MACOM Technology Solutions Holdings Inc

NASDAQ:MTSI

Earnings Call Transcript 2021-Q2

[Operator]

Welcome to MACOM’s Second Quarter 2021 Conference Call. This call is being recorded today April 29, 2021. [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.

[Steve Ferranti]

Thank you, Olivia. Good morning, everyone and welcome to MACOM’s conference call to discuss its second fiscal quarter of 2021 financial results. 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.

[Steve Daly, President and Chief Executive Officer]

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 second quarter results for fiscal year 2021. When Jack is finished, I will provide revenue and earnings guidance for the third quarter of FY2021 and then we will be happy to take some questions.

Revenue for our second fiscal quarter was $150.6 million and adjusted EPS was $0.51 per diluted share. Q2 results represent record high adjusted gross margin and adjusted operating margin since MACOM went public nine years ago. I would like to thank and congratulate our dedicated employees for their efforts to make this achievement possible. We remain focused on executing our strategic plan, which emphasizes profitability and investing in compelling R&D projects in order to win market share.

Before discussing the second quarter in detail, I would like to highlight on March 22, we announced we would use $100 million of cash on hand to pay down a portion of our long-term debt. In addition, we announced a convertible notes transaction to restructure a portion of the remaining debt. We believe these two actions reduce our balance sheet risk and create shareholder value by saving the company approximately $11 million in interest payments per year. In a few moments Jack will review in detail these transactions.

Our Q2 revenue by end market was generally as we expected and included industrial and defense at $72.1 million, telecom at $42.3 million and data center at $36.3 million. I&D was up 17% sequentially, telecom was down 18% sequentially and data center was up 2% sequentially. Our book-to-bill ratio was 1.1:1 and our turns business was approximately 16% of our total revenue. Overall, we are pleased with our Q2 bookings and the gains we are making in the market. This was a solid quarter and we believe we are on plan to meet our near-term financial and technical objectives.

Now turning to more specifics in our three end markets. Our industrial and defense end market revenue was up in Q2 driven in part by strong demand from a variety of industrial applications and U.S. defense radar programs. Over the past year, we have implemented new strategies to initiate growth, including increasing cross-selling of our technologies into industrial and defense markets, improving our sales channels, refocusing on key accounts and developing additional standard and custom products, which will appeal directly to current and potential customers. These efforts are supporting some of our recent I&D growth.

Our telecom end market revenue was down in Q2 driven by softness in 5G deployments in China. We anticipate our telecom business will begin to improve when the Chinese carriers begin to launch additional 5G infrastructure. However, today we have limited visibility as to the exact timing. We feel the secular growth opportunity in 5G remains intact as worldwide demand for improved connectivity at higher data rates is growing. We also expect revenue growth from PON, CATV and satcom in the next few quarters, primarily driven by strengthening markets, new product introduction and market share gains.

Our data center end market revenue was up slightly in Q2 driven by both domestic and international business. We expect our emerging 400G products to perform well in the coming quarters, although this growth may be tempered by flat or reduced 100G volumes.

There are four technology areas that I would like to highlight today. First, I am pleased to announce we have developed a semiconductor process to support the introduction of a new high voltage capacitor product line branded as MACOM KV CAPS. Over the past 18 months, our device and process engineers have been collaborating to produce the industry’s highest voltage silicon capacitors. The team has achieved industry leading 1800 volt standoff performance, which opens up new markets and new opportunities for MACOM.

This new process utilizes several, one of a kind proprietary MACOM technologies and it builds upon our unique knowledge in creating deep trench via structures in very conductive silicon substrates. Our breakthrough here was to successfully develop a high quality dielectric material that can withstand extremely high voltages and then combine it with other proprietary processes to maximize voltage performance. Capacitors are ubiquitous at electronic systems. Our business strategy is to target non-commodity systems where customers will pay a premium for a semiconductor solution with superior stability, reliability, chip scale size and high voltage operation. This includes radar systems, medical systems, automotive, renewable energy and various industrial applications. We estimate that this product line will expand our SAM by at least $100 million. And we believe MACOM KV CAP products fit perfectly into our strategy to target performance driven markets with unique high-performance discrete devices.

Second, I am pleased to report in Q2 we were selected to be a pallet amplifier supplier to a new U.S. defense radar program. In late 2020, we provided our customer with qualification hardware and after a technical review and competitive bidding process, our solution was selected due to its superior performance. This win validates our ability to field best-in-class RF and microwave, high power amplifier pallet sub-assemblies and at the multi-100 watt power level. The current pilot production volume is limited. However, this program and others like it represent a large growth opportunity.

And third, I am pleased to announce we have nearly finished our 25G DFB laser Telcordia qualification, which includes the completion of a 5,000 hour high temperature operating life test. We are pleased with the results to date and we believe our customers will be satisfied with our products performance and reliability. We are targeting 5G optical infrastructure as a priority and then we will focus on the data center. We expect that a formal product launch and introduction will come in the next few months.

And fourth, we are making excellent progress with the new 10G PON product development. We have completed development and our sampling laser drivers for 10G EPON, XG-PON and XGS-PON for both ONU and OLT applications. We have also released photo detectors for 10G ONU and OLT applications. We are finalizing the design of our new 1270 nanometer high power 10G DFB laser for XGS-PON. And finally, we continue to make progress on improving the burst mode TIA performance, allowing us to take market share.

In June MACOM will attend the International Microwave Symposium or IMS in Atlanta, Georgia, and the virtual optical networks and communication conference or OFC. We are excited to host a series of virtual product demonstrations and educational MACOM tech talks for each event to share information on topics, which we believe our customers will find valuable. The planned product demonstrations can contain some of our newest products and will provide insight into the technology, products and applications, which we believe will drive our future revenue growth. I’ll also note that these demonstrations exemplified the breadth of our RF, microwave, analog and mixed signal, digital and optical design capabilities.

Our IMS demonstrations can be organized into three categories high performance discretes, RF power and millimeter wave. Our two discrete component demonstrations include a demo of MACOM’s KV CAP’s product line being used in a simulated medical application and a high-performance 200 watt force throw switch and driver for military applications. Our four RF power amplifier demonstrations use our MACOM pure carbide GaN on Silicon Carbide technology. We will demo high power GaN showcasing a 3 kilowatt power level from a single device. We will also demonstrate high efficiency, GaN showcasing high efficiency performance between 3.1 and 3.5 gigahertz with the 100 watt power amplifier. We will also showcase ultra wide band GaN using our 25 watt pure carbide matched amplifier. And last, we will showcase a 5G massive MIMO GaN solution showcasing 400 megahertz, 110 watt Doherty amplifier performance in a DPD system.

And last, 2 millimeter wave demonstrations, including a 5G 28 gigahertz transceiver front-end module and a demo which highlights how to power combined to high performance KA band mimic power amplifiers to achieve over 10 watts of power. At OFC, we have multiple demonstrations planned and I’ll highlight two today. The first is a demonstration of a two chip analog solution for short reach data center applications. Here, we will be demonstrating our new two chip fully analog solution for 200G and 400G QSFP module and AOC applications. Chip number one is a PAM-4 CDR and TIA. And chip number two is a PAM-4 CDR in VCSEL driver. The chip set will demonstrate IEEE standard compliant, bitter array, and Open Eye MSA transmit compliance, and also be interoperable within Ethernet switch.

The second is a demonstration of our new 50G reference designed for 5G wireless mid haul applications. This demonstration will feature a complete 50G PAM-4 QSFP28 reference designed using all MACOM components. The demo platform is a 20 kilometer optical link with single mode fiber using 1310 nanometer wavelength. Our reference design showcases MACOM’s new PRISM 50D DSP with integrated DML driver, a 26 gigabaud 1310 ITEMP laser, , a 26 gigabaud PIN photodiode, and a 26 gigabaud PAM-4 TIA.

I’d next like to highlight that while MACOM has a large and diversified product portfolio, and we continue to invest in many new and existing product lines drive future growth. We also have a few product lines where we make minimal investment and as such, we expect in time that demand for certain of these product lines will ramp down. Two legacy product lines in our connectivity business are nearing the end of their product life cycles due to protocol upgrades or changes. We expect revenue from these product lines to decline in FY2022 by approximately $15 million when compared to the levels in FY2021.

We view these periodic events as normal product life cycle management. We are confident that our growth strategies and new products, including some of the products, which I discussed today will more than offset these anticipated declines. Our key growth driver is compelling new products, which is why we have been prioritizing improving the quality and the pace of new product introductions. In fiscal 2020, we released a record number of new products. Now I am pleased to report, we are on pace to release at least 15% more new products in fiscal 2021.

Jack will now provide a more detailed review of our financial results.

[Jack Kober, Chief Financial Officer]

Thank you, Steve, and good morning, everyone. We had record financial performance for our second fiscal quarter ended April 2, 2021, achieving gross margin of 59.2% and adjusted operating margin of 27.8%. In addition, we delivered sequential growth in revenue and earnings per share.

Before reviewing the details of our Q2 financials, I want to note that we recently completed a few strategic financial transactions initiated during the quarter, which I will summarize. First, on March 22, we announced a $100 million principal pay down of our term loans utilizing available short-term investments in cash. We view this as an important step toward delevering our balance sheet, and one that is consistent with our long-term goal of reducing our debt and associated leverage ratios. Our ability to pay down principal on the term loan is the direct result of MACOM’s improving financial performance and cash generation over the past 18 months.

Second, we took advantage of historically favorable conditions and entered into a convertible note arrangement, which has provided us with $450 million at interest rate of 0.25%. The convertible notes are due in March 2026 and have a conversion premium of 40% over our March 22 closing stock price, which is a conversion price of $82.12. We issued $400 million of the convertible notes at the end of fiscal March with the additional $50 million green shoe amount being executed in early fiscal April.

We used all the net proceeds from the convert issuance to pay down our term loan principal. And there were no penalties associated with prepaying the term loans before their May 2024 due date. With these combined actions, we reduced overall outstanding debt by $100 million. We reduced our interest rate on $450 million of debt from approximately 2.4% to 0.25%. We expect to save around $11 million in annual interest expense at current rates. And we extended the weighted average maturity date on our debt structure. I’d like to thank the Barclays banking team for their support, with our execution of the convertible note transaction.

Now onto the Q2 financials, revenue for the second quarter was $150.6 million, up slightly versus the prior quarter. The sequential improvement in revenue was driven primarily by growth in the industrial and defense end market, along with modest improvement in the data center market, which is offset by the anticipated decline in the telecom end market. On a geographic basis, approximately 48% of our Q2 revenue was from domestic customers, sequentially up from 43% in Q1. Revenue from international customers was 52% of our Q2 revenue.

As we highlighted on prior earnings calls, the semiconductor industry has seen a broad increase in demand. This is causing higher than normal levels of utilization within some portions of our supply chain. We see this, especially at some of our external foundry partners, as well as some of our assembly and test suppliers in Asia. We do not expect this temporary tightening to have a long-term impact on our ability to service customers. Although in Q3, we expect to have some delayed shipments. These delayed shipments have been factored into our Q3 guidance. Our operations team has its excellent relationships with our suppliers and has done an outstanding job to help ensure our goals are met.

Adjusted gross profit in fiscal Q2 was $89.2 million or 59.2% of revenue, up 170 basis points sequentially. Our record gross margin in the quarter is a reflection of our drive toward operational excellence and continuous efficiencies in all aspects of our manufacturing and operations activities. Many of the drivers that have been contributing to gross margin expansion over the last few quarters remain in place today. These include continuous improvement activities associated with supply chain and logistics enhancements, increased manufacturing efficiencies, scrap reduction and optimizing the utilization of our assets. As I have noted in the past, we feel there will be additional opportunities for us to continue to improve our gross margins as we move forward.

Total adjusted operating expense was $47.3 million, consisting of R&D expense of $30 million and SG&A expense of $17.3 million. Total operating expenses were roughly flat to fiscal Q1 levels. We continue to carefully balance all of our operating expenses through the management of discretionary spending, along with investments in new product development and other growth opportunities. Adjusted operating income in fiscal Q2 was $41.8 million, up from $37.8 million in fiscal Q1. Adjusted operating margin was 27.8% for fiscal Q2, sequentially up from 25.4% in Q1.

As I noted, our second quarter adjusted gross margin and adjusted operating margin represent record levels of profitability for MACOM dating back to our IPO in 2012. More importantly, we expect a combination of top-line growth, expanding gross margins, indoor stable operating expenses to provide the opportunity for continued operating leverage over the remainder of 2021.

Depreciation expense for fiscal Q2 was $6 million and adjusted EBITDA was $47.8 million. This contributed to another increase in trailing 12-month adjusted EBITDA, which came in at approximately $169 million as compared to LTM EBITDA of $148 million for fiscal Q1. Adjusted net interest expense for fiscal Q2 was $3.8 million, down $100,000 from fiscal Q1. Our fiscal Q2 net interest expense included only minimal savings from our debt pay down and the new lower interest rate associated with the convertible notes and these transactions occurred late in Q2.

Looking ahead, we expect our adjusted net interest expense to decline to around $1.3 million in Q3 and beyond, based on the lower debt level and the lower coupon payment on the convert. Our adjusted income tax rate in fiscal Q2 was 5% in line with our expectations and resulted in an expense of approximately $1.9 million. Our cash tax payments were $700,000 for Q2. We expect our adjusted income tax rates to remain at 5% for at least the remainder of fiscal 2021. Fiscal Q2 adjusted net income was $36.1 million compared to $32.2 million in fiscal Q1. Adjusted earnings per fully diluted share was $0.51, utilizing a share count of 70.5 million shares compared to $0.46 of adjusted earnings per share in fiscal Q1.

Now moving onto the balance sheet and cash flow items. Our Q2 accounts receivable balance was $68.3 million, up from $55.2 million in Q1. As a result, day sales outstanding were 41 days. Our Q2 accounts receivable balance was up sequentially due to a larger portion of revenue occurring later in the quarter, as a result of the timing of scheduled customer delivery dates in Chinese New Year. Our DSO remains in line with industry metrics.

Inventories were $84.5 million at quarter end, down another $4.5 million sequentially. Inventory turns was 2.9 times during the second fiscal quarter. While we recognize that there is a tightening within the semiconductor supply chain, which may cause fluctuations in our inventory balances, we remain very focused on inventory management. We continue to see opportunities to further improve our inventory metrics going forward, while also balancing customer demands and market opportunities.

We had healthy cash flow during fiscal Q2. Our Q2 cash flow from operations was approximately $28 million driven by improvements in operating profit, offset somewhat by the expected increase in accounts receivable. Cash flow from operations represented around 77% of our adjusted net income. We expect cash flow trends to improve as collections increase and directionally speaking over time, we believe cash flow from operations should run at a comparable amount of our adjusted non-GAAP net income.

Capital expenditures totaled $4.4 million for fiscal Q2. Free cash flow was $23.5 million for the second fiscal quarter. As we indicated in prior quarters, we anticipate higher quarterly capital expenditures during the remainder of our fiscal year 2021, based on investments in our R&D and fab infrastructure, inclusive of the 0.14 micron GaN on Silicon Carbide AFRL program, which we discussed last quarter.

Cash, cash equivalents and short-term investments for the second fiscal quarter were $268 million, down $87 million from Q1. The $100 million we utilized to pay down the term loan was offset modestly by cash generated during the quarter. Cash generation will remain a priority for us. We expect our cash and short-term investment balances, as of the end of this fiscal year to be at a comparable level to the $333 million we had on the balance sheet as at the end of fiscal 2020, even after the $100 million debt repayment.

The final area I will discuss in a bit more detail is our Q2 debt balance. We have provided a summary of this Q2 debt activity in the reconciliation section of our earnings release at the accounting for these transactions can be complex. At the end of our December quarter, we had debt of approximately $658 million. We paid down our term loans by $100 million. In addition, based on the accounting rules currently in place, we were required to bifurcate a portion of the convertible note debt, every quarter approximately $72 million as equity. The net result of these and other items for the quarter resulted in a Q2 ending debt balance of $492 million associated with our long-term debt arrangements.

Our debt structure, as of today, consists of approximately $120 million remaining on our term loans, which mature in 2024 and $450 million, including the $50 million green shoe of convertible notes, which mature in 2026. In addition, we have approximately $30 million of financing leases. With the improvements in trailing 12-month EBITDA, we exit the quarter with a net leverage ratio of around 2.3 times and gross leverage of 3.5 times. These leveraged calculations include the $72 million of convertible notes, classified as equity, as well as the $30 million of financing leases. We believe that we remain on course for solid financial performance in fiscal 2021.

I will now turn the discussion back over to Steve.

[Steve Daly, President and Chief Executive Officer]

Thank you, Jack. MACOM expects revenue in Q3 ending July 2, 2021 to be in the range of $150 million to $154 million. Adjusted gross margin is expected to be in the range of 58% to 60%, and adjusted earnings per share is expected to be between $0.52 and $0.56, based on 71 million fully diluted shares.

In Q3, we expect telecom to be up slightly. Industrial and defense revenues to be flat and data center to be down slightly. As I have noted, we maintain a long-term perspective on executing our strategy. We are confident we can continue to improve our financials and take market share in the months and years ahead.

Before opening up the line to your questions, I would like to make a couple of final comments. First, we have been encouraged by recent proposals from the federal government to make investments in the U.S. semiconductor manufacturing industry. We are very pleased to see recognition of the vital and strategic role that semiconductors play in America’s future. With over 70 years of history in two semiconductor fabs operating in the United States, we believe MACOM could be a model candidate to benefit from these programs and we will actively explore opportunities for funding.

Second, over the last several months, we have undertaken an in-depth company-wide review of our environmental, social, and corporate governance or ESG practices, with the goal of enhancing our current policies and programs to drive continuous improvement in these areas. This initiative has the support of the Board of Directors. As a first step, we have established an executive level ESG taskforce to refine our policies, enhance our reporting and programs and target best practices in key areas of focus. This will be a multi-year process, and we believe these efforts will ultimately create – help create value for our stockholders, employees and other constituencies.

Finally, on a related note, I would like to highlight that last month we announced the addition of John Ritchie as a new independent member to our Board of Directors who serves on the audit and compensation committees. John brings financial and business software and hardware and technology expertise to the board, and we look forward to working with him as we move ahead.

I would now like to ask our Operator to take any questions.

[Operator]

Thank you. [Operator Instructions] And our first question coming from the line of Vivek Arya with Bank of America.

[Vivek Arya, Bank of America]

Thanks for taking my question. Steve, on the telecom side, if I go back to kind of the middle of last year, when China was spending, you were doing something in the mid-$50s million quarterly, is that what recovery looks like when China resumes spending, because your telecomm business is almost a one-third of its highs, and if China does want to resume spending and open the 600,000 base stations, I assume that you’ll start to get some visibility around that. So give us some color on what the visibility is and resumption of these deployments in China, and when recovery does come, should we see a return back to those kinds of prior levels? Are there other puts and takes?

[Steve Daly, President and Chief Executive Officer]

Thank you, Vivek for the question. So, yes, we do think that we will achieve those prior highs. And we actually believe we will exceed those because, for this cycle, we are in a stronger product position, a lot of the growth we saw last year was fronthaul related with high performance analog chips. And on the next cycle, which will start sometime later this year or even into our next fiscal year, we would expect to have additional RF components qualified as well as lasers perhaps qualified in certain applications. So generally speaking, we would expect to see new highs achieved in the telecom end market, based on layering on those different product groups that I just mentioned. In terms of the timing, as I pointed out in the script, it’s very difficult for us to estimate when that new cycle will begin.

So for that reason, we have not really included a significant 5G contribution in this fiscal quarter. And as we look into Q4, we’re also – we’ll certainly take a conservative view of that unless something materially changes. The good news is it moves a lot of that growth revenue into next year. And it could really set us up for a very strong fiscal year 2022. And I will also add that these delays that we’re seeing in China at some level are actually working to our advantage as we complete the qualifications of some of our new product lines. We have more time to engage customers. One final point on 5G, we are not just focused on the China market. This is a global market and we expect in the next year to two years to be a significant contributor to European and U.S. deployments.

[Vivek Arya, Bank of America]

Got it. And then on the Datacom side, I know that that’s the segment where you’ve had quite a bit of a moment and restructuring and so forth. When should we start to see that business really start to take advantage of all the investments that the hyperscalers are making? When do you see that segment starting to really grow in line with some of the other semiconductor companies that are benefiting from cloud investment?

[Steve Daly, President and Chief Executive Officer]

Yes. So as you know, the data center segment is one of our smaller end market segments. And it’s really a mix of some legacy product lines that I highlighted on the call earlier, as well as generally analog solutions for short reach applications. And we still remain a dominant supplier into that market. Those are primarily CWDM4 for short reach 100G applications. We expect that business over the long-term to be strong. We are seeing in this moment, I would say, level, run rates or flat production levels. And so we think in the near term, the growth will come actually from our new 400G products, which include a four channel 56-gigabaud drivers, four channel linear TIAs. And these products can be used with other companies, DSPs to service the 400G market.

And then we are working on other product categories for the data center, including active copper cable, analog solutions and equalizer solutions. So I would set the expectation of a consistent growth, but not hyper growth let’s say, or if we have a limited product set for that end market. And over the long-term, we would expect both industrial and defense and telecom to outgrow a data center.

[Operator]

And next question coming from the line of Tom O’Malley with Barclays. Your line is now open.

[Tom O’Malley, Barclays]

Good morning, guys, and thanks for taking my questions. Jack, I think my first one center around some of your commentary about some of the push outs in the orders. Could you just talk about where you’re seeing the tightness in the supply chain? Is that on the supplier side? Or is that really on the backend and test? And could you quantify the size of what got pushed out and will you be seeing that revenue kind of come in the fourth quarter?

[Jack Kober, Chief Financial Officer]

Thanks, Tom. Yes, as I had highlighted, we are experiencing some of those supplier tightness items. That I did refer to. And some of that’s coming in from a substrate standpoint, but there is some assembly and test items that are out there. So our operations team has been doing a fantastic job, making sure we’re managing through this. So it’s a bit of business as usual in that our operations team is generally working through these issues in the ordinary course, but paying special attention to it now. In terms of quantification, maybe upwards of about $5 million that is pushed out, I would say. But we are working to make sure we manage that. So it’s – and that is factored into our guide.

[Tom O’Malley, Barclays]

Great. That’s really helpful. And then my second one is really for Steve. Steve, you mentioned some of the moving pieces of the data center. You mentioned the 400G products doing a bit better. And then you made a comment about some weaker 100G, you guys prior had kind of expected really strong fiscal year 2021 growth almost 20%. Can you talk about what’s happened since the last call on the 100G market, that’s made you kind of a bit more cautious there?

[Steve Daly, President and Chief Executive Officer]

Yes. We’ve seen our lead customer level off their production run rates. And so that’s sort of a directional change for us. We still do think that the data center will be a double-digit growth year-over-year. So but the primary driver for our change is that the run rates have slowed a bit, and although as we are gaining market share in international markets, especially for 25G and 100G applications, those wins have not yet offset some of the – what we’re seeing in on the domestic side.

[Operator]

And our next question coming from the line of Harsh Kumar with Piper Sandler. Your line is open.

[Harsh Kumar, Sandler]

Yes. First of all, congratulations, very impressive results among supply tightness. So Steve or Jack, your gross margin was super impressive. Is this the new base that we should be working off of as you look at your business going forward? That’s my question number one. I have a another one.

[Steve Daly, President and Chief Executive Officer]

So maybe I’ll make a few comments and then Jack can follow-up on that question. So we continue to make improvements in the execution of our business. And as Jack highlighted, a lot of that work is being done on the operational side. We are also adding higher value products to the portfolio, and that will over the long-term support improvements in gross margin. For example, we talked about the new product technology for high power in high voltage capacitors, we were calling them KV CAPS. And this is a really unique type of a product line where we can go to market with something very different and command premium pricing. And so this is the type of thing that will ultimately allow us to breach the 60% gross margin levels and then grow from there. So we’d like to think that we can continuously do better. As you know, as you continue to improve the gross margins, it gets harder. But based on what we’re seeing based on next, based on the portfolio, getting stronger from the technology point of view. We think we can continue to improve our performance. Jack, do you want to add to that?

[Jack Kober, Chief Financial Officer]

I think you did a great job covering. We are very pleased with the improvement that we’ve seen over the past quarter going up 170 basis points. As Steve noted it, it does become a bit more challenging. We do take a longer term view to many of the improvement initiatives that we have. And to some extent, come back around to some of the same initiatives to see if we can further improve them. But it does become a bit more challenging as we go forward.

[Harsh Kumar, Sandler]

Thank you, guys. Very helpful. And for my follow-up, maybe a question for Steve. Steve, you touched upon this with what you’re displaying at OFC and the international symposium for microwave symposium. But could you maybe give us an update on the timing of your laser opportunity for commercialization also silicon photonics? When do you actually expect revenues? And then secondly, as a part of that question, when I look at the laser industry, I see guys in the laser business having sort of subpar margins, you’re at sort of a premium company with – close to call it high-50s gross margin. How does that product fit into your grand plan for gross margin expansion?

[Steve Daly, President and Chief Executive Officer]

So regarding the timing of revenue for the laser portfolio, and I suspect you’re referring specifically to 25G FP and DFB lasers, because those are the newest part of the portfolio. And well, because as you know, we still are a main supplier to the GPON market with some lower data rate lasers. We announced the new platform for our DFB product line back in September of 2019. And since then we’ve been working with customers to introduce the product, get them familiar with the performance and in parallel with that running a qualification, which is about a six-month process.

As I highlighted in my script, we are just finishing up that long-term reliability test. It will be done pretty much at the beginning of May. And so we would expect laser revenue from these new product categories as early as the Q4 time period, but most likely Q1 of FY 2022. In that timeframe, and just to level set, we believe it will start at a low modest level and it will grow over time. I’ll highlight that we do have some significant advantages when we go to market. As I’ve talked about before, we’ve created a platform which allows us to generate multiple wavelengths relatively easily due to the platform and the design.

And your question about other companies having lower gross margins with their laser portfolios, I just like to highlight that we are – I believe the only company today in the industry that is producing for indium phosphide lasers and the way we manufacture these lasers allows us to do on way for optical testing, without cleaving the wafers and doing it with let’s say, a more manual than in a more costly test method. So we believe we have a cost advantage because of the size of the wafer. And we have a cost advantage because of the methodology we employ on test.

And I’ll add to that. We are going after higher data rates. And when we enter the specifically the data center market, which we hope to enter next year – next fiscal year, we will do so with a premium product that has high reliability that can scale quickly. And we’re confident we can be successful there. Now with that said, it is a competitive market. We believe that the laser portfolio will be accretive to our existing margins. So we’ll have to wait and see how that works out. But that’s our current thinking.

The other thing you asked about, of course, was silicon photonics. So we continue to do design work with that portion of the portfolio. Our primary focus is 400G DR4 and DR1 picks, these are the discreet silicon photonic devices without the lasers attached. And you will not see any revenue from Silicon photonics this year, this fiscal year for MACOM. And it’s unclear as to the timing as to whether it will be first half or second half of next year. I can tell you that we’ve had a few challenges in the last two to three months regarding process control at one of our key suppliers on this technology. And that is delaying a little bit some of the work that we’re doing there. But just for modeling purposes, you should expect silicon photonic revenues sometime in FY 2022 most likely in the back half.

[Operator]

And our next question coming from the line of Quinn Bolton with Needham & Company. Your line is open.

[Quinn Bolton, Needham & Company]

Congratulations on the record margins. I wanted to ask, Steve, you mentioned in the data center category $15 million products going into live next year. Can you give us a little bit more detail on what those legacy products are? And as you look at the data center business with sort of a flattening outlook for 100-gig CWDM4, do you think that that business can continue to grow in fiscal 2022, given the headwind from those legacy products?

[Steve Daly, President and Chief Executive Officer]

Thank you for the question. So the $15 million decline would – I guess you could organize that into sort of three different product areas. The first is, we have integrated OTN devices that service 10G and 40G applications. And these are used basically in a transport network core layers. And these products were introduced by AMCC, prior to MACOM acquiring AMCC. They were introduced in the 2009 and 2012 timeframe. And as these networks have moved to higher data rates, the need for the 10G and the 40G product is falling off. So that would be the first category that we would expect to see the decline. And the second is, we have some older Ethernet 5 products in production. These are generally used in enterprise switches that operate at 10G. These products were introduced in the 2006 to 2007 timeframe.

And again, we think that next year will most likely be the last year that we’ll see revenues on those products. And then the third is, we have a category we call power PC. This is at least a 10-year old product line that we actually end of life over a year ago mainly because the process was going obsolete. And these are basically general purpose processors that would be used in communication systems, defense systems, in some cases medical systems. And the industry has moved really away from these type of processors, more to ARM processors. So we believe that that product set will also ramp down next year. And we highlight this today because recently MACOM’s management went through a review of our fiscal year 2022 projections. And these items came up as notable declines, and we wanted to put that information out there and share it with everybody.

In terms of your question, about 100G CWDM4 growing next year, I think the short answer is yes. We believe it will grow even though our lead customer today is leveling off their productions. We continue to win market share with the products that we’re launching today. And I’ll highlight by the way, as I talked about for one of the OFC demos, where we’re demoing a 200G and 400G chipset, which is meeting the open-eye analog protocol. This is the first time we’re putting out for this data rate of excellent driver combo chip, a VCSEL driver in CDR combo chip, as well as a TIA in CDR driver combo chip. And these that’s a first. So while we have had limited success at 200G, I can tell you that our combo chips, again, the VCSEL driver in CDR and the TIA in CDR, just to be clear those are new products to the market.

And we think that we will be well-received with those products in terms of the sort of our core CWDM4 business. We are, as I said, continuing to push new versions of existing designs, whether we’re going from package devices to bumped devices and shrinking designs down to make sure that we are fielding the most competitive solution. And we’re doing a lot of great work there. So we are still all in on CWDM for over the few years. We think the voles generally speaking will continue to grow.

[Quinn Bolton, Needham & Company]

Great. And then my follow-up, Steve is the new KV CAPS capability. How long will that take to sort of sample and qualify at customers? When would you expect to see ramp from the new KV CAPS product line?

[Steve Daly, President and Chief Executive Officer]

So the good news here is the design and process for the capacitor should be relatively quick. And we have a very large built-in customer base, right? So we have thousands of customers that today buy our high voltage diodes, they buy some of our high power amplifiers. And we know they buy capacitors. We were talking to one company that’s in the medical industry, and they’re purchasing over $20 million of high voltage capacitors a year, and that’s just one company. So our sales force is being wound up right now to bring these products to market. We believe we have a lot of existing accounts that will be interested in the product. And so we would expect some modest contributions starting next fiscal year. Of course, there’s a design cycle that needs to take place. We’ll offer these as bare-die, as packaged parts, as well as screened for military and space.

So it’s a great product line. We believe it should be relatively easy to sell given. It’s so unique. Most capacitors that are at the 1000V level and above are typically ceramic capacitors, which are larger and arguably less reliable, or they’re large packaged capacitors using slightly different technologies. So what’s unique here is achieving really a 1000V operation at the chip level. And that really speaks to the technology that we have at the local facility here in Massachusetts, and our ability to do, I’ll say complex etching and trenching of via to allow us to achieve these voltages. So modest contribution next year, the team is excited about the launch and we’ll have to wait and see ultimately what generate – what revenue we generate next year, but it certainly, it will be a fast selling cycle.

[Operator]

Our next question coming from the line of C.J. Muse with Evercore. Your line is open.

[C.J. Muse, Evercore]

Good morning. Thank you for taking the question. I guess, a little bit of a follow-up to the last question, question for you, Steve. I guess two part on the industrial side, can you speak to the sustainability of the strength that you’re seeing into September and beyond, and as part of that, can you update us on where you stand on the cross selling aspect of bringing incremental I guess, tools to the portfolio and driving incremental growth. We’d love to get an update there.

[Steve Daly, President and Chief Executive Officer]

Sure. So the IND is, as everybody knows has really been range bound in revenue over the last three to four years, between $40 million and $50 million. And what you’ve seen here in the last few quarters is some significant growth. Now we’re above $70 million. A lot of that is being driven by the things I talked about in the script, including cross-selling including winning market share. I mentioned the pallet that we recently won a multi-100 watt power amplifier for a radar system. And so whether the – certainly, having sequential growth of 17%, I would argue that’s probably not sustainable. And we wouldn’t – don’t expect that, of course, but I think over the long-term, you will start to see that part of our business grows. We have a very diverse customer base. It’s not only defense, it’s also industrial. We include automotive and industrial, and recently we’ve seen an uptick in our automotive business, in our sensor business.

In terms of the cross-selling that work continues. And I can tell you, we’re starting to see requirements for RF over fiber. We’re starting to introduce our optical design capability to defense contractors for the first time. And we’re bringing more high power, interesting products to the defense industry. And we’re getting a lot of accolades and a very warm welcome there.

So the cross-selling continues and by the way, it’s not just optical into defense, it’s also analog and mixed signal into industrial markets. Our HPA or High Performance Analog team, which is historically been focused on telecom is now doing custom analog designs for defense contractors and industrial companies, whether they’re a drivers circuits, whether they’re a complex switching networks or regulators. So the team is fully embracing the concept of diversifying their businesses and their revenue streams. So that work will continue. Generally speaking, we do have a long-term view at our business. And so some of these things will take time to turn into revenue, but I think we’re doing all the right things.

[C.J. Muse, Evercore]

Very helpful. And then Jack, a follow-up to supply constraint question earlier from Tommy. You talked about $5 million push out from June. Do you expect the supply constraints to be fixed into the second half of the year? Or is that an ongoing headwind that we should be thinking about through the calendar year?

[Jack Kober, Chief Financial Officer]

Yes. I think it’s something that we’re paying close attention to. And at this stage, we kind of view it as a one-time item that we’re going to be working through. But we will continue to monitor as we go forward.

[C.J. Muse, Evercore]

Thank you.

[Operator]

And our next is coming from the line of Tore Svanberg with Stifel. Your line is open.

[Tore Svanberg, Stifel]

Yes. Thank you and congrats on the record margins. I had two clarification questions. First of all, Steve, when you talked about 5G China, were you suggesting that there’s being delays? Or are you suggesting this just very low visibility as when those deployments are going to start or restart?

[Steve Daly, President and Chief Executive Officer]

So we’ve been expecting a new round of tenders to emerge in – basically, six months ago we were expecting the new tenders to emerge in the April timeframe and that hasn’t happened. And now there’s talk about the China operators starting sort of a new cycle of bids, possibly in the June timeframe in and around the World Telecom Day event. So we are – our eyes are on the new tenders. Now, if we look at the number of 5G base stations deployed in calendar Q1 of 2021, it was about 48,000 base stations. So there’s still continues to be 5G deployments today, but those deployments are based on last year’s tenders and last year’s contracts. So we’re focused on the new tender cycle. And from our point of view that event hasn’t started yet.

[Tore Svanberg, Stifel]

Thanks for that clarification. And then on the other one, which is a little bit more longer-term. So you talked about how in telecom, obviously you’re going to have more opportunities, right, given new products. Could you maybe talk about that in data center too, because there’s a lot of puts and takes here. But it does sound like in aggregate, especially with the lasers being qualified for data center that over time you would have more opportunities in data center as well, even though it’s the smaller business unit.

[Steve Daly, President and Chief Executive Officer]

Well, that’s right. And I didn’t mean to sort of underserved our focus on the data center, of course. So the growth drivers for us are really organized into different product sets. So of course, we have the 100G analog solutions, which are mostly today CWDM for NRZ type applications. Then you layer on top of that 200G and 400G analog solutions for PAM-4. And I talked about some of the new combo chips that we’ve for that. You have 400G EML drivers and 400G linear TIAs and these would be for DR4 type applications. We have, as you know, a PAM-4 DSP in production today, it’s a 100G PAM-4 DSP that started production about a quarter ago, maybe two quarters ago.

And those are all of our existing products today running in production. And to the extent that we can win market share that those base product lines will grow. And that is our expectation. When you add on top of that, some of the new technologies you would add, of course, the lasers and we plan on targeting the data center with our laser technology at the beginning of our next fiscal year. Of course, you can add photo detectors, as well as the data rates go higher. We have a unique technology coming from our Ann Arbor fab for very high speed PIN detectors, which would be used inside the data center.

And then we have new technologies that we’re developing, including active copper cable, which are allowing us to not only service the AOC market, but also the copper market. And we have some very exciting technology there. And then sort of last and maybe furthest out as the silicon photonics that I talked about earlier, where we’re focusing on first 400G applications. So we do have a very large suite and any one of those product areas could drive significant growth for us. Of course, we’re at a run rate right now of mid $30 million run rate. So certainly one laser design win could be millions and millions of dollars inside the data center. And so we’re very focused on making sure that all of those different product lines that I talked about will be successful.

[Operator]

Our next question is coming from the line of Karl Ackerman with Cowen. Your line is open.

[Karl Ackerman, Cowen]

Yes. Thank you. Two questions if I may. First one is more of a housekeeping question, but which is on gross margins. I understand there are rising substrate and shipping costs as evidenced by many of your peers. So I appreciate it if you walk through what supports your systematic improvement in gross margins for the June quarter, despite flattish revenue and particular such as new product mix versus price. And I have a follow-up.

[Steve Daly, President and Chief Executive Officer]

Sure. Maybe again, I’ll try to help answer that and then Jack can step in. So a vast majority of the improvements are coming from operational execution, yield improvement, focusing on wringing out costs along our manufacturing production lines. And that has been and will continue to be a big effort. And we still believe there’s ample opportunity to improve that. And then second there’s a mixed component depending on the product lines, of course, and depending on the different end markets. So, from our point of view, while we achieved a nine year record high, if you look at our gross margins and compare them to a high-performance analog and mixed signal company that’s a multi-billion dollar company. These companies have margins that are in the high 60’s and low 70’s, and that’s what we aspire to achieve. And that will take time and it will happen when we begin to increase the number of unique products to the market and when we can command premium pricing and that’s a long-term effort.

And so doing things that other people can’t do like 1000 volt capacitors, like 0.14 micron GaN on Silicon Carbide, doing 400G high-end analog solutions to knock out a DSP. These are things that are – that will create value for the company. And that will certainly be our focus. And I’ll highlight that we are very focused on the industrial and defense markets. And as I mentioned earlier, this is an area for MACOM that’s been range bound for years, and we are breaking through that now.

And when you move into that space, you generally see less commodity in a lower less commoditization let’s say of the platforms. So you’re able to command stronger pricing. And so whether it’s selling products to a satellite manufacturer or defense contractor or focusing on industrial or even medical equipment these are markets that demand performance, and that’s going to continue to be a focus for the company. Jack, did you want to add to that?

[Jack Kober, Chief Financial Officer]

I think you did a really good job covering that. But we are seeing margin improvements across many of the product lines that we do serve. So it is fairly broad based and not just limited to the I&D items that Steve was referring to.

[Karl Ackerman, Cowen]

Great. Thank you for that. Maybe for Steve for my follow-up. I was hoping you could describe the level of orders you are seeing within your RF. And I guess, telecom business more broadly. I ask because some of your peers across e-comms, supply chain have spoken about a push out in tender activity and weaker massive mano production plans, which you touched on a little bit in your prepared remarks. At the same time, one of your peers recently spoke about improving 10-gig PON activity. So I’d love to hear your thoughts on, I guess, why there is a pause in tenders and what are the investments in PON? Our park lighting into front hall where you should benefit from a recently introduced front hall lasers. Thank you.

[Steve Daly, President and Chief Executive Officer]

Sure. Well, just a few comments. So there’s – MACOM has a very unique portfolio. There’s really no company in the industry that is a direct peer that represents our product portfolio. So we are in very different markets and most of our peers are more focused, let’s say in one technology set. So I think we have a very unique portfolio where we have RF microwave, high performance analog and optical. And so I think we’re in a little bit of a unique position, which makes it difficult to do that one-to-one peer comparison.

Regarding telecom, actually this past quarter, it was our strongest booking in new order and market segment. It had the highest level of bookings and that’s a bit of obviously a leading indicator of things to come. And that was driven by a broad business, broad drivers, not just 5G. We are seeing strength in cable infrastructure. We are seeing strength in satcom. And so we think that we’re gaining market share there.

In terms of your question about why the pause in the tenders, I really can’t answer that. And then as it relates to 10G PON, I can say that the growth for MACOM will come from new product introductions there. We do believe year-over-year from FY2021 to FY2020, we will have very strong year-over-year growth, and that will be even better when we look FY2022 to FY2021. We are just moving some of the latest products into the market. I mentioned we do have a burst mode TIA, but we have a better one coming that we think will allow us to gain market share. And then the one question you had about the 10G laser that laser is not ready for production yet. It will be ready for production beginning of next fiscal year.

[Operator]

And our next question is coming from the line of Ruben Roy with Westport Capital. Your line is open.

[Ruben Roy, Westport Capital]

Thank you for taking my question. Steve, I think you just touched on this, but maybe just talking about it just a little bit more based on your guidance for the June quarter and assuming we don’t see a big fall off in the September quarter, you’re on track to hit that double digit growth that you guys had targeted as a soft target for the fiscal year and you just talked about 2022, possibly being a bigger growth year than 2021. So I just wanted to talk about that a little bit. In terms of 2022, it sounds like you have a couple of drivers coming up, potentially 5G coming back in China, new products ramping, including your 25G lasers, what you’re doing with cross-selling, et cetera. But when you look at all of that in aggregate, can you give us an idea of how you’re thinking about each of those items relative to each other as driving the growth as you look into next year, which are kind of the biggest growth drivers that you think help 2022 maybe grow faster than 2021. And if I’m on track thinking about is that the right way.

[Steve Daly, President and Chief Executive Officer]

Sure. And just to clarify, I’m not sure I did say that FY2022 will outpace FY2021. I may have been referring specifically to a product line or a product set. So we have not given guidance and have not commented on what we expect our FY2022 growth level to be. That’s work we’re currently doing today. And it’s just too early to talk about how we think FY2022 might shape up. Obviously, what we talk about is our growth will come from new products, and that’s why the heavy emphasis on talking about the different things that we’re doing. And to the extent that 5G kicks in, and we have success with not only on the power side, but also on the optical side and some of our new front end modules that we’re gaining traction on.

We do think it will be a very or has the potential to be a very good year. But I wouldn’t necessarily want to call out any one of these product categories, the way we organize our business, we have six engineering silos. Let’s say, each one is very focused on growing their individual businesses. Our largest – one of our largest segment is HPA and diodes. And so we would expect those organizations to have more modest growth let’s say, compared to our smaller units, such as RF power. Our RF power business has tremendous potential and our Lightwave organization has tremendous growth potential, and these are some of our smaller business units, let’s say. So in aggregate, we’ll have to see how it works out. And that certainly work that we’ll be doing between now and the end of our fiscal year.

[Ruben Roy, Westport Capital]

Okay. Thanks for that, Steve. And just a quick follow-up for Jack. Jack, you mentioned and it’s right on your balance sheet. Just wondering if you have any comments on channel inventory by some of your end markets?

[Jack Kober, Chief Financial Officer]

That’s something we’re very proud of the inventory improvements we’ve made on our balance sheet over the past 18 months or so. We pay special attention to that to make sure we’ve got the right levels of inventory. And I’ve been working very closely with our customers to ensure we’ve got the right inventory to meet their requirements. And from a channel perspective, we continue to monitor that. We believe that the inventory levels there remain at fairly healthy levels, which I think bodes well for us as we go forward.

[Operator]

Our final question is coming from the line of Harlan Sur with JPMorgan. Your line is open.

[Harlan Sur, JPMorgan]

Hi. Good morning. Great job on the quarter execution and strong results especially on the margin front. The U.S. defense spending budget is quite strong this year. It was strong last year. It looks like the proposals for next year for spending levels to sustain at these current strong levels. And I believe the visibility here is very good because obviously these programs are very strategic in nature. So does the team see further growth in your defense business next year? And I know you can’t disclose specific programs, but the strength you are seeing in defense are centered around what areas, is it radar, is it weapons systems, MILCOM, UAVs, ground-based airborne any color here would be great.

[Steve Daly, President and Chief Executive Officer]

Sure. And we view our defense business as so small relative to the overall budget and growth opportunity. And as I highlighted it’s an area of focus for the company. Part of our growth, I have to say will come from new account penetration. And we do not have as strong relations with the major U.S. defense contractors as we should. And so we’re still working on that, which is a very fundamental issue that we’re making great progress, resolving and fixing. And when we do that, we think we’ll start to see for the first time opportunities that we just hadn’t seen before. So the team is doing a great job. Our U.S. sales force is absolutely phenomenal. And they continue to impress, Jack and I as to the type of opportunities and the quality of opportunities that they’re digging out.

The other thing I’ll highlight is we’re not a subsystem house. We are focused on component level or high power amplifiers sub-assembly type applications. And we will only go after a subsystem if we believe we have a tremendous leverage from the chip point of view to leverage into the overall subsystem. Your question about what are the main applications, so most of our defense business revolves around RF and microwave components. So it’s primarily discrete diodes, RF and microwave mimics, power devices and these are typically used in as you highlighted radar, MILCOM, ground-based radar, ship borne radar. We have content in numerous missile applications and that’s growing, and those are generally high volume applications as well.

So the good news is we have a very diversified business within the defense area, and it’s just getting more diversified. And the fact that we’re now letting a lot of radar houses know that not only do we have best-in-class GaN on Silicon Carbide, but we’re willing to build a very high power amplifier for you because we have the expertise to do it just makes the growth opportunity, even that much more exciting. So I think we’re doing all the right things there.

As you know, we highlighted on our last call, the relationship with the Air Force Research Labs to bring in some very high frequency, high power GaN on Silicon Carbide to our manufacturing facility. And we believe this process will have some of the best power efficiency numbers in the industry. So we are very focused on the defense industry and we do expect to win more market share.

[Harlan Sur, JPMorgan]

Great. And then maybe switching from to a more product – new product perspective. Last call, you guys talked about the potential opportunity for active copper cabling in the data center for short reach. You mentioned it today as well. Obviously, it’s more economical versus active optical cabling, and we’re hearing more and more from some of your cloud data center architects and customers talking about ACC. Can you give us a sense in terms of what high performance analog solutions you’re developing for this new opportunity and maybe timing of a product introduction?

[Steve Daly, President and Chief Executive Officer]

So we are engaged with the major customers that would want to build an active copper cable. And we are following their roadmaps. So I don’t necessarily want to get into the specific data rates or construct per se. But we are one year into this and we would expect that if we’re successful with some of our lead customers, that it will provide some new production next fiscal year. So it is a very interesting area. We are very excited about the volumes. These are generally very high volume applications. And we think we can solve problems that they haven’t had other vendors solve. So we’re a new capability and maybe a better capability design, capability to solve the problems. But generally speaking, these are higher data rates, and I probably shouldn’t go into any more detail until we make formal announcements.

[Operator]

And I’m showing no further questions at this time. I would like to turn the call back over to Mr. Steve Daly for any closing remarks.

[Steve Daly, President and Chief Executive Officer]

Thank you. In closing, I would like to acknowledge our customers, our suppliers and our hardworking employees for making all these results possible. Thank you very much.

[Operator]

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