lasers in them or 12 different lasers in them, depending on the application. So all I -- to summarize, I would say that we are in a very good position right now. As we look at the back half of our year, we are tempering our expectation. We know that these qualifications take time. And so I would only recommend that investors recognize that we are setting ourselves up for success here, but we're keeping very modest expectations in the back half of our fiscal year. Regarding silicon photonics, the work there is primarily focused on launching our first products, which means we need to complete the development. We are focused on basically 400G applications. We do not believe we'll be launching a product this fiscal year, but we will be getting very close to completing the development work. So regarding expectations for revenue contributions in the back half of our fiscal year, I would say that you should take that out of your models. It's more of a fiscal '22 activity.

And our next question coming from the line of Tom O'Malley with Barclays.

Congratulations on the really nice results. My question was just around the shape of the fiscal year. You're seeing this I&D business now that's growing pretty strong double digits. You talked about 10% growth. I'm sure that's a soft target, I'm sure internal expectations are to outgrow that. But could you talk about what you're seeing in the second half that kind of gets you to that double-digit range? You keep seeing this growth on the I&D side, I mean, you get there pretty easily. Are you looking at Telecom and data com (sic) [ Data Center ] and expecting some weakness from one of those in the back half that kind of offsets? Any color around just the moving pieces into the back half would be really helpful.

Yes. Thank you. So we do expect our I&D business to continue to be strong this fiscal year. We're very confident of that. We are hedging our expectations for Data Center and Telecom for some of the reasons that I stated earlier on Telecom, specifically the -- sort of that unknown of what will be happening in China regarding the timing and the deployment and the number of base stations that are being built. I can tell you that our -- as I just talked about the lasers, we are actually improving our position in the market. So when things turn on, we think we'll benefit. So I would say that we are taking a very conservative look at the second half, and that's sort of why we're saying at least 10% revenue growth. We are setting ourselves up, like I said, for success. But there is uncertainty given the COVID overlay, given China dynamics and certainly what might be a fragile global economy. So we're proceeding with caution, and we hope to exceed everybody's expectations in the second half.

All right. That's helpful. My second one was a broader topic. You spoke in your prepared remarks about the R&D agreement with the United States Air Force Laboratory, and I think you mentioned that it's additive to the SAM. Obviously, it seems like something you're really excited about. Can you talk about how additive that could be to the SAM? And what areas you could see growth?

Yes. So -- and I'm glad you asked that question because the millimeter wave GaN mimic process is very different than the discrete RF power products that we currently are building under the pure carbide brand. So this is a mimic process. It allows us to include capacitors, inductors, resistors and build a complete chip, which allows us to make a complete power amplifier as well as integrating switches and LNAs onto the same power amplifier chip. So we size this market today at north of $200 million when we look at the competitive landscape. We think that in 5 years that number will be over $350 million. And today, we have 0 market share. And so we are very excited to work with AFRL. This process fills the gap in our technology portfolio. AFRL has been working on this process for years, and they have effectively set the bar for power density and frequency performance. So we really look forward to implementing this process. I will say that we're taking the approach of a copy smart where we will literally pick up the modules and the methods and the formulas and drop them into our fab. In areas where we may not have the exact same equipment that the Air Force has, we will either go out and buy that equipment, some of which, by the way, is already on order or we will work with the Air Force to use the existing equipment that MACOM has in-house. So this is not a science project. This is a transfer of technology on a process that's known to have leading performance. And we will build a product line not only for the defense industry as a primary target, primarily airborne applications, phased array radars, most specifically. But we'll also target commercial applications, including some of the ones I mentioned in the script, test and measurement, satcom. This process lends itself very nicely to a Ku-band or 14 to 15 gigahertz products as well as Ka-band, which is in the 30-gigahertz range. So we're very excited about it. It is, as I pointed out, a 2-year project. We are -- we hit the ground running, and it is absolutely additive to our overall SAM.

And our next question coming from the line of Karl Ackerman with Cowen.

Two questions, if I may. Just maybe to follow-on that millimeter wave discussion. Any update on your GaN on Silicon partnership? And I guess what kind of -- what sort of customer feedback and design opportunities are you getting from your recently introduced GaN on Silicon Carbide amplifier line? I think your silicon carbide products previously would take until the end of this calendar year to ramp. But I guess I'm curious if design wins are ahead of your prior view 90 days ago. And I have a follow-up.

Yes. So the first part of your question was regarding the GaN on Silicon project with ST. I can tell you that, that project continues to proceed and is making progress. I can report that all of our equipment is in place at ST's Catania fab, and they are going through a series of DOEs to bring that equipment online and qualify it. Now that the equipment's online, they can also finish the development of the transistor cells that we need to make our products. And so they're making reasonable progress on that front as well. We would expect to receive the first devices from their process in about 6 months' time. And from that, we will begin to evaluate the competitiveness of those transistors and look at how they -- how those transistors perform inside of very specific applications. In terms of your question on GaN on Silicon Carbide under our pure carbide product line, as you know, we have 5 products, most specifically, products that are targeting what we call multi markets. So these are generally 50-watt all the way up to a 2.6-kilowatt product. So they're targeting industrial and defense, test and measurement type of applications. Since we launched this product line, we have won over $2 million of development or, I'll call, special project business from customers in the defense industry. So they're very excited. They like what they see. We're doing some novel things regarding achieving high power levels. And so I can tell you that our sales force is extremely excited to have these products and they're off running. So we're excited about the early successes, but I'll also caveat those comments that these markets are also slow moving. And so it's about planting lots of seeds and lots of different applications so we can build up the revenue. But I would say that the team is on track. We have another wave of products that are in development, that we're targeting for release before June of this year. And so the team is very focused on executing that new product introduction plan.

No. I appreciate that. For my follow-up, clearly, you've seen the consolidation in the optical space as an acknowledgment of how important this will be on a go-forward basis for -- across data center and telecom markets. And I appreciate the demand update in your optical business in your prepared commentary. But could you discuss in a bit more detail the opportunity you see from 400 gig? I ask because the bare debate for quite some time has been the analog-based optical products are challenged as line speeds grow to 400 gig. But in December, even December, you introduced several products for 400 gig and even 800 gig. So your longer-term opportunity in optical would be great.

Yes. Thank you for that. And so I think you're right, as you move higher in the data rates, it certainly does get harder for the analog solution to be successful. Just to remind everybody, so part of our core business is supporting 100G analog solutions, which represent 25 gig per lane and these lanes run in parallel when combined for 100. We're now doing the same thing to support 200G applications with 50 gig per lane. We will continue that effort in that scaling, and we'll have 100G per lane solutions that support 400G. The 400G DR4 market is a very large market, and we think we can be successful there. I can tell you that our focus is primarily with effectively quad channel TIAs as well as optical drivers, multichannel optical drivers. And so that is really where we see ourselves being very, very competitive. We are a merchant supplier, and we see there are companies that have their own DSPs that want to look to MACOM to support them, not only for, I'll say, 100G DR1, but also 400G DR4. So our focus is continuing to be successful with the TIA in the drivers. We will also and we are working on what I would consider a complete analog solution, which includes the clock and data recovery. That may be more challenging for us to be successful there, but it is a work that we're -- it's on our road map, and it's work that we're doing today. So that's really the focus for the company. And then, of course, when we overlay lasers and we overlay silicon photonics, you're going to get a bump in revenue due to that -- those new technologies adding content to our business.

And our next question coming from the line of Tore Svanberg with Stifel.

Congratulations on the results. Steve, back to the AFRL announcement you had earlier this week, where was that process already today? And my understanding, your fab in Massachusetts is pretty full. So what type of CapEx commitments do you have to do in order to get that project up and running?

Right. So that -- well, so that process was developed at Wright-Patterson's Air Force Base in Ohio, and that's the prime -- in their labs, let's just say, where they have a -- there in some other locations, they have semiconductor capability and development capability. And so our plan is, as I pointed out, is to move that technology directly into our fab. In terms of your comment regarding the fab being full, I would say that our fab is highly utilized, but we have tremendous leverage. We run a sort of a medium-volume, high-mix business. And this technology fits perfectly into that model because we are targeting very high-end applications. We're not talking about tens of thousands of wafers. We're talking about hundreds or thousands of wafers, which is very manageable for our business. So we don't see that we're going to have capacity constraints. And to the point that we see that coming, of course, we add staff, and at the various pinch points, we'll add additional equipment. In terms of the overall capital expenditure, so I would say that we can complete this transfer for -- and spend between $2 million to $3 million of capital in total over the course of 2 years.

Well, that's great news. My follow-up question is on Data Center. So you did talk a little bit about when you expect Telecom to perhaps start improving. But any visibility on Data Center other than you guiding it to be flat sequentially this coming quarter?

Tore, it's very difficult for us to really look out to Q3 and Q4. So I would not necessarily want to comment on what might happen in the back half of the year. I will say that we expect both Industrial & Defense and Data Center business to experience high double-digit growth this fiscal year when we look year-over-year. So we would expect the Data Center to grow by at least 20% or more year-over-year. There are new design wins, as we talked about on our last conference call, in Asia. That good work continues, and we're picking up market share in Asia for our 25G and 100G products. And so we think there's lots of interesting opportunities. We're also going after different areas within the Data Center. As I highlighted in my comments, we're looking seriously at working with customers that are developing solutions using copper cables, which are very, very short-reach connections within the data center. And so that's an area of interest for MACOM, and I'm confident we can be successful there.

And our next question coming from the line of Quinn Bolton with Needham.

Guys, let me offer my congratulations on the great margins. Steve, just wanted to come back to the AFRL agreement. I'm wondering, is that exclusive? Or would they have the rights to license that process to other folks in the mimic industry with whom you compete?

So I can't get into the specific details of the agreement, so -- difficult for me to comment there. I will say that, ultimately, AFRL's goal is to have this technology industrialized. So to the extent that they want to work with other wafer foundries or defense contractors that have their own fabs, they'll do that. And so that -- it's hard for me to say or comment on what they might do or what they've done in the past. I can tell you that they are very focused on seeing MACOM be successful. This is good for them. It's good for us. It will be good for a variety of U.S. defense programs when we kick into production. There are very limited companies here in the U.S. that have this capability. And so we will be part of the select few. And MACOM has a very strong manufacturing muscle. And when we put our minds to moving things into high volume production, we can do it very successfully. So the Air Force is very excited about that as are we. One other point I'll highlight. Every year with our employees, we create a top 10 priority list, and this is right up there on that list.

Great. And then the second question is just kind of looking forward to calendar '21 and the next round of 5G tenders. If 600,000 base stations drive something like 8 million to 10 million fronthaul modules, I guess my question is, do you tend to see the module vendors beginning to build or pre-stock inventory ahead of the tenders? Or do you think that a lot of that manufacturing build only happens once those tenders are released?

Some -- we do see some customers getting in front of it, and they do start production ahead of those tender releases. We have seen some movement of our channel inventory in the last, I'll say, 4 weeks, and it's probably addressing the exact point you're making.

Got it. So it sounds like the leading indicators are pretty good that, that activity is picking up, even though we don't have exact timing on the tenders.

Correct.

And our next question coming from the line of Chris Caso with Raymond James.

I guess the first question is regarding some of the commentary regarding some of the tight supply we've seen in the industry, particularly at some of the foundries and back-end vendors. I guess, firstly, for your internal capacity, if you could give us some more color about where utilization is right now. And it sounds like you're comfortable in your ability to meet that supply from internal. Some more color there. And then with regard to some of the outsourcing, what we've heard from some others is some price increases at some of those outsources in order to secure supply. Are you seeing that as well? And are you able to pass some of those cost increases, if that's the case, on to your customers?

Great. So thank you for the questions. And our fab here in Massachusetts runs 7 days a week, 24 hours a day. We're always busy. I can't really comment specifically on the actual utilization. That varies from period to period. I would say that we are not constrained by our ability to meet our goals. And to the extent that we need to hire more people or add more equipment, we'll certainly do that. Clearly, from our operating margins achieving sort of a 13-year high, you can see that we're running very efficiently right now, and we do expect that to continue. Regarding the industry and our -- some of our wafer foundry partners, we do typically have long-term agreements, including price agreements. I can't really comment specifically what any of our fab partners are doing with pricing to us directly. As -- generally speaking, though, whether it's a fab or a component or a package, if we see that our suppliers are raising prices, we will go through a calculus to determine whether it's appropriate to pass that cost on to customers or not. In some markets, that's easily done. In other markets, it's just not acceptable. So there's a bit of a balancing act there. But I would say, generally speaking, we're not concerned about the supply chain. As I highlighted, our operations, our planners, our team in purchasing does just a phenomenal job. And the results clearly show, as we've been driving margins up -- gross margins up, they've had a big hand in some of that work. So I congratulate them there. This is not on our top worry list. We worry about getting our products into the market as fast as we can and making sure that those products are extremely competitive, and that's our focus.

And just to build on that, our teams are constantly moving through continuous improvement initiatives to help offset some of those price increases to the extent that we can. And then just one other point of clarification. I think Steve had mentioned our operating margins were at a 13-year high. I think it was a 13-month high in my prepared remarks -- 13-quarter high on that front, not 13 years. Thanks.

That's very helpful. As a follow-up, if I could just drill into a little bit about some of the conservatism you expressed, particularly in Data Center, for the second half of the fiscal year. And based on 20% year-on-year growth, but I guess that's not a lot of growth on a quarterly basis for these levels that you're talking about. But there's still some digestion at your customers, meaning they'd be burning off inventory. So -- and I guess, is this a question of that inventory needs more time to burn off? If it's just general uncertainty and you're just being very conservative on it? If you could just explain that a bit more for me.

Yes. I think a lot of what you said applies, right, to our view in giving guidance. And as you know, we're in different parts of the data center. We're in short reach -- high-volume 25G short-reach applications. We're in 100G SR4 applications. We're now getting designed into 400G PAM4 applications. And each one of these programs is running at a different rate at different customers for different reasons. So we have -- I have seen and we've experienced, certainly in the last 18 months, a lot of different dynamics even within the Data Center. We had a tremendous Q4 in the last fiscal year driven by the Data Center. It was about $44 million of revenue. And so if you take that quarter out and you look at how we've been ramping for the last 4 or 5 quarters, you do actually see incremental growth, where our Q1 results were actually better than last year's Q3 results. So we do like the steady progress. We are diversifying the revenue stream, which I think is very important. But it's just very difficult for us to comment on what might happen in the back half of the year given the uncertainty.

Our next question coming from the line of Ruben Roy with Benchmark.

Steve, I just wanted to follow up on the previous question on the supply commentary. Certainly sounds like you're happy with sort of where you are from a supply perspective. But just -- I want to understand, in terms of any bottlenecks out there that other suppliers might be having, are you hearing anything from your customers on potential pauses of builds because certain components rather passives or otherwise, are not widely available at this point? Or do you think that everything is kind of flowing smoothly throughout the supply chain?

Yes. So I'm not aware of any specific bottlenecks that are -- where our customers are having component shortages that's preventing them to ramp and purchase MACOM products. I will say -- with that said, I will say that the automotive industry has experienced some issues, and we do have a few parts designed into some platforms and there's maybe been a small impact on that -- on those volumes. But I would also say that there's other dynamics in the market, including COVID in general and demand within some of these end markets. So it's difficult for us to connect all the dots. But I would say, generally speaking, we do not have supply issues with our main customers -- sorry, main suppliers. It's -- our team is doing a great job managing anything that comes up, and it's just not an issue for this fiscal year.

Got it. And just a quick follow-up for Jack. Great margin performance again. And with the guidance for the March quarter, obviously, some product mix and end market segment mix going on. Can you give us a little bit of an idea now with some of the detail that you've given us around Data Center and telco, and obviously with the infrastructure and defense (sic) [ Industrial & Defense ] continuing to be strong, how to think about gross margin as you kind of flow through the year -- fiscal year?

Yes. Thanks, Ruben. Yes, we've been pleased with our gross margin improvements. And as I mentioned, there's a number of things that we have underway. We have not disclosed any longer-term target model that's out there. We have been in the high 50s going back over time. We're starting to bump up against that now, which is a credit to the teams and all the work that they've been doing. But we still believe there's more for us to do internally to help try and improve those margins going forward. And with the guide going into Q2, we've taken that up to the 57% to 59% range, which was a step-up from our guide last quarter.

And our next question coming from the line of C.J. Muse with Evercore ISI.

This is Kevin Feeney on for C.J. So there's kind of been an increased focus on U.S. national and domestic semiconductor manufacturing in recent months, including additional semis provisions in the most recent NDAA. So does MACOM stand to potentially benefit on the shift from either additional contracts on the more positive stance toward U.S. semis or increased subsidies for either R&D or manufacturing beyond the announced U.S. Air Force contract?

Yes. I think it's a very important topic that you've raised, and we will certainly be canvassing various agencies for funding to modernize and expand and improve to the extent that there's grant money, we want to be sitting at the table with our hand out. So yes, that is absolutely something that we are focused on. I can tell you that our fab here in Massachusetts is already considered a U.S. trusted foundry, which makes it a preferred fab to run DoD business in. And so we will certainly pursue those avenues for grant money or contracts or support. I will say that those are very difficult to win. It's a multiyear program. So even if we started today, I wouldn't expect any major awards for modernization for a year or 2. These things generally take time to come to fruition.

Okay. Great. And lots of discussion on Data Center and Telecom, but Industrial, I think, overall, is kind of expected to see a strong cyclical recovery in '21, and I think you're already starting to show pretty good growth there. So how are you positioned to kind of take advantage of potential upside here on core Industrial, whether that be underlying demand or share gains as we go through '21?

Thank you. I think we are getting stronger and stronger, and we're continuing to improve the product line to make our products more competitive. We have a focus on cross-selling a lot of our technologies into the industrial market. That includes our optical capability, our high-speed analog and certainly our RF and microwave. We see that this is a sort of a target-rich environment for the technology that we have. We are making sure that all of our engineering organizations are spending more than their fair share of time in the industrial markets. And so that's something that's a little different than what MACOM has really done in the past. And as you highlighted, today, Industrial & Defense is about 40% of our overall revenue, and it is probably our largest segment and could be our -- continue to be our largest segment as we go forward. So we do expect long-term growth from that end market. There are a numerous number of end submarkets within that industrial and defense headline name, and we are absolutely focused on growing this part of our business.

And our next question coming from the line of Harlan Sur with JPMorgan.

Congratulations on the solid results and execution. As you guys mentioned, we're starting to see 400-gig optical deployments in cloud and hyperscale. I think Amazon was the first to pull the trigger last year, and you've got a lot more of the cloud-type units transitioning this year. I know I think you guys are targeting this market, right, with your amplifiers, your 56-gigabaud laser drivers. But I feel like you guys also have the opportunity to potentially intercept this emerging opportunity with a 56-gigabaud laser. I think you already have a 56-gigabaud laser that supports your 100-gig single lambda PRISM solution. So can you guys just be purposed the laser for, let's say, 400-gig DR4 module configurations? And just what's the plan of attack here for this particular opportunity?

Right. So you are correct that we can use our laser technology for applications at 400G, and so -- and we will absolutely do that. We've talked a lot publicly about our 25G laser. I can tell you that we have versions of our 25G lasers that are working at 50G PAM4. And so obviously, the next step will be 100G PAM4, but we'll have to see if we're able to do that. But I will -- the short answer is, yes, we will address that market, whether it's a DFB laser or a CW laser. We do see a lot of our customers that are working at 400G moving towards silicon photonics, and they'll use a Mach-Zehnder modulator, and they'll require a CW laser. And so I think in my prepared remarks, I talked a little bit about that, and it's an area of focus for us.

You guys continue to do a good job of building out the catalog portfolio. It sounds like you've got good traction with the pure carbide line of GaN amplifiers. Do you guys manufacture these GaN PAs in Lowell or Ann Arbor? Or are these with your outsourced manufacturing partners? And then if you could just give us a quick update on 10-gig connectivity trials, qualifications, early deployment time lines?

Sure. And maybe I'll take the second question first. GPON is going well. We are seeing -- and by the way, I'll highlight at -- sort of at the -- our base business is 2.5G PON, where we think that total market size for lasers, for example, would be about 80 million lasers a year. We estimate we have about 50% market share, and that's growing. As we look at 10G PON, what I've talked about in the past that we look to expand our product line to include more products, we think, potentially up to 5 different products, including different types of lasers as well as APDs or photodetectors and basically burst mode TIAs. So very -- and lasers, as I mentioned. So we are beginning to see higher volumes. We think our 10G laser -- sorry, our 10G overall revenue year-over-year will grow by at least 50%, maybe closer to 100%. So we are seeing an uptick in volumes. And we think the back half of this year and going into next fiscal year, those volumes will increase. Regarding your comment or your question on our GaN portfolio. So it really depends on what parts of the portfolio you're referring to. The GaN on Silicon, today, we have licensed to a third-party to manufacture for us. In the case of our other power devices, we have not commented publicly on where that -- those products are being manufactured.

And our next question coming from the line of Richard Shannon with Craig-Hallum.

I think, Steve, my first question is on data center. You've talked about for a few quarters about seeing some success in international markets. As we look forward here, I think your comments earlier on the call about potentially seeing 20% growth in Data Center, how should we think about the relative dynamics between domestic and international growth? And is domestic going to grow? And what are the dynamics driving success in the international markets here recently?

So I would say that today, the vast majority of our business is U.S.-centric, and we're just beginning to tap into the Asia market. And -- so that's the first comment I would make. The dynamics around the international market are primarily 25G and 100G analog solutions. We are seeing market share gains on CWDM4, which is very exciting for us because that's a very large market. And we have the right products, and we are beginning to form very solid relationships with our target customers in Asia. So generally speaking, the dynamics for the market, we've talked a lot about today about the uncertainty and the timing of various programs. I probably don't have any other comments on what I've already said on that point.

Okay. Fair enough. My quick follow-up question on gross margins. Jack, I think you talked largely about efficiencies. Any dynamics here regarding mix, either backward-looking or specifically forward looking? I think your industrial and defense markets typically are fairly rich and you're growing there, but you didn't identify mix as a driver there. How should we think about those dynamics as we look at your gross margins going forward?

Yes. Thanks, Richard. The -- we do have a very diverse portfolio of products with some of them manufactured internally and others that are fabbed outside of MACOM. So that mix item can come into play on numerous occasions. In terms of looking at our individual end markets and specific margins there, we haven't broken that out historically, and it can vary from period-to-period depending on what we have going through. But I don't think there's anything too discernible looking back in terms of having a major impact on our margins. And going forward, we've got initiatives that are happening not only within our manufacturing locations, but our operations teams are also working with folks on the outside to see what we can do to become more efficient as we go forward from a margin point of view. So there's a lot of things going on internally within MACOM as well as externally to make sure we stay focused on our margins.

I'm not showing any further questions. I would now like to turn the call back over to Mr. Steve Daly for closing remarks.

Thank you. In closing, we would like to acknowledge our customers, suppliers and our hard-working employees for making all these results possible. Have a nice day.

Ladies and gentlemen, that concludes our conference call today. Thank you for your participation. You may all disconnect.