MACOM Technology Solutions Holdings, Inc. (MTSI) Q4 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to MACOM's Fourth Fiscal Quarter 2020 Conference Call. This conference call is being recorded today, Thursday, November 5, 2020. [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 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 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. With that, I'll turn over the call to Steve Daly, 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 FY '21 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 $0.40 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 8, 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 3 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 helped 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 discipline. 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 lightwave solutions. Today, MACOM is present across the 5G network with product content in the antenna systems as well as in front haul, midhaul 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 6 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 road maps are aligned with their future needs. Road map 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 in Ann Arbor, Michigan wafer foundries. This is critical for our long-term industrial and defense end market growth. We have revamped our process technology road maps 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 make -- is to take market share with best-in-class lasers and photodetectors 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 in each one of our engineering organizations, now has detailed product road maps 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 10G PON market. Today, MACOM is a leading supplier of 2.5G PON lasers. Historically, we have supplied 2 GPON products in volume production: lasers and laser drivers. As 10G PON emerges and ramps up, we expect to provide up to 5 products across 4 product families, namely: high- and low-power lasers; laser drivers; transimpedance amplifiers; and photodetectors. 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 & 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 1.1:1. I'll also note, in FY '20, we had periods of exceptional bookings driven by healthy underlying demand across our end markets, augmented at times by long-lead time I&D 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 end 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 test and 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 6 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 in 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 2 flagship general purpose pure carbide GaN products last quarter. Since then, we have expanded our pure carbide GaN portfolio to a total of 5 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 multibillion-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 end 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 help 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%. 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 $0.40 in fiscal Q4, utilizing a share count of 69.3 million shares compared to $0.33 of adjusted earnings per share in fiscal Q3. For fiscal year 2020, adjusted net income was $67.1 million and adjusted EPS was $0.98 as compared to a net loss of $19.2 million and a loss of $0.29 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 year's United States tax return receivables. These cash receipts are considered onetime in nature and are not expected to recur in the future. Cash receipts are considered onetime 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 onetime 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, days 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 2.8x during the fourth fiscal quarter, which has 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 3.4x. 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. MACOM expects revenue in Q1 ending January 1, 2021, to be in the range of $146 million to $150 million, which is approximately 24% year-over-year growth at the midpoint. Adjusted gross margin is expected to be in the range of 56% to 58%. And adjusted earnings per share is expected to be between $0.41 and $0.45 based on 69.8 million fully diluted shares. In Q1, we expect Industrial & Defense revenues to grow approximately 20% sequentially, and Data Center and Telecom to be down approximately 10%. And 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 2 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.

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

Solid performance, congratulations. Just a set of impressive numbers. Steve, first question for you. Industrial & defense turning up. I think you said 20% sequentially. So I'm curious what is happening there, if some of that is onetime in nature? Or do you -- you've been counting on sort of the turn in industrial? Or is that turn 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 I&D end 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 3 to 4 years has been -- 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 on silicon carbide to this end market. So there's really a tremendous opportunity in this end market. And I would like to think that this level of growth will continue. I'll just caveat my comments with the fact that 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 I&D business will help that tremendously.

For my follow-up, Steve, when you say fiscal '21 will be a 10% grower, did you mean that -- and this is just to clarify again, do you mean that for the industrial business or do you mean for the overall company?

Yes. I was meaning year-over-year company growth.

Okay. And then for my follow-up, Steve, historically, in a couple of -- few years around December time frame, 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 the 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 that -- 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 fronthaul 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 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 their inventories, but also to react to the turn on when 5G begins, specifically fronthaul, where our customers are demanding fast delivery of products when they want to build their modules.

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

Yes, Tore Svanberg here. Congratulations on the strong quarter. Steve, you talked about in 10-gig PON, you're really adding some content. I believe you said from 2 products to 5. Is that just a result of the architecture? Or are you basically introducing new parts that would gain share? And when do you expect 10-gig in earnest to become more material?

Yes. So Tore, historically, we have serviced 2.5G PON, as I highlighted. And so as the newer next-generation systems are emerging, there's really 3 different versions that we're interested in, XG-PON, which is asymmetrical system that has 2.5 and 10G data rates, then XGS-PON, which is basically 10G both ways and then EPON. So we see -- and we've been developing products to support each of these really for the past year, 1.5 years. In terms -- 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 to fiber. So this is an area where customers are looking for a very cost-effective, 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 or [indiscernible] 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 million and 10 million ONUs, which are the user premise. And -- but we think in the out years and the peak years, that could be 30 million to 40 million units a year. So when you multiply that by 4 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, and we have direct customer access and engagement. So we're actually quite excited about the next-gen PON systems.

Yes. My follow-up is for Jack. Even when adjusting for the tax return, your operating cash flow 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's -- 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 -- sorry, we did have a very good cash generation quarter here. And the way we look at 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 1:1. 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 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 with Barclays.

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 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 our -- 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 end market has been growing for 5 sequential quarters. It is an area that -- it's a very interesting area for MACOM. I can tell you that the growth areas over the next 2 to 3 years will include not only the products, sort of next-generation products on the analog side, but we also have set our targets on supporting the data center with our next-generation lasers. And 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 2 quarters ago, our 25G FP 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 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 fronthaul, 5G fronthaul with. Now why is that part important? Because it validated our approach to move towards 25G DFB lasers. And this is -- 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 sue MWDM12 or DWDM 16 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 wavelength 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 wavelength 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 a very compelling product.

Great. That's really helpful color. My next one is 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 margin. And you're also kind of guiding to more industrial and 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 2 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, 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 have been taking place throughout the organization that have been contributing to that improving margin. We've talked about some of the scrap processes that we 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 I&D 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 as we look at this, looking longer term, we want to get back to some of those higher gross margins that we had, which were in the high 50s, going back a few years. And once we get to those higher levels, 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 of 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 and 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 fronthaul 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 and engineering is doing to develop chips that can demand higher prices. I'll also add to that, that our MMIC 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 command very high price points. And to do that, you have to rely on either proprietary processes, which we can do because we have 2 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 die 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 Karl Ackerman with closing column.

Two questions, if I may. Jack, one for you. How should we think about the -- 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 -- 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. Steve, would you like to add?

Yes. The only thing I'll add to that is, and I'll come back to our underlying theme, which is we plan to outgrow 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. So -- and all of those customers have been driven to 0. So we're not expecting any upside for any of those companies. So it really comes back to our ability to launch more products faster. And by the way, there may be, in 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, maybe there's an opportunity there. But the real growth story for MACOM is new products. And our 6 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 PAM4 100-gig DSP design, 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 road map that could perhaps increase your competitive capabilities and also substantiate your long-term value to that customer base?

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've communicated was that we would finish some of the projects that were in-flight and bring them over -- 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 a 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 400G 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 midhaul 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. 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 is coming from the line of C.J. Muse with Evercore.

I guess first question, Steve, you talked about wanting to grow more than 10% in fiscal '21. And just curious if you could send some light on where you see 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 3 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 I&D 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 Tom's gross margin question. You had been kind of suggesting, at least externally, maybe not internally, trying to hit 57% in the back half of fiscal '21. And here, we're seeing that 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?

Yes. Maybe we should try to answer that in 2 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 went through 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.

Yes. CJ, so obviously, going back to kind of that 57% number, that is at the midpoint of our guide going into Q1. So with the -- 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 2.

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

Jack, maybe we could just continue on that line of questioning. And maybe just to move down to the OpEx. You guys did a great job, and you talked about a lot of the strategic initiatives you're taking to manage expenses. In the context of looking out towards the 10%-plus growth into 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 expense. So 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've 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 we -- 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. You add on, sorry.

Yes, I'll just make -- 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 certainly earmarked a capital for our fabs. And that shouldn't scare people because in our -- we're not talking about tens or hundreds of millions of dollars. We're talking about this year, probably a capital investment for our low fab here in the range of $5 million 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 on capital employed. And that is absolutely something we'd 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.

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 4 or 5 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. 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? So -- 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 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 making slow progress bit by bit.

Your final question coming from the line of Quinn Bolton with Needham & Company.

Steve, wanted to come back to the guidance you gave 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 -- is the data center sort of a 1, 2 quarter period digestion? Do you think it's a fairly temporary pause? Just wondering, you gave us -- 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 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 -- extends over 1 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, 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.

Got it. And then second question, just a follow-up on the lasers. Are most of the 5G fronthaul lasers, the FP lasers? Or are you going to need the DFB lasers also for some of those fronthaul applications? It sounded from your comments in the script that it was going to be a mix of both FP and DFB lasers and fronthaul, 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 -- they have better overall temperature performance. They're allowing you to run higher distances. And there are also -- there's new requirements that have come out. So CWDM6 and MWDM12, 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 25G FP 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 showing any further questions at this time. I would now like to turn the call back over to Mr. Daly 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.

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