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MACOM Technology Solutions Holdings, Inc. (NASDAQ:MTSI)
Q4 2018 Earnings Conference Call
Nov. 13, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to the MACOM's Fiscal Fourth Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of today's conference call, instructions will be given for the question and answer session. As a reminder, this conference call is being recorded today, Tuesday, November 13, 2018. I will now turn the call over to Steve Ferranti, Vice President of Investor Relations at MACOM. Steve, please go ahead.

Steve Ferranti -- Vice President of Investor Relations

Thank you. Good afternoon, everyone, and welcome to MACOM's Fiscal Fourth Quarter 2018 Earnings Conference Call. Joining me today are MACOM's President and Chief Executive Officer, John Croteau and Senior Vice President and Chief Financial Officer, Bob McMullan. If you have not yet received a copy of the earnings press release, you can obtain a copy on MACOM's website at www.MACOM.com under the Investor Relation's section.

Before I turn the call over to John, I would like to remind everyone that management's prepared remarks and answers to your questions contain forward-looking statements, which are subject to certain risks and uncertainties. Because actual results may differ materially from those discussed today, MACOM claims the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. For more detailed discussion of the risks and uncertainties that could result in those differences, we refer you to MACOM's filings with the SEC, including its current report on Form AK filed today, its annual report on Form 10K, filed November 14, 2018, and its current reports on Form 10Q, filed in 2018. Any forward-looking statements represent management's views only as of today, November 13, 2018 and MACOM assumes no obligation to update these statements in the future.

The company's press release and management's statements during this conference call will include discussions of certain adjusted non-GAAP measures and financial information, including all income statement amounts and percentages referred to on today's call, unless otherwise noted. These financial measures and a reconciliation of GAAP to adjusted non-GAAP results provided in the company's press release and related Form 8K, which was filed with the SEC today and can be found at the Investor Relation section of MACOM's website. For those of you unable to listen to the entire call at this time, a recording will be available via webcast for at least 30 days in the Investor Relation section of MACOM's website.

And with that, I'll turn over the call to John for his comments on the quarter.

John Croteau -- President and Chief Executive Officer

Thank, Steve and welcome everyone and thanks for joining us today. I'll begin today's call with an overview of our Fourth Fiscal Quarter 2018 Results. I'll then turn the call over to Bob McMullan, our CFO, who will review our financial performance in further detail. I'll conclude today's prepared comments by discussing MACOM's key in-quarter milestones and growth drivers for the year ahead, and close the call with guidance for the fiscal first quarter of 2019. As I mentioned last quarter, we're squarely fixated on returning to our target financial model of 60% gross margin, 30% operating margin and 60% free cash flow. Fiscal Q4 was a solid step toward reaching that goal.

Jumping right into the numbers, revenue for the fiscal fourth quarter was $151 million, up 4% sequentially with adjusted gross margin of 55% and adjusted earnings of $0.16 per diluted share. During the fiscal fourth quarter across all end-markets, product revenue was up 10% sequentially, excluding $7 million of services revenue the prior quarter. Operating margins were up 90 basis points quarter-on-quarter. Earnings per share was up 23% sequentially and we generated $11 million in free cash flow.

I'd like to take a moment to thank the team for a quarter of solid execution. Q4 wraps up a transitional year for MACOM. We entered the year at the trough of a major cyclical downturn in China, which had a pronounced impact on a number of our served markets. Over the course of Fiscal 2018, demand progressively recovered and our revenue and margins rebounded from trough levels. Entering Q1 of Fiscal 2019, we believe that this recovery is now complete.

I'll turn it over to Bob for a more in-depth review of our Fiscal Fourth Quarter Financials.

Bob McMullan -- Senior Vice President and Chief Financial Officer

Thank you, John, and good afternoon, everyone. Before I review MACOM's Fiscal Fourth Quarter Results and financial position, a couple of summary points. Our Fiscal 2018 non-GAAP operating results, revenue $577.4 million, gross margin 54%, EPS $0.52. We believe the investments made at Fiscal Year 2018 leaves us well-positioned to meet customer and market demand over this and future fiscal years.

Next, we received $7 million in full payment in Fiscal Q4 of the non-GAAP revenue in Fiscal Q3. Despite customer acceptance for contractual terms and cash payments, we did not meet the new technical requirements for GAAP revenue recognition in fiscal Q4. Now the Fiscal Q4, which taken as a whole from a financial metrics perspective, delivered much-improved results. Starting with some key financial metrics, cash flow from operations and free cash flow were both positive. Cash flow from operations totaled $25 million and free cash flow $11 million after $14 million of capital expenditures in the fiscal fourth quarter. Total cash and cash equivalents increased by $10 million sequentially, now totaling $193 million.

Non-GAAP revenue in Fiscal Q4 was $151 million, down 9% year-over-year from $166 million and an increase from $145 million, up 4% sequentially. To dissect these numbers further for those who may not be familiar with MACOM's recent strategic actions, year-over-year revenue was essentially flat after adjusting for fiscal fourth quarter '17 revenues from our LL4 optical sub-assembly business, which we exited in Fiscal Q3, 2018.

Revenue in Fiscal Q4, grew $6 million, or more than 4% sequentially. Revenue was negatively impacted in Fiscal Q4 by the US Department of Commerce Denial Order issued in August, actually provided our Fiscal Fourth Quarter guidance prohibiting MACOM from fulfilling orders from Chinese aerospace customers for components that were not previously subject to export control before this recent denial order, resulting in revenues below the midpoint of our guidance. This denial remains in effect and impacts quarterly revenue in the range of $2 to $4 million. We expect that it will have a continued impact as long as it is in effect.

Revenue by end markets. Telecom was $53 million and 35% of total revenue, down 19% year-over-year, but up 8% after adjusting for the exited LL4 optical sub-assembly revenue. Data center was $46 million and 30% of total revenues, down 3% year-over-year, and industrial and defense was $52 million and 35% of total revenue, essentially flat year-over-year. Sequentially, telecom was up 5%, datacom was 5, and industrial and defense up 8%.

Non-GAAP gross profit and gross margin in fiscal Q4 was $83 million and rounding to 55% of revenues, respectively, compared to $97 million and 58% of revenues, respectively, year-over-year, and $81 million and 56%, respectively on a sequential basis. Loss of revenue to the
Chinese aerospace customers affected gross margin mix. In terms of operating expenses, total non-GAAP operating expenses were $64 million compared to $59 million year-over-year and $65 million sequentially. Adjusted operating expenses were down approximately $1 million, or 1% sequentially. Adjusted R&D and SG&A expenses were $41 million and $23 million, respectively in fiscal Q4. Non-GAAP income from operations and operating margin were $19 million and 12% of revenues, down 50% in dollars and down 46% as a percentage basis, respectively, year-over-year, and up 13% in dollars and up 8% on a percentage basis, respectively, sequentially.

Net interest expense was up $100,000.00 sequentially. Our normalized non-GAAP income tax rate of Fiscal Q4 continue at 8%. Our GAAP effective tax rate was -14% for the fiscal fourth quarter. As to cash taxes, we had net payments of approximately $100,000.00. Our Fiscal Q4 non-GAAP net income and EPS were $11 million and $0.16 per fully diluted share, respectively down from $30 million and $0.46 year-over-year and up from Fiscal Q3 non-GAAP net income of $9 million and EPS was $0.13. Net income was down 65% year-over-year, but up 23% sequentially. Non-GAAP EPS was down 65% year-over-year, but up 23% sequentially. The share count used to calculate fiscal fourth quarter non-GAAP EPS was 65.9 million fully diluted shares. Adjusted EBITDA or earnings before interest taxes, depreciation, and amortization was $26 million down 45% from $47 million year-over-year, but up 8% from $24 million sequentially.

Note, Fiscal Q1, 2018 was the low-point for the non-GAAP revenue and EPS. Year-over-year comparisons should turn the corner to reflect positive growth.

Moving to cash flow. As I mentioned, GAAP cash flow from operations was $25 million compared to our Fiscal 2017 Q4 of $12 million and $100,000.00 during Fiscal Q3. Improved operating income and working capital management contributed to this $25 million increase. After deducting capital expenditures adjusted free cash flow was positive $11 million compared to $7 million in Fiscal Q4 of 2017 and up from -$13 million sequentially.

Capital expenditures in Fiscal Q4 were $14 million or 9% of revenues, essentially flat sequentially. Depreciation expense was $7 million, essentially flat sequentially.

Now to MACOM's balance sheet numbers. At fiscal fourth quarter end, our cash, cash equivalents, and short-term investments were $193 million, up from $183 million sequentially. Accounts receivable were up $97 million, down from $111 million sequentially. Day's sales outstanding was improved, 59 days, down from 64 days sequentially. Inventories were $123 million supplied sequentially. Inventory returns were flat at 2.2 times. Day's inventory were 163 days compared to 178 days sequentially. Long-term vet was $687 million, inclusive of capital leases. Long-term debt is termed with minimum annual principle repayments until maturity day, 2024. And covenant life, we also have $160 million of availability in undrawn credit line maturing in May of 2021.

Back to you, John.

John Croteau -- President and Chief Executive Officer

Thanks, Bob. Before discussing our secular growth opportunities, we had a couple of noteworthy milestones since our last earnings call that I'd like to cover. To begin, I'm pleased to announce that we've concluded our settlement of the Infineon litigation regarding ownership rights of GaN-on silicon intellectual property. Under the terms of the agreement, Infineon has assigned ownership to MACOM to patents that were under dispute for all fields of use. We have, in turn, agreed to license the cabinets back to Infineon, but they're restricted from selling GaN-on silicon RF Bay Station products in production quantities until 2021. I'll explain the significance of this later in the call.

Next, we continue the controlled production ramp of our 25 gig lasers, which contributed to our data center sales growth in Q4. This quarter, we'll build upon that progress as we continue to scale manufacturing output to meet a very robust demand profile for 2019.

It's worth noting that total manufacturing cycle times for this type of laser from epitaxial wafer orders through pilot tests take 7 months from start to finish. So it'll take multiple quarters to ramp revenue fully as material flows through our production models.

Next, as we've done throughout the year pruning our portfolio and consistent with our previously announced plans, we took actions toward the closure of the Ithaca Fab and divested the Lawrence Hiron Facility in Fiscal Q4.

In telecom, we're seeing resumed pork count growth in metro long-haul drivers and continuing global deployment in PON and fiber back haul. In metro long-haul in particular, we're seeing improved demand trends across our customer base. Forecast for coherent apportionments in 2019 are healthy and we're in the midst of securing design wins and share allocations in next-generation coherent applications with 64 Gigabot drivers, which carry higher ASBs out of the gate. Based on expected competitive developments in this market, we feel confident in maintaining or improving our share position in Fiscal 2019.

In Q4, we supported our customers' success at a PAN-4 PlugFest with our single Lambda DSP Phi solution. The PlugFest was a major milestones for industry adoption of PAN-4, ensuring interoperability of different vendors transceivers with various switch hardware before they're released into production.

Now, before turning it over to questions, I want to provide some additional perspective on our longer-term growth drivers entering Fiscal 2019. Through last year's downturn, we focused our R&D to bring specific proprietary and disruptive products to fruition in specific markets with identified secular growth and revenue contribution in Fiscal 2019. We chose to focus on these products due to the quality and strength of our design lens and first-tier customer commitments. As a result of these actions, we're now positioned to monetize our strategic investments during the next phase of global infrastructure spending led by cloud data centers, followed by 5G telecom, and now a surge in civil and defense spending for global and homeland security. It's worth noting that all of these opportunities span well beyond China and many are inherently North America based.

Starting with 5G telecom, I can finally speak more openly about the magnitude of the opportunity now that we've settled our long-running litigation with Infineon. Let me explain why SD is so invested in teaming with us and why Infineon was so invested in litigating with us over rights in RF. Gallium nitride is effectively a requirement for 5G bay stations due to its superior efficiency and power density at the higher 5G frequency bales. Forecasts from our top bay station customers show a strong surge in our powered semiconductor content both in dollars and especially in wafer consumption through 2023 for 5G. We're talking 3 times greater demand in 5G than the previous 4G LTE cycle. We therefore believe that the billion-dollar R-power market is poised to triple over the next few years on the back of GaN and 5G bay stations.

Billion-dollar markets require high-volume semiconductor FAFs. With a dramatic increase in wafer demand for 5G, it's imperative that the industry has high volume sources for GaN production. Like SD Micro's factory, where we're sourcing GaN and contideon sicily. Contideon is an order of magnitude greater in scale and output than the world's largest compound semi-FAFs.

One and 3 to 5G cycle with ownership of the fundamental patents, we're now more excited than ever about this opportunity for the following reasons. First, we can scale GaN-on silicon in existing high-volume silicon fabs to fulfil the 5G buildout. Even the most optimistic plans for GaN-on silicon curbite factory expansion announced by silicon curbite leaders can service but a small fraction of that 5G demand. Second, the higher frequency bands, more modest power requirements, and targeted price points of 5G max and de minimal antennas line up ideally with the properties of GaN on silicon substrates.

Third, this is a different class of product than the high-powered transistors that were used in 4G LTE. These are 5G mimics that don't require the backend operations infrastructure of incumbent LD MON suppliers. So we're playing on home turf in 5G.

MACOM's GaN-on silicon is fully proven, validated, and qualified within our customer base and now enjoys executive level sponsorship for adoption. In some cases, we're already in production with initial programs.

Finally, with the Infineon settlement, we control our own destiny in GaN for bay stations and, in fact, GaN for all fields of use. The nitronics pad portfolio lays a multidimensional, multilayer minefield that we firmly believe is impossible to navigate with infringing one or more or our fundamental patents.

After this high-profile litigation with Infineon, we believe customers understand this intimately and plan to work with vendors who have access to the patents, namely, MACOM and her licensees. Between Infineon and our partner ST, we've now enabled a healthy industry supply chain for the 5G buildout, 2 of the Top 5 8-inch semiconductor manufacturers globally.

Now, stepping back and reflecting on the entire 5G telecom opportunity, GaN is but one of several highly proprietary MACOM technologies that are poised to play industry-enabling roles in 5G. The second is LGAS, our switch technology that enables superior reception on the receive side while providing superior power handling on the transmit side. Our heterolithic mic wave ICs, or HMics, add three-dimensional glass structures to maintain superior RF performance at leadership power walls. That's what differentiates antennas in terms of coverage and energy efficiency.

Last but not least, our Indium Fos 5 Etch Facet Lasers allow the optical backbone to scale cost effectively to 5G network bandwidth and latencies and fiber front wall de minimal. Each of these compound semiconductor technologies, from GaN-on silicon, HMic, and LGAS, to Indium Fos 5 Lasers, are deeply rooted in MACOM's long heritage and core competence in specialized high-performance materials, processes, and packaging. 5G is right in our wheelhouse.

Major bay station customers and network operators understand this better than anyone. For that reason, you'll understand why we're bullish as we enter the global cycle of 5G telecom infrastructure deployments.

Next, in the area of global and homeland defense, from our vantage point, we see a coming point of public and private sector investment in active antennas that utilize our high-performance arc to mic-wave components and scalable planar array, or SPAR tile, assemblies. Leveraging many years of work with MIT Lincoln Labs, we believe we have a unique approach that can readily scale to high volume with a commercial cost structure for a wide array of military and civil applications. The prime example is the US government's sensor program, which is shaping up to be the largest radar system deployment in US history. It's jointly sponsored by the FAA, DoD, and Department of Homeland Security. Sensor is expected to consolidate and replace outdated radar systems to support air traffic control, as well as protect against modern day threats in US air space.

Last month, our five responses from the major prime contractors featured MACOM's piles prominently in their sensor proposals. Over the life of the buildout, sensor represents a multiyear, multibillion dollar opportunity for MACOM. While field deployment is still a couple of years out, final bids now require full-scale preproduction bills, which we plan to support in engineering, as well as manufacturing over in Fiscal 2019 and 2020. Even before the sensor program, these same tiles were being used in low-cost mobile, expeditionary, as well as fixed antennas to detect the potential use of commercial drones by terrorists and other criminal elements. The FBI and Department of Homeland Security are getting increasingly concerned about drones being weaponized with chemical, biological, or even radiological agents.

Legislation is currently before Congress that would allow drones to be taken down near open-air venues and public facilities. But first, they have to see them coming. They need sufficient range for early warning in any and all light conditions. That's radar. And that's why low-cost, scalable planar array tiles come in. A prime example is Sky Chaser, which I mentioned last earnings call, but there are numerous other opportunities that we see coming to fruition.

Security radar antennas could become as ubiquitous as security cameras and cellphone towers are today. The world's leading radar customers and US government agencies understand MACOM's unique position with scalable planar arrays better than anyone. For that reason, you can understand why we're bullish about the growth prospects of public and private sector investment in defending against these modern day threats to peace and prosperity.

Finally, in data centers, our service providers are still in the early innings of a long upgrade cycle to 100-gig and greater connectivity within their hyper-skilled data centers. Customer forecasts project 2019 and 2020 to be strong growth years for CWDM core, in particular, with the potential for 100-gig unit demands more than double in 2019 reaching estimated volumes over 10 million units next year. While CWDM won't represent the vast majority of unit volumes over the next few years, 2019 is also expected to see meaningful adoption of single lambda PAN-4. Rolling availability of 12.8 turbit switch token, like Broadcom's Tomahawk 3 Chip set, has spurred the introduction of new 128-port 100-gig Ethernet switching platforms from leading network equipment providers.

This, combined with a successful PlugFest in September, has triggered our customers to move forward with 100-gig PAN-4 transceivers. MACOM has entrenched design wins for 100-gig PAN-4 with the key skill players who are planning volume production next year. So we believe we are well-positioned to establish pre-eminent share in this first year of meaningful deployments of PAN-4. All in all, we expect optical connectivity for cloud data centers to remain a strong growth opportunity for years to come with an accelerated pace of innovation and strong underlying economics. With each sequential quarter, we expect to build upon our business in the intellect CDRs, drivers, and TIAs, layering on Top 25-gig lasers, DSP 5s, and LPegs for CW to M4, as well as PAN-4 as it grows to relevant share over time.

Major network equipment and transceiver OEMs and cloud service providers understand MACOM's potential better than anyone. For that reason, you can understand why we're bullish on our short- and long-term growth prospects in cloud data centers.

To conclude, we remain squarely fixated on getting back to our target financial operating model of 60% gross margin, 30% operating margin, and 60% free cash flow. Our Fiscal Q4 results were another step in the right direction. Over the course of Fiscal 2019, we expect a combination of growing revenue contribution from our secular growth drivers and prudent OpEx management to provide leverage for expanding operating margins.

The current trade tensions with China present lingering uncertainties and will remain on-watch for signs of sluggishness in the intellect markets, as recorded by some of our larger peers. In light of these factors and historical seasonality, we're guiding Q1 based on hard orders and backlogs. Moving forward, we're taking it one quarter at a time, guiding based on customer backlog, order visibility, and our operational ability to scale these new products and technologies.

That brings me to Q1 guidance. For the Fiscal First Quarter ending December 28, 2018, we expect revenue to be in the range of $150 to $156 million. Adjusted gross margin is expected to be between 55% and 57%, and adjusted earnings per share between $0.18 and $0.22 on an anticipated 66.5 million fully diluted shares outstanding.

Operator, you can now open the call for questions.

Questions and Answers:

Operator

Thank you, sir. Ladies and gentlemen, at this time, if you'd like to ask a question over the phone lines, press * and then 1 your telephone keypad. To everyone participating in the Q&A session today, we kindly ask that you limit yourself to one question and a follow-up to allow everyone a chance to ask a question. If your question has been answered or you wish to remove yourself from the queue, simply press the # key.

And our first question will come from the line of Quinn Bolton with Needham & Company. Your line is now open

Quinn Bolton -- Needham & Company -- Analyst

Hey, guys. Congratulations on the results. I wanted to start, first round, on the data center opportunity. You've got a pretty strong position in PMDs for the energy market. It sounds like you also have some growing traction in the PAN-4. Can you give us some sense, how quickly could the PAN-4 business ramp in Fiscal '19 for you? Sounds like you've got wins across both some network equipment, as well as transceiver customers.

John Croteau -- President and Chief Executive Officer

Good question. So let me address that on PAN-4 first. So, like I said, the PlugFest that was actually on September 11 of all days, was very successful for our customers. They began the process of introducing products. I have to be a little careful about telegraphing their introduction timelines. I would say it starts making material contribution in the latter half of 2019. And it'll ramp materially, but it's still going to be, frankly, dwarfed by CWDM4 volumes in 2019.

I missed the second half of the question. You can do a follow-up.

Quinn Bolton -- Needham & Company -- Analyst

Oh, yeah. It was just, the follow-up was actually going to be more on the 5G GaN-on silicon opportunity. If you talk about that market tripling as we move to 5G and GaN-based PAs, and again, sort of a similar question. Big opportunity for you over a multiyear period, but is it significant for you, do you think, in Fiscal '19 in terms of the GaN contribution?

John Croteau -- President and Chief Executive Officer

Yeah, I mean, we've learned the hard way about trying to guide one quarter at a time. The simple answer to that is if you look at the public reports on 5G deployments, our revenue opportunity reflects exactly that ramp, which there are deployments beginning this year, but it really hits its stride in 2021--2022 timeframe and it continues into '23. So I wouldn't describe it as a present tense, but certainly it is hot and heavy right now in terms of customers lining up their supply chain. Now that the litigation is over I can talk more openly. It's actually quite shocking when you see the unit volumes and the wafer consumption requirements. You're talking about integer multiples higher than LDMAs in the previous cycle of the 4G LTE cycle. So it's really an operations challenge for our customers, but I think we're perfectly positioned with this settlement.

Quinn Bolton -- Needham & Company -- Analyst

Thank you.

John Croteau -- President and Chief Executive Officer

Yeah, you're welcome. Good questions.

Operator

Thank you. And our next question will come from the line of Harsh Kumar with Piper Jaffray. Your line is now open.

Harsh Kumar -- Piper Jaffray -- Analyst

Hey, guys. A couple of questions. We are hearing about a lot of dislocation in China. Your numbers are fine. I guess I'm curious, what are you seeing in the Chinese market? I know that's a big important market for you. Also, at this time, the China optical -- usually adjust inventory. You seem to be avoiding that. Again, could you talk about some of things that you're seeing there? And I had a couple of other follow-ups.

John Croteau -- President and Chief Executive Officer

Yeah, absolutely. So China, I mean, we're a little bit different. A lot of the other people who report about China are more pure play. They have a single business. We have two, three, four significant businesses. So it's kind of a mixed bag. On the positive side, the metro long-haul stuff looks to be quite healthy. The customers have burned off the inventory. The forward shipments are very healthy and growing. There is that mix from long-haul to metro. But I think that's back to normal. You go to the other end of the spectrum, we got this unexpected denial order on product going into aerospace customers in China. So that was ugly. And there's other stuff, like the PON market that's kind of in the middle. So there's no simple answer, at least for us, in China.

Harsh Kumar -- Piper Jaffray -- Analyst

Got it, John. And then I was curious, a couple of the other companies that we cover have talked about China data center ramping pretty hard and fast in early part of 2019 with 25-gig lasers. You have those products. You've got, historically, a pretty strong presence in that geography, as well, and in optical. I'm curious if your opportunity charts, sort of, that path. And then, also, on a similar line, several other companies are talking about small revenues and 5G. I'm curious if you can talk about what revenues you have. They are talking about a steep ramp, which I think you're talking about, too, if I'm not mistaken.

John Croteau -- President and Chief Executive Officer

Yeah, so on China data center, we don't have to wait for lasers. Our analog business is smoking over in China selling into Chinese data center customers and applications. So in China, in general, both for data center and 5G mid-haul, front-haul, there is an extreme interest in moving to these 25-gig lasers and associated 100-gig analog components and quite possibly even the PAN-4 5s. So China will be an exciting market, too. It's still, I think, going to be a challenge to catch up. Certainly on the data center side, you have the strength between the Facebooks, Googles, Amazons, Microsoft, Apple. It's still a very North American centric market. But forecasts for 5G optical are similar magnitude. So it's, to me, a very healthy global market for our analog components, lasers, and 5s.

On the 5G revenues, we don't break things out at that level of detail. We are shipping material revenue in 5G fans, as well as hand products and those initial systems. But I wouldn't say it's a growth driver, yet. But there is very real revenue with the right guys.

Harsh Kumar -- Piper Jaffray -- Analyst

Got it. Thank you so much.

Operator

Thank you. And our next question will come from the line of Blayne Curtis with Barclays. Your line is now open.

Blayne Curtis -- Barclays -- Analyst

Hey, guys. Thanks for taking my question. Maybe just from a very high level, your guidance for December is up a few million dollars. Just any color on the segments? I think it sounded like data center would grow again, but maybe some color on the other segments would be helpful.

John Croteau -- President and Chief Executive Officer

That's a good question, Blayne. I would say the end-market demand across all segments is fine. It's healthy. The two things that really moderate our projections for the next quarter, one is we have that headwind now, unanticipated, with Chinese aerospace customers, which we quantified at $2 million, maybe as much as $4 million. So it would have been stronger in the absence of that. The other thing is, we have seen in previous years and we're planning for in our guidance, year-end inventories to canyon, especially over in China. Our customers, in many cases, are incentivized with bonuses on year-end inventories. So we want to make sure that we can support them in the manner that they want to manage their inventories.

So I would say with those two factors aside, the end-markets across all three are still quite very healthy.

Blayne Curtis -- Barclays -- Analyst

Thanks. And then maybe a question for you or Bob. I thought that you were going to see an elevated amount of CapEx from your foundry partner in September. It looks like it was kind of flat. So one, is that happening December? And maybe can you just give us some color as to the progress of ramping ST Mic up?

Bob McMullan -- Senior Vice President and Chief Financial Officer

Blayne, you're correct. We did identify a capital expenditure for ST Micro. That's been pushed out for reasons that are not to be translated to anything else, that I expected to make a one-time payment, but I've learned that we can pay for that over time. Not in an installment-like payment, but we make a deposit first, and we make progress payments, as I noted last quarter, is a large amount, but it will be paid as it comes together, here. And the final payment will be on delivery. So rather than it being a one-time full amount payment as I anticipated last quarter, it will be paid in multiple payments across the balance of Fiscal '19.

John Croteau -- President and Chief Executive Officer

So you added a little quote there at the end, there. I'll speak to Blayne. So in terms of working with ST to ramp capacity, let me tell you, at the top ranks of ST, along with us reacting to these very bullish forecasts in terms of capacity commitments, we're working together to get that -- not just the initial capacity ramps, but we need a 3- to 5-year capacity ramp for this as well as adjacent markets. Now that we have the rights for the GaN-on silicon patents, we can enable ST on a broader basis. So that relationship and the outlook on collective business has never been brighter. I think if you talk to the ST folks, you'll hear a similar level of enthusiasm.

Blayne Curtis -- Barclays -- Analyst

Thanks, guys.

Operator

Thank you. And our next question will come from the line of C J Muse with Evercore. Your line is now open.

C J Muse -- Evercore ISI -- Analyst

Good afternoon, thank you for taking my question. I guess, first question is, you looked at Fiscal '19. Trying to parse through what is near-term growth for you guys versus a bit longer-term. So if you think about data center 5G, defense, other, how would you rank order what you would expect in terms of revenue growth in absolute terms looking at Fiscal '19 versus Fiscal '18?

John Croteau -- President and Chief Executive Officer

Yeah, again, we're cautious to guide one quarter at a time. And the reason is, is simple. In the short-term, here, the thing that -- we've got a nice, healthy, strong industrial defense demand. That said, we just posted 8% sequential growth after a 10% the prior quarter. So it's hard to sustain that on a quarter-by-quarter basis. But that demand seems to be holding up quite well. The telecom stuff, I think it's the 5G kick-in as you go through the course of the year. It's kind of back-loaded. The data center stuff right now, ramping specifically the lasers and merchant market sales, as well as our solutions business is, I would say, the clear and away No. 1 organic growth driver.

In terms of our ability to grow this year, I think you get the sense from the bullishness of my comments about long-term growth prospects, we have a lot of juice. I can tell you, we are very well-positioned in a lot of areas that the industry is really heating up. But the most difficult thing and the thing I really caution is, you got to be careful with time. We have the right customers. They have the right programs. You got certain field trials that are going very well. But until we see the orders and we can guide, we keep trying to express caution.

But everything I spoke about has never been more real.

C J Muse -- Evercore ISI -- Analyst

That's very helpful. I guess a question for Bob. It looks like your applied OpEx is around 65.5 million, pro forma, give or take. And just curious, as part of that, are you including the full benefit of reduced litigation expense as well as cost savings from factory shutdowns?

Bob McMullan -- Senior Vice President and Chief Financial Officer

So just help me with the question of timing. In that question, are you -- litigation, I think...

C J Muse -- Evercore ISI -- Analyst

So the OpEx that you guided for implied in December, does that include the full benefit of factory shutdowns, as well as reduced litigation expenses? Or should we be thinking about further savings looking into the fourth quarter?

Bob McMullan -- Senior Vice President and Chief Financial Officer

The answer is the expense savings for the shutdowns are included in the sale of the businesses, particularly the high rail business. The litigation expenses, we did not include in GAAP results as not being more or less one-time event. So they don't impact the level of operating expenses that we report.

C J Muse -- Evercore ISI -- Analyst

Okay, thank you.

Operator

Thank you. And our next question will come from the line of Harlan Sur with JP Morgan. Your line is now open.

Harlan Sur -- JP Morgan -- Analyst

Good afternoon. Thanks for taking my question. InFX glued the $7 million in non-product revenues from the data center business in June. Your data center business was strong already. It grew close to 20% sequentially. Can you guys just help us understand what drove the strong product growth? I know you mentioned the 25-gig laser ramp was probably a big part of that. I'm also wondering if the transceiver solution, the white box conceiver partnership also contributed to the incremental revenues in the quarter and any other colors on some of the incremental growth drivers in the DC business.

John Croteau -- President and Chief Executive Officer

Yeah, it's a good question. So just to be clear, when we talk about laser sales, it's both in a solutions model, as well as merchant market. So we really don't segment it out. I don't want to confuse people with the product service model. With some of the lasers, a laser is a laser is a laser. How the demand was generated, it was a separate issue. But yeah, you're right. It was a strong contribution on the laser ramp. That wasn't just it.

We actually had some recovery on some stuff in the core connectivity business, which was previously known as applied micro, there's some core stuff with a particular large customer that comes, kind of, lumpy. So we had a favorable tailwind last quarter. I won't get into the operational challenges that customer has, but it can show up as tailwinds or headwinds on a quarter-by-quarter basis.

But unequivocally, you're right. It was 18% sequential growth on data centers on product revenue. And lasers was and continues to be a big part of that.

Harlan Sur -- JP Morgan -- Analyst

Good to see the momentum there. Bob, on the gross margins in the September quarter, it was about 120 basis points below the midpoint of your guidance range. First, I guess, is what drove the slightly lower margin performance? And then on the flip side, what's driving the strong 120 basis improvement in margins going into the December quarter?

Bob McMullan -- Senior Vice President and Chief Financial Officer

Harlan, there's a couple things. So we did have the tail-end of the high rail business that wasn't our most attractive gross margin business. That goes away for the small piece it was. That will contribute to the increase in gross margins in Fiscal Q1. And then again, the aerospace customers that we were denied the ability to ship had very, very attractive margins, and that, too, brought the margin, overall, down. Those things are accounted for now in our guidance and, therefore, the range that we have delivered here.

Harlan Sur -- JP Morgan -- Analyst

Great, thank you.

Operator

Thank you. And our next question will come from the line of Mark Delaney with Goldman Sachs. Your line is now open.

Mark Delaney -- Goldman Sachs -- Analyst

Good afternoon, thanks for taking the questions. First question was a follow-up on the data center and the laser opportunity. I know shipping components to white box suppliers to go into hyper scale, or has it been one of the efforts, either through licensing or direct sales? And I was wondering if you could be a bit more explicit to what extent you're starting to see volume revenue of those programs either in the completed quarter or what's assumed in your guidance?

John Croteau -- President and Chief Executive Officer

Yeah, now you're talking about slicing and dicing at a lower level, yet. I don't have the numbers in front of me, actually, in laser breakout between different customers with different models, but I can give you the general shape. I would say because the new lasers with the improved yield and reliability are still new, it tends to be skewed toward the demand that we generated ourselves with our solutions model earlier.

That said, we are very aggressively going out selling what we call merchant market sales of the lasers. Frankly, we have no preference to one model versus the other. Anybody wants to buy a laser at the right price is more than welcome to do so. It's just one is more controllable demand creation. The other one is more traditional component demand creation. And I think over time, there is a lot of very healthy people out there who have their own designs that are more than happy to be buying our lasers. So it's really speculative about how much share we can drive, how quickly. And that's going to be an unfolding situation over the course of the next 90 days as we go out and drive that demand creation.

Mark Delaney -- Goldman Sachs -- Analyst

Got it. And then a follow-up question on the settlement and license with Infineon that you mentioned. Can you help us better understand what financial terms might be associated with that? Is Infineon paying MACOM any sort of royalties? And maybe help us understand, are those potential royalty payments, are those things that MACOM will be seeing now? And when Infineon potentially can start ramping in 2021, what does that mean for potential royalty payments?

John Croteau -- President and Chief Executive Officer

Yeah, so there are confidential terms in the settlement. And this was perhaps the most sensitive area for Infineon. So I don't have the liberty to discuss the financial terms of the settlement other than just the fact that we accomplished all the goals for all of the litigation, not just that, that we had set out when we originally litigated against Infineon. So I don't mean to dodge the question, but we are covered by confidentiality in the terms of the agreement.

Mark Delaney -- Goldman Sachs -- Analyst

Got it. Maybe just that couldn't count for my second question. Maybe a different one, then. There's potential M&A among some of the optical companies and I was hoping you could help us understand what impacts you may see to that to MACOM, if any, in the near and intermediate term. Thank you.

John Croteau -- President and Chief Executive Officer

Yeah, I don't think there's anything that's been going on that's had positive or negative impacts. I think we're just fascinated by the 2-6 finSR combination. I don't see that, necessarily, as a positive thing or a negative thing for MACOM. It's a very interesting combination. But this optical industry continues to evolve. And the consolidation was predictable and further consolidation is probably predictable. A lot of these high bandwidth transceivers, one would look at it as commoditizing. We view it as just scaling into semiconductor-type model. So the more differentiating, more boutique -- and I say that in a positive sense, not a negative sense -- transceiver guys, it makes sense for them to consolidate. But it's all good. They're all good customers for our end-log and metro, long-haul businesses. So it's just fun to watch, to be honest.

Mark Delaney -- Goldman Sachs -- Analyst

Thank you.

Operator

Thank you. And our next question will come from the line of Mark Kelleher with DA Davidson. Your line is now open.

Mark Kelleher -- D.A. Davidson -- Analyst

Great, thanks for taking the questions. Just wanted to ask, back on the data center business -- I know we've talked a lot about that, here -- but can you just give us, maybe, a high-level view of what you see as the competitive position there? I know you're selling to a partner and the partner is selling on, but very price competitive part of the market. And there was also some disruption this quarter with a competitor that couldn't deliver. So I'm just wondering if you're seeing any changes in the market share dynamics or in the pricing dynamics over on the data center side?

John Croteau -- President and Chief Executive Officer

Very fascinating question, yeah. So I would describe it this way. As any market evolves from a modest sized boutique into a very high-volume market, like we're seeing these high-speed connectivity products into data centers, the economics change. The ASPs change. And we have done a fantastic job in our high-performance analog supplement of following those market price points, maintaining and growing share, maintaining -- not growing -- gross margin. We have long-term agreements with very high share companies that we've grafted. So we've been able to survive and thrive in that consolidating market. And it's a natural progression. It's not a negative thing. You just have to plan for it and plan your cost structure accordingly.

I describe it this way, in our analog business, we tend to compete with Suntec inside the data center -- inside. Outside the data center, it tends to be we compete with In-fi. And Suntec's a great company. It's good. The industry needs multiple healthy sources and they're a high-quality competitor.

On the laser side of things, yeah, there's been some negative developments for some of our -- I wouldn't call them competitors as much as customers. They're not part of our SAM, but certainly part of the FAM. And there's some share-shifts that are available, favorable to us. We don't thrive on other people's misfortune, but we've had our own struggles that we worked through, ourselves. And now other people are dealing with similar things. I think we're showing up at the right time with the right products, proven reliability, great cost structure, and the industry continues to sing for the laser side in a supply shortage mode for the foreseeable future. It's all good. And now, as the PAN-4 stuff starts to ramp, PAN-4 to us is just another standard. We're not religiously for or against it.

We've got a great position with our 100-gig 5. We'll have the lasers. We already have the analog content leadership position. So it's a very healthy spot to be in and I think we have a very credible position selling pretty much something to everybody. Not everything to everybody. It's never a world domination, but it's a very nice area. There's a lot of healthy growth because the economics are good. Cloud data center is a revenue generator for them, not a negative thing. So we're obviously very bullish and I think we're holding our own, if not expanding our position.

Mark Kelleher -- D.A. Davidson -- Analyst

Okay, great. Congratulations on the progress. Thanks.

Operator

Thank you. Our next question will come from the line of Tim Savageaux with Northland Capital. Your line is now open.

Tim Savageaux -- Northland Capital Partners -- Analyst

Good afternoon and congrats on a solid quarter. Let me continue to beat the datacom horse. As you noted, you had, I guess, both a customer and a competitor struggle with some of the very same issues on the laser side that many have encountered. That didn't appear to impact your overall datacom business. But I wonder, I think you called that double-digit growth and analog ICs and datacom last quarter. Should we assume that had some impact and that datacom growth in the quarter and maybe heading forward is more laser and maybe legacy driven than analog IC driven, or no?

John Croteau -- President and Chief Executive Officer

No, no. Well, percentage wise, sure. As we're in a fully mature position, leadership share, on the analog side, and we're a relatively new entrant with the lasers. But in spirit, I'd put it this way. There's a lot of moving parts, both on the analog side as well as the laser side. We're in a relatively supply constrained or supply defined growth curve. On the laser, it's simply because we're moving material through our factory and it's a multi-floor production time. And you don't start uncontrolled with a step function in materials. So it's a controlled ramp, as we described.

Even on the analog side, lead times from our suppliers for those class of wafers are extended. So it's not like we can magically pull more material in. I think it's one of the reasons why we've been able to hold shares so well because our customers understand that whether it's us or our competitors, people aren't just sitting on infinite inventory to be able to react momentarily to some share shift. So it's very methodical in terms of the growth. The unit growth is fantastic. Again, it's moderated with the changes in the ASPs. But I think from an operational execution standpoint, we're clicking on all cylinders in that business. And it looks like we're off to the races with the lasers, now, as well as.

Tim Savageaux -- Northland Capital Partners -- Analyst

All right, so it sounds pretty balanced. And just to follow-up, in terms of guidance, I just want to make sure I understand. So given the denial order that you mentioned, should we expect industrial and defense down $2 to $4 million sequential and the offset to be growth of the communication side? And in that context, it sounds like datacom would be probably driving that based on some of your comments.

John Croteau -- President and Chief Executive Officer

Well, actually, so on the I&D side, we grew 8% sequential, having taken that hit on the aerospace and Chinese aerospace stuff. So that continues, but it's not a sequential impact. And I'm sorry, I missed half your question. It was about telecom or data centers?

Tim Savageaux -- Northland Capital Partners -- Analyst

Well, no. The second half was predicated on the first half, and you just said there's no incremental impact. So that's fair enough. I think you were asked before about the relative drivers of any sequential growth heading into the December quarter and it sounds like you put datacom at the top of that list.

John Croteau -- President and Chief Executive Officer

Yeah, datacom, it clearly would be the strongest. I'd put it this way. I don't want to dodge the question, but the end-market health across all three is solid. So we don't see an end-market demand issue. The thing that we can't predict is -- one of the factors we calculated in is December tends to be a seasonally soft quarter. We have customers who manage their inventories down. We just don't know which customers and which product for which end-market. So that is, kind of, a top-level judgement that we apply. And depending where and which products, it could show up weakening one versus others or all three. We just don't know. But there's nothing that we see in our portfolio that is showing end-market weakness.

Tim Savageaux -- Northland Capital Partners -- Analyst

Got it. Thanks.

Operator

Thank you. And just as a reminder, ladies and gentlemen, please limit yourself to one question and one follow-up. Our next question will come from the line of Richard Shannon with Craig Hallum. Your line is now open.

Richard Shannon -- Craig Hallum -- Analyst

Hi guys. Thanks for taking my questions. I'll apologize. I'm remote today and a little bit of background noise. So if it's too loud, I apologize. I'll just ask one question and jump out of line, here, on gross margins for you, Bob. You talked about a goal of getting to 60%, so you've held for quite some time. And it sounds like we're on a trajectory moving that way. Maybe if you can give us some help on a multi-quarter trajectory of, perhaps, what kind of revenues do you need to get to that? And are there any puts and takes either above or below incremental gross margins that allow you to get to that level? Any way you can help us track that path over the next few quarters as you continue to grow?

Bob McMullan -- Senior Vice President and Chief Financial Officer

Richard, in the context, and again, beholding to our one quarter guide at a time, I'll give some flavors of what drives mix that increases gross margin. And let me start with lasers. We talk about the improvement in yields where there, as John talked about in his prepared remarks incrementally increasing yields, significantly contributes to gross margin expansion over the course of Fiscal '19. Our field trials that are supporting 5G rollouts, both internationally as well as in North America have very high-margin products. They're mature in technologies and priced the right way, all of which contributing to continued growth on the top-line and continue margin expansion as we march through the year.

Richard Shannon -- Craig Hallum -- Analyst

That's helpful. I'll jump out of line, guys. Thank you.

Operator

Thank you. And our next question will come from the line of Vivek Arya with Bank of America. Your line is now open.

Vivek Arya -- Bank of America -- Analyst

Thanks for taking my question. A question on China. You mentioned that the recovery is complete. I'm curious, how much is China as a percentage of sales now. Was there any abnormal bind because of the tariffs-type issues, and are there any steps that you're taking to make sure that the industry, kind of, avoids some of the inventory issues that we saw over the last year?

Bob McMullan -- Senior Vice President and Chief Financial Officer

Vivek, so China business this year was up about 130 basis points over the last quarter, which is 29 and change of total revenues. And again, it goes across multiple markets. It would have been higher if we could have shipped to the aerospace customers. But that, from our peak at almost 40% of revenues still has some room for recovery just in China, alone. Some of that reduction in revenues, as we've talked about in the past, some of the products we're offering, our next generation products at lower ASPs, no effect on gross margin contribution, but a different revenue mix in markets, some of our more mature markets we've talked about. No, we don't see abnormal buying ahead of any government imposed, whether US tariff or China tariff at the moment. As John talked about, we do see seasonality in China, particularly in our first fiscal quarter, and this is what we expect to continue here. So we see no unusual buying pattern as we've seen here, today, nor are the orders coming in in a way that would suggest something different.

Vivek Arya -- Bank of America -- Analyst

Thanks, very helpful, Bob. And for my follow-up, I was hoping you could talk about the competitive landscape in PAN-4. I think one of your competitors has spoken about a lot of design wins. How important is gaining market share in PAN-4 to what you're thinking about in 2019 from a top-line growth perspective?

John Croteau -- President and Chief Executive Officer

Good question. So first of all, we're a little bit different than I think the people you are referring to. We have a very strong position inside the data center with the stuff that is in very high volume today. So PAN-4, even with 100% market share, go to the extreme, it contributes meaningfully. I don't want to say it's not meaningful, but it's not a huge swing factor in terms of our data center business. It's not like the lasers. The lasers are addressing the 90-something percent of demand, which is CWDM4. Sorry, I don't want to understate the importance of PAN-4. On a go forward basis, it becomes more and more important.

I think the other thing, the confusion factor, is a couple of things. One is when we inherited applied micro, they had pursued, I call it, a quality design win program, rather than a quantity design win program, meaning, the people they have are the people who matter in a big way. And we've sustained those and supported those and those that you keep referring to. They also tend to be the people that we can't talk about publicly because they're the people who hold their strategy near and dear to their hearts. They don't appreciate us telegraphing to the world what they're doing.

Lastly, I think that there is a lot of swirl and confusion about 40-gig versus 100-gig PAN-4. And the thing I would caution people is we're a semiconductor vendor, not a transceiver guy. And PAN-4 at 400-gig, at least, is similar to where CWDM4 was about 3 years ago, I would say, is probably the analogy. So in that early part of the ramp, there is meaningful transceiver business. You can have a nice transceiver business. But in terms of return on investment and material revenue as a semiconductor provider, you have to go where the volume is. And that's the reason why we're fixated right now on 100-gig because if you look at the customer forecast for 100-gig, they start to meaningfully overlay on top of CWDM4 and that's where we're fixated.

In terms of our position at 100-gig, to be honest, we don't see anybody right now with a product that meets the power budgets, that has production mass sets that can mold into mainstream manufacturing in the next year. So I think we're pretty comfortable with our share position and the guys that we've been servicing who I think are the market makers. So it'll be nice, I think. It'll contribute to the top-line growth. But at least for the next year, the mix is much more toward CWDM4. I think that changes, by the way, as you move forward over the coming three years. But when we're talking about next year, which is what we tend to try to talk about now, rather than over the horizon, PAN-4 has a very modest contribution in terms of mix.

Vivek Arya -- Bank of America -- Analyst

Thanks very much, John. I appreciate it.

Operator

Thank you. And our next question will come from the line of Tore Svanberg with Stifel.

Tore Svanberg -- Stifel -- Analyst

Yes, thank you. John, maybe a follow-up on the last question. So if you look at the market for next year, what are you expecting for 110-4 ports next year? And are you still expecting close to 10 million ports for CWDM4?

John Croteau -- President and Chief Executive Officer

I got to be careful because if I talk about our ports then I'm going to be telegraphing what our customer forecasts are. So I'd like to get back to you, to be honest, so I can pull on the market reports from one of the analysts, so then I'm not inappropriately sharing customer information. But anyways, I would say, let me generalize and say PAN-4 would be 1 less than 10% of the ports relative to CWDM4. Maybe that helps.

Tore Svanberg -- Stifel -- Analyst

Thanks. That makes sense. And as my follow-up, could you maybe go to some of the sign posts that we should be following when it comes to the capacity ramps for GaN? So obviously, you have that partnership with ST. CapEx is probably going on right now? When will the capacity be up and running, at least as far as meaningful revenue is concerned?

John Croteau -- President and Chief Executive Officer

Well, we have meaningful revenue today. But the spirit of your question is when does it turn into an inflection point to really be the secular growth driver that we talk about? I would say as you go each quarter through the second, latter part of 2019, if you look at general market reports of 5G deployments, the later you get into '19. But where it really hits its stride and the other customers are very concerned about supply is when you get into the following year, 2020. And '21, '22 are -- actually, I would say even '20, '21 and '22 are very intense years in terms of the buildout, the profile that our customers have given us.

So I don't want to create impressions that this is a step function in the present sense in the first-half of next year. But I can tell you that the design for the programs are very, very real.

Tore Svanberg -- Stifel -- Analyst

That's very good. Thank you. Thank you, John.

Operator

Thank you. That concludes our question and answer session for today. So now, it's our pleasure to hand the conference back over to John Croteau, Chief Executive Officer for closing comments and remarks.

Great, thanks. So before closing out today's call, I will mention that we'll be attending a number of investor events between now and year-end, including the Raymond James technology conference on December 3 in New York. Barclays global TMT conference on December 5 in San Francisco, Collins Networking and Cybersecurity Summit on December 11 in New York and then the D. A. Davidson Laser Optical Forum on December 13 in Boston. If you'd like to arrange a meeting at one of these upcoming events, please email us at IR@MACOM.com. That concludes today's remarks. Operator, you may not disconnect the call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Everybody have a good day.

Duration: 68 minutes

Call participants:

Steve Ferranti -- Vice President of Investor Relations

John Croteau -- President and Chief Executive Officer

Bob McMullan -- Senior Vice President and Chief Financial Officer

Quinn Bolton -- Needham & Company -- Analyst

Blayne Curtis -- Barclays -- Analyst

C J Muse -- Evercore ISI -- Analyst

Harlan Sur -- JP Morgan -- Analyst

Mark Delaney -- Goldman Sachs -- Analyst

Mark Kelleher -- D.A. Davidson -- Analyst

Tim Savageaux -- Northland Capital Partners -- Analyst

Richard Shannon -- Craig Hallum -- Analyst

Vivek Arya -- Bank of America -- Analyst

Tore Svanberg -- Stifel -- Analyst

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