Lumentum - Q4 2023

Transcript

Operator (participant)

Good day, everyone, and welcome to the Lumentum Holdings' fiscal fourth quarter and fiscal year 2023 earnings call. All participants will be in a listen-only mode. Please also note today's event is being recorded for replay purposes. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. At this time, I would like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please go ahead.

Kathy Ta (VP of Investor Relations)

Thank you, and welcome to Lumentum's fiscal fourth quarter 2023 earnings call. This is Kathy Ta, Lumentum's Vice President of Investor Relations. Joining me today are Alan Lowe, President and Chief Executive Officer; Wajid Ali, Chief Financial Officer; and Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer. Today's call will include forward-looking statements, including statements regarding our expectations and beliefs regarding synergies of recent acquisitions, including NeoPhotonics, financial and operating results, macroeconomic trends, trends and expectations for our products and technology, our end markets, market opportunities and customers, and our expected financial performance, including our guidance, as well as statements regarding our future revenues, financial model, and margin targets. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings.

We encourage you to review our most recent filings with the SEC, particularly the risk factors described in the quarterly report on Form 10-Q for the quarter ended April 1, 2023, and those in the Form 10-K for the fiscal year ended July 1, 2023, to be filed by Lumentum with the SEC. The forward-looking statements provided during this call are based on Lumentum's reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements except as required by applicable law. Please also note that unless otherwise stated, all financial results and projections discussed in this call are non-GAAP. Non-GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with GAAP.

Lumentum's press release with the fiscal fourth quarter and full year 2023 results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. With that, I'll turn the call over to Alan.

Alan Lowe (President and CEO)

Thank you, Kathy, and good morning, everyone. We are extremely optimistic about the long-term secular demand drivers in the markets in which we participate and lead. Additionally, our efforts and investments to grow our share in our existing markets and adjacent markets are generating positive traction that will benefit us for years to come. Our focus on technology and product leadership will ensure our growth and differentiation in support of our customers' needs now and into the future. In the near term, we are facing significant headwinds as both our direct and end customers actively work to reduce their elevated inventory levels. We believe that the current customer inventory correction cycle will continue through the balance of the calendar year, and therefore, our shipments will be well below end market demand.

Even at these depressed shipment levels, we believe we are continuing to grow our market share outside of the consumer market. We are seeing meaningful demand strengthening for our datacom chips as hyperscale customers prepare to ramp AI capacity. We believe that our telecom and datacom revenue will be up in calendar 2024 compared to calendar 2023, as inventory levels should return to more appropriate levels at our customers and their customers. Despite the inventory headwind we experienced in the second half of fiscal 2023, our full year revenue was up 3% from fiscal 2022. Also, fourth quarter revenue and EPS were both above the midpoints of our guidance ranges we announced last quarter. Our acquisition integration is going very well, and in fact, we have completed our ERP consolidation and are now running on one company-wide ERP system.

We are tracking ahead of our previously announced synergy plans, while we continue to deliver on our new product and technology roadmaps. At the same time, we continue to focus on our customers to drive an even stronger partnership and a differentiated level of satisfaction. ROADM revenue was especially strong in Q4, with increased sequential shipments across all ROADM product categories. Also, our commercial lasers business grew sequentially, particularly in new applications of ultrafast lasers for the solar cell market. As I indicated earlier, long-term demand trends for photonics products continue to be extremely favorable. Generational upgrades to C+L band, as well as extended C band and extended L band architectures, are underway in the backbone of networks where our transmission and transport products are highly differentiated and enabling for our customers.

We are designing products for the next generation of our customers' photonics roadmaps, which will use 130 Gbaud and 200 Gbaud data rate coherent technologies. We are developing these high-speed products in both discrete and integrated form factors, paving the way for enhanced performance in metro and long-haul applications, as well as new applications at the edge of the network. With the addition of the teams from our NeoPhotonics and IPG acquisitions and the capabilities to develop DSPs and RFICs, we believe that our vertically integrated approach to these high-speed transmission products will give us the lowest product cost in the industry. We demonstrated our coherent 800G ZR technology earlier this year, which we believe is the industry's first, which will provide high-speed connectivity with extended reach for data center interconnect within metropolitan areas.

Turning to cloud data centers, as I indicated earlier, we are seeing increased customer activity for AI in the data center and expect this to translate to increased shipments of our chip level products for 800G transceivers. We have broadened our datacom product portfolio with continuous wave or CW lasers for silicon photonics applications that connect server racks in AI clusters, which require higher data rates while consuming less power. Starting in fiscal Q1, we expect a return to sequential growth in our datacom revenue. The data center optical component market is projected to grow sharply over the next four to five years to accommodate the increased traffic associated with AI as customers employ ever higher bandwidth interconnects between racks, within racks, and between servers and storage.

We also believe that datacom VCSEL growth will be meaningful in the next several years as copper is replaced by short-reach, multi-mode optical links. As stated earlier, we expect telecom and datacom revenue to be up in calendar 2024 from calendar 2023 as customers reduce their inventory levels of our products and our shipment rate is more in sync with end market demand. Before I provide additional detail on the fourth quarter results, I would like to address the topic of China's export controls placed on gallium and germanium. We have determined that our existing supply is sufficient for the medium term, and therefore, we expect that these controls will have little to no impact on our manufacturing output. We will continue to monitor the situation and work with our suppliers to source material outside of China to mitigate any long-term impacts of these controls.

Now, let me turn to the fourth quarter and full year results. Telecom and datacom revenue was down 2% sequentially, but up 2% year-on-year. As expected, we saw sequentially lower shipments of tunable access modules in the quarter. As we expand our customer base and current customers complete near-term product transitions and reduce inventory levels, we expect this business to return to growth in fiscal 2024. The lower revenue in tunable access modules was partially offset by sequential increases in narrow linewidth tunable lasers and ROADM shipments across several leading customers. In fiscal 2023, our tunable access module product line achieved new record revenues, growing 57% year-over-year, with strength in metro access and fiber deep applications. These products enable cable MSOs and wireless network operators to improve network performance while avoiding the cost of replacing existing infrastructure.

In fiscal 2023, we doubled our manufacturing capacity for tunable access modules in our wafer fab and our back-end assembly and test factories to address the anticipated growth in our shipments to these customers. Our ultra narrow linewidth tunable lasers and our advanced ROADMs are key enablers of our customers' next generation network architectures that are just starting to be deployed. We saw sequential growth in narrow linewidth tunable lasers and across all major categories of ROADMs, including low port count, high port count, and contentionless M x N platforms. Fiscal 2023 ROADM revenue grew 22% from fiscal 2022, driven by the adoption of these advanced ROADM architectures. Cloud data centers are being redesigned to support the high bandwidth requirements of AI workloads. These workloads require several times more bandwidth than traditional cloud computing.

At this early stage of AI hardware deployment, 800G transceivers can provide the bandwidth while also reducing latency. The new 800 gig transceivers utilize eight different wavelengths at 100 gig per lane, triggering orders for our EML products and driving a return to growth for our EML product line. Additionally, we are seeing strong demand for our high-power CW lasers for customers utilizing silicon photonics to build 800G transceivers. In calendar 2024, our 200 gig per lane EMLs will enable the next generation of transceivers with capacity of up to 1.6 terabits. We expect to start ramping shipments of 200 gig EML products in calendar 2024, and customer qualifications of 800G and 1.6 terabit transceiver designs are well underway.

We expect our 200G per lane optics to be the workhorse of hyperscale data centers for years to come. To further address the connectivity requirements for AI and machine learning clusters, we have been developing high-speed VCSELs for short-reach connections between servers and switches in these systems, and we expect to begin to ramp these shipments meaningfully in calendar 2024. In the longer term, we also expect to supply even higher power CW lasers for leading AI hardware architectures to provide the high bandwidth, low latency, optical interconnects essential for training and inference applications. Turning to industrial and consumer, fiscal Q4 was down from Q3 and down year-over-year as expected, due to smartphone seasonality and end market demand.

We continue to expect our fiscal 2024 3D sensing revenue will be lower than that of fiscal 2023, due to our assumption around 3D sensing end market demand, pricing, and an additional competitor on a certain socket, as discussed previously. In the fourth quarter, commercial lasers revenue was up 4% sequentially, but down 2% from the same quarter last year. Overall, fiscal 2023 commercial lasers revenue was up 8% from fiscal 2022. We achieved a 35% sequential growth in ultrafast laser revenue and over 25% sequential growth in fiber lasers, which was partially offset by sequentially lower solid-state laser shipments, primarily for semiconductor applications. Our growth in ultrafast lasers is being driven by new applications, particularly in solar cell processing. We expect that as demand for these new types of applications grows, we will continue to gain share in ultrafast lasers.

Based on our latest customer forecasts, we expect overall commercial lasers demand to be softer over the next several quarters due to customer inventory digestion and macro factors impacting end markets. We expect continued rapid growth in new applications for our ultrafast lasers to partially offset these near-term headwinds. Although we expect our shipments in the near term to be soft, I'm very confident about Lumentum's mid to long-term prospects, given the current softness is primarily driven by high inventory levels, the fundamental end market and technology trends driving our growth expectations are strong and unchanged, and Lumentum is investing in R&D to capitalize upon the long-term growth drivers, and is uniquely positioned to serve our customers at scale with financial and structural resilience built into our business model.

In the near term, we are focused on expense controls while maintaining crucial R&D to continue to drive the forefront of innovation as we partner with our customers. Before turning it over to Wajid, I would like to thank our employees and our customers around the world for their focus and dedication as they continue to collaborate and partner with Lumentum as we execute upon our strategy. With that, Wajid?

Wajid Ali (CFO)

Thank you, Alan. Net revenue for the fourth quarter was $370.8 million, which was down 3% sequentially and down 12% year-on-year. As Alan mentioned, this revenue level was not unexpected and was driven primarily by the customer inventory digestion we have seen and expect to persist through the end of the calendar year. During the quarter, we had three greater than 10% customers, all in the telecom market, with no 10% customers in the consumer market. GAAP gross margin for the fourth quarter was 24.2%, GAAP operating loss was 15.1%, and GAAP diluted net loss per share was $0.88. Fourth quarter non-GAAP gross margin was 36.7%, which was down sequentially and year-on-year, primarily driven by product mix, factory underutilization, and lower revenue.

Fourth quarter non-GAAP operating margin was 9.1%, which decreased sequentially and year-on-year. Fourth quarter non-GAAP operating income was $33.7 million, and adjusted EBITDA was $59.4 million. Fourth quarter non-GAAP operating expenses totaled $102.4 million or 27.6% of revenue. Non-GAAP operating expenses were down $2.5 million from Q3 due to tight expense controls. Q4 non-GAAP SG&A expense was $40.7 million. Non-GAAP R&D expense was $61.7 million. Interest and other income was $13.3 million on a non-GAAP basis due to higher interest rates on our cash and investments. Fourth quarter non-GAAP net income was $40.2 million, and non-GAAP diluted net income per share was $0.59.

Our fully diluted share count for the fourth quarter was 68.6 million shares on a non-GAAP basis. Our non-GAAP tax rate remains at 14.5%. Turning to the full year results, fiscal 2023 net revenue was $1.77 billion, which was up 3.2% from fiscal 2022. GAAP gross margin for fiscal 2023 was 32.2%. GAAP operating loss was 6.5%, and GAAP diluted net loss per share was $1.93. Full year fiscal 2023 non-GAAP gross margin was 43.2%, which was down relative to fiscal 2022. Fiscal 2023 non-GAAP operating margin was at 19.2%, down from fiscal 2022. Fiscal 2023 non-GAAP operating income was $339.2 million, and adjusted EBITDA was $431.7 million.

For fiscal 2023, our fully diluted share count on a non-GAAP basis was 69.1 million shares. Non-GAAP net income was $315.3 million. Non-GAAP diluted net income per share was $4.56. On to the balance sheet. Cash and short-term investments increased $346 million sequentially to $2 billion, primarily driven by our convertible note offering. During fiscal 2023, we generated $179.8 million in cash from operations, of which $49.2 million was generated in fiscal Q4. During the quarter, we purchased 2.67 million shares for $139.8 million, which includes 2.34 million shares repurchased concurrent with the issuance of our 2029 convertible notes.

As we make progress on the integration of NeoPhotonics products into our global manufacturing footprint and attain synergies without impacting customer deliveries, we plan to carry elevated inventories over the short term. However, we expect inventories to decline by approximately $30 million exiting calendar year 2023 as we continue to focus on cash generation. Turning to segment details. Fourth quarter optical communication segment revenue at $320.5 million decreased 4.4% sequentially and down 13.6% year-over-year. Optical communication segment non-GAAP gross margin at 36.1% decreased sequentially and year-over-year. Our fourth quarter laser segment revenue at $50.3 million was up 4.1% sequentially and down 1.8% year-over-year.

Fourth quarter lasers non-GAAP gross margin of 40.6% was up sequentially, but down year-over-year. Let me move to our guidance for the first quarter of fiscal 2024, which is on a non-GAAP basis and is based on our assumptions as of today. We expect net revenue for the first quarter of fiscal 2024 to be in the range of $300 million-$325 million. Within this Q1 revenue forecast, we anticipate telecom and datacom and commercial lasers to be down sequentially, driven primarily by customer inventory dynamics we have discussed. We expect industrial and consumer to be approximately flat sequentially. Based on this, we project first quarter non-GAAP operating margin to be in the range of 1%-4% and diluted net income per share to be in the range of $0.20-$0.35.

Our non-GAAP EPS guidance for the first quarter is based on a non-GAAP annual effective tax rate of 14.5%. These projections also assume an approximate share count of 67 million shares. In terms of expectations beyond Q1, as Alan mentioned, we do expect a return to growth in telecom and datacom shipments in calendar 2024 compared to calendar 2023, as customer inventory levels are reduced and our shipment rate is more in sync with end market demand. Our synergy plan that we communicated at our March investor event at OFC is proceeding ahead of schedule in terms of operating expense reductions. We will exit certain manufacturing facilities at the end of this calendar year, which will deliver significant cost of goods sold synergies over the subsequent quarters.

Overall, we remain on track to the total synergy plan of $80 million in annualized savings that we articulated previously. We have achieved over half of the savings in fiscal year 2023. With that, I'll turn the call back to Kathy to start the Q&A session. Kathy?

Kathy Ta (VP of Investor Relations)

Thank you, Wajid. Before we start the Q&A session, I would like to ask everyone to keep to one question and one follow-up. This should help us get to as many participants as possible before the end of our allotted time. Now, let's begin the Q&A session.

Operator (participant)

Thank you, ma'am. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press star followed by the number one on your touch-tone phone. Again, that's star followed by the number one. If you would like to withdraw your request, please press star followed by the number two. Your first question comes from the line of Meta Marshall from Morgan Stanley. Please go ahead.... Again, Meta Marshall from Morgan Stanley, your line is now live. Please go ahead.

Meta Marshall (VP)

Sorry, thank you so much. Just having a buttons day. Just in terms of, you know, how you guys are evaluating, you know, how much of this is inventory correction versus potential for share loss or just not being involved in certain platforms? Just how are you kind of evaluating that given, you know, kind of repeated kind of step downs and maybe more particularly on the telecom business? Maybe as the first question.

Alan Lowe (President and CEO)

Yeah, thanks, Meta. As we said in the, in the remarks earlier, we believe we're not losing any share other than in the consumer space, where we've been talking about that share normalization and the third competitor. I'd say in telecom, we're very confident in our ability to continue to hold share, if not gain share, especially as we introduce new products. I, I, I firmly believe that, that, that the, the slowdown in revenue and the, and the is really mostly inventory correction and has really nothing to do with share.

Meta Marshall (VP)

Great. I mean, just as a follow-up, just how do you examine kind of what or get a sense of what the inventory positions are, and is kind of the belief that revenue would resume, kind of in the revenue growth would resume in the calendar 2024 period, based on, you know, when people are telling you that they want to start to get equipment again? Or is it a matter of, you know, that's when you think that budgets will open up from your customers, and they're expecting. I guess just, is that an expectation or is that backed by kind of conversations you're having with customers?

Alan Lowe (President and CEO)

Yeah, I wouldn't say it has to do with releasing of budgets. I think it's primarily due to the inventory levels on, on their balance sheets, and their desire to lower those, given the availability of components and the availability of us to supply. I, I, I would say that, you know, as we look at the next few quarters, telecom is gonna be tough, through the balance of the calendar year. I'd say that we're seeing some signs of inventory absorption faster than expected at, at some of the hyperscalers, where we expected that to, to take longer. I think AI is helping with that, both inside the data center as well as in the data center interconnect space.

I, I think from, from that perspective, you know, that's why we're confident about calendar 2024 being higher than calendar 2023. Those are really in-depth conversations with customer executives and, and really viewing our inventory in their locations and at their contract manufacturers. And, you know, that's why we believe that the next couple quarters are gonna take to get rid of that inventory.

Meta Marshall (VP)

Great. Thank you. I'll pass it on.

Kathy Ta (VP of Investor Relations)

Thanks, Meta.

Operator (participant)

Thank you. Your next question comes from the line of David Vogt from UBS. Please go ahead.

David Vogt (Managing Director and Senior Equity Analyst)

Great. Thank you very much for taking my question. Just two for me. One, Alan, you know, going back to the inventory question, I guess, can you kind of help us understand... You made a comment that you think you're under shipping to industry demand, where that demand might be today, and how you see that demand sort of progressing as we move through this sort of more challenging period of time in 2023 into 2024, that kind of colors your view about recovering, you know, back to growth in calendar 2024? Then maybe a longer-term question, I'll just give you both at the same time. When you think about mix of the business today, obviously, you know, consumer industrial is a lot smaller than it was last year. And presumably that's, you know, a relatively strong gross margin business.

How should we think about the operating leverage as growth recovers in telecom and datacom in calendar 2024 from a margin perspective? You know, obviously, it's unlikely that you're going to get back to the high 40s gross margin, but want to get a better sense for maybe gross margin trajectory as we move through the balance of this, you know, the next four quarters into maybe fiscal 2025. Thank you.

Alan Lowe (President and CEO)

Yeah. Thanks, David. I, I'd say on the under shipping question, I'd say that, you know, clearly at the revenue levels that we're having today, our customers are shipping out more than we're shipping in, and I think that's really due to, you know, the fact that they've built up inventory over the last few years when, when there was fear that components would not be available. I do believe that, that that's the case. That said, you know, there are some North America carriers that have talked about lowering their CapEx, but not significantly. I'd say that, you know, the demand for bandwidth continues to, to be robust, and there's nothing that's going to slow that down.

I would say that again, on the hyperscaler side, you know, AI is really consuming a lot of the inventory that we had shipped over the last couple of years, and now we're starting to see signs that things could pick up before the end of the year in the hyperscalers. But in the normal carrier space, I'd say that's probably premature until calendar 2024. Wajid, do you want to take the operating leverage question?

Wajid Ali (CFO)

Yeah, sure. So, you know, on operating leverage at, at the revenue levels we're currently seeing, you know, for the back half of this calendar year, you can appreciate that we're having a lot of underutilization charges within our internal factories, you know, due to the lower revenue levels and our desire to bring down our company inventory to a more normalized level.

As the back half of the fiscal year, you know, moves on, our expectation is, is that we'll really have three things working for us. One is, is that we're expecting to continue with our synergy plans that we've done, that we've executed on quite well to date on NeoPhotonics. You know, the consolidation of the factories in the back half of this calendar year should start to show through the P&L in calendar 2024. The second thing is, is that our, our datacom business is a chip business. You know, we're expecting to see improved demand in that part of the business, you know, through calendar 2024 and even actually in the back half of this calendar year as well.

That should give us some uplift. Like Alan talked about, you know, once the telecom business becomes more normalized, the underutilization charges should reverse themselves, and we should, we should see improvement. Those are, those are kind of the three tailwinds from, from, from this point in time that can help us.

David Vogt (Managing Director and Senior Equity Analyst)

Great. Thanks, Wajid. I'll get back in the queue.

Kathy Ta (VP of Investor Relations)

Thank you, David.

Operator (participant)

Your next question comes from the line of Alex Henderson from Needham. Please go ahead.

Alex Henderson (Managing Director and Senior Research Analyst)

Great. Wanted to start off with the comment on 3D sensing that the business would be flat into the September quarter. Historically, the June quarter is a seasonally softer quarter. The September and December quarters are seasonally stronger. Can you parse a little bit between, is that a late start because of some production issues, and therefore we make up a little bit of the 3D sensing in the fourth quarter? Or is it truly as steep a decline as the numbers would indicate? I think if it's if it's flat sequentially, that's 60 some odd percent decline year-over-year. It's a pretty steep number.

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Hey, Alex, this is Chris. Thanks for the question. Yeah, I think, a couple of things go into to our outlook. I think as we've alluded to on prior calls, that, we've anticipated the impact of having an additional competitor in the mix, and so that and current, you know, demand environment are both factored into our guidance, and that's what's impacting the sequential and year-over-year comps you're asking about.

Alex Henderson (Managing Director and Senior Research Analyst)

Yeah. Again, the question is: Is there a shift between September and December? Historically, September has actually been a little stronger than the December quarter. Is this a late start to some extent, and therefore a little bit more in the December quarter, or should we be using that as the new level of seasonal strong period?

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

I would say it's a little early to guide that product line for that time frame, but I would think you should think about it being flattish between the two quarters.

Alex Henderson (Managing Director and Senior Research Analyst)

Ah, great.

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Is our best-

Alex Henderson (Managing Director and Senior Research Analyst)

Second question I had for you is, looking at the broader context of the trajectory of demand, I think we started back in the September time frame saying that we were going into an inventory correction, at least in datacom. Telecom obviously started later than that. You had initially thought that by the end of the June quarter and into the end of the summer, datacom would start to recover, then you pushed it out to the end of the fourth quarter calendar. At this point, it sounds like that's holding, but it may be a little bit steeper initial decline.

Can, can you talk a little bit about, you know, what's going on relative to, you know, the, the trajectory, you know, from the expectations that you gave last quarter to the expectations you gave this quarter on that business and within telecom as well? Has it, has it steepened as a result of excess cutbacks in shipments at the service providers? You know, what, what, what's the linearity of the, the, the demand structure there? Did it fall off towards the end of the quarter?

Alan Lowe (President and CEO)

Well, let me take them one at a time. I'd say on the datacom market, as you said, in September, we talked about it getting better in the summer, and we're seeing that in a lot. I'd say that, in fact, we're seeing it so much that we probably ratcheted back our capacity more than we should have on datacom, that's now in full force to accelerate the output of our datacom chips. I think that's why we talked about Q1 being up from last quarter, and then we expect to see sequential growth in our datacom chip business through the balance of this year, as well as into calendar 2024. Datacom, I think, is on the right trajectory.

On telecom, I, I'd say that, you know, our, our customers are, are telling us that they want to bring down the inventory, to, to normal levels. I think the confidence that they have in our ability to produce what they need when they need it, and that the component suppliers, including semiconductors, are going to be there when they need it, gives them confidence that they can live with even less inventory than originally anticipated. I'd say, you know, nothing really changed there other than, you know, inventory levels need to come down further, and, and that therefore, we're shipping into our customers, less than they're shipping out to the carriers, which in turn should take care of that problem and, and more normalized as we get into calendar 2024.

Alex Henderson (Managing Director and Senior Research Analyst)

Okay. Thank you.

Alan Lowe (President and CEO)

Thanks, Alex.

Operator (participant)

Your next question comes from the line of Samik Chatterjee from JPMorgan. Please go ahead.

Samik Chatterjee (Executive Director of Networking Equipment and IT Hardware Senior Analyst)

Hi, thank you for taking my questions. I guess for my first one, if I can just ask you to delve a bit more into the AI-related demand that you're seeing. How much of that is, are you seeing in terms of interest on the VCSEL side versus EML? When you think about also the customer set there, how much of the engagement is hyperscalers versus other newer sort of companies coming into the ecosystem? Any thoughts in terms of what you expect that sort of demand to look like in a couple of years would be useful. I have a follow-up. Thank you.

Alan Lowe (President and CEO)

Yeah. Let me address that, and then I'll ask Chris to add on. I'd say you're right, it's, it's beyond the hyperscalers, we've collaborated with a lot of the new customers for us that are leading the way in AI figuring out how do we then customize a product laser, high-power laser, or external laser source to satisfy the future needs of AI in a unique way. We are doing customization of our products to meet the needs of those unique situations, where the data bandwidths are just huge. I'd say that that's really more of an impact in calendar 2024, but that work has been going on now, those products will come to market, you know, in the, in the, in the calendar 2024 stage.

I'd say that what we're seeing today is more EML-based driven, 800G transceivers that both use our CW high-power lasers for silicon photonics, as well as eight EMLs for each transceiver. Because those are the products that are available today, that can satisfy that bandwidth needs that the hyperscalers are going through. That's what we're seeing. As far as VCSELs are concerned, you know, we're going through the qualification work on those 100G VCSELs I talked about, and we see that really starting in a meaningful way to contribute to our revenue in calendar 2024.

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

I'd, I'd also add that in addition to the VCSELs, which are, are, are just ramping, and, and the EMLs, we're, we're market leader, and we also, there's CW lasers that power certain silicon photonic solutions. We've really focused, as we've commented in prior calls, of broadening our product portfolio in, in datacom, to be able to address, you know, different parts of the data center and different approaches to the same parts of the data center. We do anticipate significant uptick in, in the market, in, in datacom, in the coming 12 months, relative to kind of the, obviously, the down year that we had at, at being a chip supplier over the last year.

You know, this is gonna be a multi-year phenomenon that we, we definitely believe that you're talking, you know, 10s of % CAGRs for AI-related deployments over the next few years. Very exciting opportunity for us.

Samik Chatterjee (Executive Director of Networking Equipment and IT Hardware Senior Analyst)

Got it. Got it. For my follow-up, just rotating back to the results and the guide for the fiscal first quarter. I think with, 3D sensing in the past, you've obviously had a certain seasonality to the business, through a year. Any thoughts of how you're thinking about seasonality this year? Should investors expect sort of, as you get to beyond 1Q, to see sort of sustained sequential growth in the business? Given some of your comments about the sort of calendar year being inventory digestion impacted, it's really more of a step up into the second half of the fiscal year. I think where I'm trying to get to is, we all understand the earnings power of the business at this run rate is depressed because of the lower demand or the inventory digestion.

In terms of revenue increasing, your OpEx savings coming through, what do you see as the normalized run rate for the business where you want to exit the year?

Alan Lowe (President and CEO)

Well, normalized, it's hard to say. I'd say in the short term, in the next couple of quarters, telecom is gonna be tough. You know, as, as we said, 3D sensing, you can think about being flat. Lasers is gonna be, you know, down sequentially from Q1, in Q1, and you can think of that as being flat, with fiber lasers, going down in Q2, but being offset by our ultrafast lasers. I think then the, the real mover between Q1 and Q2 is the datacom demand, and that's really gonna be gated by our ability to meet that supply, that demand.

I would say that there's some, you know, small uptick in, in Q2, then assuming that the inventory is taken care of over the next five months, then, you know, we should start seeing some pickup in the first half of, of calendar 2024. Normalized demand happens when we're shipping into our customers exactly what they're shipping out. I think, you know, we're confident we can get back to the levels of revenue we've had in the past. With our model, the, the operating leverage is, is pretty immense, and we should see, you know, significant bounce back when we get up to that $400 million-$450 million, even $500 million in, in revenue. I think that's, that's, that's doable, you know, in the not-too-distant future.

Samik Chatterjee (Executive Director of Networking Equipment and IT Hardware Senior Analyst)

Okay. Thank you. Thanks for taking my questions.

Kathy Ta (VP of Investor Relations)

Thank you, Samik.

Operator (participant)

Your next question comes from the line of George Notter from Jefferies. Please go ahead.

George Notter (Managing Director of Equity Research)

Hi, guys. Thanks very much. I wanted to ask about the gross margin performance in the quarter. You know, down, gosh, roughly 400 basis points sequentially on a pretty similar revenue number. I, I guess I'm wondering if there's certainly the lower 3D sensing, you know, is, is an element of that, I, I suppose. I'm wondering if there's some excess and obsolete inventory charges there or anything else that drove that, you know, big sequential step down. Thanks.

Wajid Ali (CFO)

Yeah. You're right. The 3D sensing number did come down into Q4. Excess and obsolescence was pretty, pretty normal from a run rate standpoint. It was really underutilization. You know, as, as we've been working through where we really want our inventory to be, outside of some of the prebuilds that we're doing as part of our consolidation strategy, we had a pretty hefty impact within our fiscal Q4 with underutilization that hit both our OpCom and our lasers business pretty significantly. We're seeing that really flow through into the back half of the calendar year.

George Notter (Managing Director of Equity Research)

Got it. Is it fair to say that a good portion of the product that you shipped in the June quarter was then manufactured in prior quarters? Is that, is that the way to read that?

Wajid Ali (CFO)

Yes, that's, that's fair. Yes, that's fair.

George Notter (Managing Director of Equity Research)

Okay.

Wajid Ali (CFO)

That's right.

George Notter (Managing Director of Equity Research)

Is there, is there some strategy here to kind of, you know, I, I don't know, I, I guess, produce a softer gross margin in the June quarter, take that underutilization hit, you know, all at once then, and then you can kind of clean that effect up, you know, going into the September quarter, or is, is it, is there some other strategy in terms of how you run your utilization?

Wajid Ali (CFO)

Yeah, I mean, really, the only way to do it is to produce more, or consolidate facilities. We are consolidating facilities, and we'll start to see the benefit of that probably in the January time frame, 'cause we'll be out of the facilities in the November, December time frame this year. We'll start to see the impact of that in our fiscal Q3. That'll be, you know, pretty, pretty sizable. It's really production coming back up at all of our facilities to a more normalized level. Those are really kind of the only two ways that you can improve that.

Alan Lowe (President and CEO)

Yeah, just to add to that, though, I'd say that the June quarter datacom was below on datacom, and those chips that are produced in our fabs, absorb a lot. As that ramps back up, we should see, you know, a better absorption and utilization of the fabs that we have in Japan making datacom chips.

Wajid Ali (CFO)

Yes. That's fair.

George Notter (Managing Director of Equity Research)

Got it. Okay. Is that-

Kathy Ta (VP of Investor Relations)

Thank you, George. Oh.

George Notter (Managing Director of Equity Research)

I was just going to say-

Kathy Ta (VP of Investor Relations)

Yeah, please, go ahead.

George Notter (Managing Director of Equity Research)

... is that inventory, thanks for letting me follow on here, is that inventory that you built up from a manufacturing perspective in the March quarter, is that inventory then consumed heading into the September period?

Wajid Ali (CFO)

Well, no, not all of it, because if you take a look at our inventory turns, it doesn't turn that fast. Yes, some of it will flow through. It already flowed through our fiscal Q4, and then some of it will flow through our Q1. A lot of it is very product-level dependent. Like Alan said, in Sagamihara, where our datacom chips are produced, that inventory is turning very fast. You know, as the finished goods are coming out, it's being shipped. At our, you know, Rose Orchard facility, where we have internal wafer fab, that's moving a little bit more slowly. As well as what we've got in Thailand, that's built up for lasers as well.

It, it is a little bit dependent, and, and because BOM costs are lower on datacom chips, the impact at a consolidated level doesn't show up as well as it does when you take a look at by BU inventory turns.

George Notter (Managing Director of Equity Research)

Got it. Thank you very much.

Kathy Ta (VP of Investor Relations)

Thanks, George.

Operator (participant)

Your next question comes from the line of Michael Genovese from Rosenblatt. Please go ahead.

Michael Genovese (Managing Director and Senior Research Analyst)

Hey, great. Thanks. I want to dig in on this guidance for telecom and datacom to be up, you know, for the year. In fiscal 2024, my first question is, is that, is that more of a datacom comment that datacom will be way up, or are we saying that telecom will, will, will also be up as well year-over-year?

Alan Lowe (President and CEO)

Yeah, Michael, I, I think, what we said was that calendar 2024 would be up from calendar 2023, given that we believe the next two quarters of telecom shipments are going to be depressed, given the, the inventory reductions that are happening at our customers and at the end customers. Not fiscal year, year-over-year, I'd say calendar year, we're pretty confident that telecom will be up in calendar 2024 from calendar 2023. That said, again, I'd say datacom is going to grow sequentially each quarter between now and the end of calendar 2024.

Michael Genovese (Managing Director and Senior Research Analyst)

Okay, that makes sense. That's a calendar comment. Thanks for that clarification. I guess my other question is, you know, when I look at the datacom, you know, 800G above AI opportunity, you guys are in EMLs, and it looks like they're trying to, you know, prioritize in VCSELs as well. I guess my question is, is, you know, are there any other parts of the datacom market now with this improvement? You know, but are those, you know, that, that, that Lumentum can do?

Alan Lowe (President and CEO)

Sorry, Michael, we, we couldn't hear your last question. I think the question, though, was around, are there any other parts other than EMLs and VCSELs that are showing signs of demand growth? Is that your question, or have we lost you?

Michael Genovese (Managing Director and Senior Research Analyst)

Oh, yeah. No, I'm sorry. Here. Hopefully, this is better.

Operator (participant)

Mr. Genovese has disconnected. Is it okay to proceed to the next question?

Alan Lowe (President and CEO)

Yeah, maybe we try to answer the question if we understood it right, and we can talk about, you know, different kinds of lasers, CW lasers, and such. Chris?

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Yeah, certainly our focus is on serving the hyperscale cloud market, primarily. Our transceiver customers that we supply to also certainly supply into the enterprise and markets. Again, supplying EMLs is the largest product line, and that's primarily playing now into the transition to 800G. We will also have 200G per lane EMLs coming up in calendar 2024 ramping. That's for either a next generation of 800G transceivers, and then the eventual transition to 1.6 terabit per second. We highlighted the VCSELs ramping so that we have a broader product portfolio, as well as the CW lasers to intersect 800G and 1.6 terabit silicon photonics-based approaches.

Alan Lowe (President and CEO)

Yes, just the only other thing is we're providing a, a series of different types of lasers to address the InfiniBand as well.

Kathy Ta (VP of Investor Relations)

Thank you. Okay, Lara, we'll take the next question.

Operator (participant)

Your next question comes from the line of Ananda Baruah from Loop Capital. Please go ahead.

Ananda Baruah (Senior Equity Analyst)

Yeah, good morning, guys, and thanks for taking the question. Yeah, just a couple if I could as well.

I mean, I guess just sticking with, you know, with datacom chips and lasers, I've been trying to frame for myself how meaningful this could become as a part of your business, and I think, like, just sort of clarify this, correct me if I'm wrong, I believe that on the company's sort of prior, prior rev, you know, let's, let's say, believe, 12 months ago, before things really started to, you know, before the, before the hyperscalers really started to, to work down their inventory, you know, the run rates at which, at which you were thinking could occur back then, which I think got to the kind of $240 million, $250 million, $260 million level annually, you know, would, would sort of suggest if you could still achieve those, you have more of a tailwind.

On current run rates, you could begin to see sort of 15%, 16% of the company once achieved the, the on-- and I think those are primary EMLs. Now you have what's going on, GenAI related, you're doing some new VCSEL work, and I know, I know a bunch of this you teased out at OFC, but there's CW laser work, talking about integrated laser work as well. You know, could, could we be in a situation in eight quarters where, like, 20% of the company is, you know, is, is, is GenAI, datacom, chip, laser related? I just have a super quick follow-up after that. Love to get your thoughts there. Thanks.

Alan Lowe (President and CEO)

Yeah, good, good question. I think it depends on how fast the other parts of our business grows, but I, I, I think, you know, your, your numbers are not too, too far off. I'd say that, you know, we have gone down significantly over the last year from a datacom revenue standpoint, both from the standpoint of unit shipments are way down, and, and average prices have gone down in, in this past year. We're in the midst of growing that. I'd say that you're certainly within the next eight quarters, could we get back to the kind of $240 million-$260 million annually? Yeah, absolutely, and I think we're, we're putting capacity in place to do that. We have capacity. As you remember, three years ago, we've been continuing to add capacity.

We're in the midst of going to larger wafers to address the demand we've seen in the long term. That, that certainly could be, a, a significant growth driver from where we are today.

Ananda Baruah (Senior Equity Analyst)

Yeah, Alan, that's really helpful. I guess the quick follow-up is, like, longer term, what's your view on, on, you know, sort of NeoPhotonics ZR technologies role in data center, you know, for, for, for AI related at all? That's it for me. Thanks.

Alan Lowe (President and CEO)

Yeah, we're very, very happy with the acquisition of NeoPhotonics and the technology and the team that came along with that. I'd say that, you know, there was a buildup of inventory of ZR and the, and, and ZR modules at certain hyperscalers. I think that that is being consumed, and we're starting to see signs of life, frankly, of hyperscalers needing more ZR, ZR modules. We're also providing a lot of the components to go into the world's ZR market. From that perspective, you know, we're, we're, we're happy with the, the whole AI-driven data center demand, but also data center to data center, there's a lot of bandwidth going between them. I don't know, Chris, is any, any other thoughts?

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Yeah, I mean, I think the, that, you know, one of the pieces of the acquisition with regard to ZR was that it would provide a, a sort of stronger company, if you will, to give customers confidence, and that certainly is bearing out. Unfortunately, as Alan highlighted, that the acquisition closed at about the point where they also realized they had a lot of inventory. Now that inventory is beginning to clear at hyperscalers, we do expect ZR to be one of the products that recovers earlier in our telecom portfolio.

With the level of vertical integration we have, customers are very excited about us as a supplier because they view us as being able to both evolve obviously from a, a cost and volume standpoint, given our vertical integration, but also lead the transition to 800G, and next generation solutions that follow on beyond the, the current 400G products.

Ananda Baruah (Senior Equity Analyst)

That's great context. Thanks a lot, guys.

Kathy Ta (VP of Investor Relations)

Thanks, Ananda.

Operator (participant)

Your next question comes from the line of Tom O'Malley from Barclays. Please go ahead.

Tom O'Malley (Director of Equity Research)

Hey, good morning, and thanks for taking the question. I just wanted to square just a couple comments you've made. I think that in response to Nanda's question, you talked about getting back to a greater than $200 million run rate in the datacom business. Then on a question about Q2 in the fiscal year in December, you talked about just a moderate sequential increase, just given the fact that you don't have the capacity, and you said, "Hey, you know, maybe in retrospect, we would have not taken down capacity as much." Just to kind of put those two in perspective, if you look at this coming fiscal year, are you guys going to be able to get back to the levels that you saw in fiscal year 2023? I think you started the year around $50 million.

Is that something you'll be able to get to, or is capacity going to hold you back really until the back half of calendar year 2024, which would be your fiscal year 2025? Thank you.

Alan Lowe (President and CEO)

Yeah, I would say it's certainly not a lack of demand that would get us there. I, I'd say that, you know, in calendar 2024, there's certainly enough demand. The question is, can we get the capacity back up, given that ASPs are down? We have to actually produce a whole lot more chips to get to that $50 million run rate. But that said, the gross margin on those chips are still very, very solid, so we're anxiously driving the team to grow the output. And you're right, we, we took down capacity more than we should have, but at the time, it was the right thing to try to drive to try to drive the, the, the underutilization.

I, I'd say that, you know, the cycle time on datacom chips is such that, you know, starting wafers today doesn't really impact, you know, the next 4 months. It is a long cycle time. We're working on that as well. That's why we're, we're trying to dampen the expectations of, of rapid growth in the December quarter for datacom, but we are expecting to see an uptick in datacom in the December quarter.

Tom O'Malley (Director of Equity Research)

Got you. That's helpful. Then just on the technology side, and this, and this may be just a broader question, but I just wanted to hear your take here is, you know, if you look at the early days of AI here, there's obviously some, some drivers that are pointing more towards EML, but clearly, there's a lot of drivers that are pointing more towards VCSEL. You guys are looking to ramp that product. I guess the question is, if you look at the market for lasers today in AI, how would you split out the percentage of lasers that are being used between VCSEL, CW, and EML? Do you think that just given that maybe there are some more VCSELs early on, that you're missing out on some of that opportunity? If it's the other way around, just any color would be helpful there. Thank you.

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Yeah. I, I would say from a, you know, the end market opportunity in unit quantities, the VCSEL arrays and, and basically short reach and, and longer reach, that's really what we're talking about, are not that different from a volume standpoint. Therefore, and being a leader in the EML, that indicates why the VCSEL is such a good opportunity for us to grow, in addition to just market growth, to grow share. In terms of CW, CW and EML sort of compete with each other a little bit in that certain silicon photonic architectures are able to do the needed distance or reach that the EMLs at the lower end do.

There is a little bit of cannibalization or, or, you know, zero sum between those two, but that's why we introduced and have both sets of, of products now. That said, EMLs will lead the transition to the 200 gig per lane, and so we expect the EMLs to really be the workhorse of, of, the longer reach AI links.

Alan Lowe (President and CEO)

Just to note that while the units are about the same, the VCSEL cost or price, are, you know, significantly lower than the EMLs.

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Yeah. So the market is much larger for, for the longer reach EMLs.

Kathy Ta (VP of Investor Relations)

Thank you, Tom.

Tom O'Malley (Director of Equity Research)

Thank you.

Operator (participant)

Your next question comes from the line of Vivek Arya from BofA Securities. Please go ahead.

Vivek Arya (Managing Director and Senior Analyst)

Thanks for taking my questions. I was hoping you could help us quantify what percentage of your Q4 sales were related to AI. You know, were they all in lasers or telecom, datacom segment? Just where do the AI-related sales show up, and how large were they in the quarter?

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Yeah, I think the primary products going to AI would obviously be our datacom business. We don't break that out, but it's, it's, you know, sub 10% of company revenue. That said, we don't know when we ship an EML to a customer, whether that's going in an enterprise customer or a cloud AI customer at this point. What we do expect, and as Alan has highlighted, that the growth we are seeing going forward is primarily AI driven.

Vivek Arya (Managing Director and Senior Analyst)

Sub 10% of your datacom segment is AI or EML related?

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

No.

Vivek Arya (Managing Director and Senior Analyst)

I just wanted to-

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

I would say a very high % of our datacom revenue is EML related. It's just that the datacom business is a smaller % of the overall company revenue, given it's a chip-based business. Lower ASP, high margin, but lower ASP.

Vivek Arya (Managing Director and Senior Analyst)

All right. For my follow-up, I'm just trying to think about the path back to growth, right? Seems for the overall company, seems like Q2 will probably, you know, could be in the same range as, as Q1, and Q3 has in the past tended to have seasonal headwinds. But I don't know whether the mix now is different. Is it really fair to think that Q4 is the earliest we should be thinking about meaningful sequential growth? Do you think seasonality and mix could play out differently this year?

Alan Lowe (President and CEO)

Yeah, I, I would say seasonality probably doesn't play as much as it has in the past. When you look at the March quarter, just given how much less we're shipping into our customers today than they're shipping out. I think it all comes down to their inventory levels, and when does that equalization happen? You know, we think that it's gonna take until at least December, that said, you know, we're gonna see some strength in demand for new products. I talked about the 130 Gbaud, 200 Gbaud type products, as well as some new products we have in ROADMs and, and other, that, that should drive demand growth in, in Q1, regardless of inventory situation, because they're new products and, you know, they don't exist in the inventories today. I'd say, you know, it, it just depends.

Vivek Arya (Managing Director and Senior Analyst)

Thank you.

Kathy Ta (VP of Investor Relations)

Thanks, Vivek. Lara, I think we have time for one more question, please.

Operator (participant)

Thank you, ma'am. Our last question will come from the line of Jeff Koche from Raymond James. Please go ahead.

Jeff Koche (Data Infrastructure Senior Research Associate)

Yeah, thanks, guys. Jeff with Raymond James in for Simon. one of your big competitors put out a forecast for the datacom transceiver market, basically calling for roughly $5 billion increase from 2023 through 2028. I just wanna know what your thoughts on that forecast are. Do you think that's reasonable? And, you know, I guess your strategy and your milestones that you're targeting for that business would be helpful.

Chris Coldren (SVP and Chief Strategy and Corporate Development Officer)

Sure. I think that's not I'm not familiar with the exact numbers you referenced, but it is not inconsistent with our assumptions around growth in the overall datacom market, particularly driven, driven by AI.

Kathy Ta (VP of Investor Relations)

Simon, did you have a quick follow-up? Go ahead.

Jeff Koche (Data Infrastructure Senior Research Associate)

Yeah, yeah. I'm just wondering, too, if I got this right, that the... Did, did you say that if NeoPhotonics was up or down sequentially in the quarter? Is it safe to say that the majority of the downtick in September and December is gonna be in the legacy telecom business, and that NeoPhotonics is gonna do, is more, I guess, that inventory digestion with the ZRs is more played out. Is that fair to say?

Alan Lowe (President and CEO)

Yeah, Jeff, you know, the delineation between Neo products and legacy products after a year is pretty much gone. You know, we're still seeing strength, as we talked about, in narrow linewidth tunable lasers. I think I said we're, we're seeing growth again in expectations for ZRs as we move forward. You know, I'd say that Neo products in the June quarter were down from previous. And we expect as the inventory of whether it's the narrow linewidth tunable lasers or other products that we got through the acquisition, as those burn down, we're gonna see growth across the board. I wouldn't say it's anything specific to legacy versus Neo products. It's an inventory issue at our customers that we're trying to take care of.

Jeff Koche (Data Infrastructure Senior Research Associate)

Perfect. Thanks. Appreciate the call.

Alan Lowe (President and CEO)

Thanks, Jeff.

Kathy Ta (VP of Investor Relations)

Yeah. Thank you. Lara, I think we'll turn the call back over to Alan for some closing remarks.

Alan Lowe (President and CEO)

Thanks, Kathy. Thank you, everyone. I'd like to leave everyone with a few thoughts as we wrap up the call. You know, as I said before, mid to long-term fundamentals are solid for our business as we serve the exponential growth in network bandwidth in the artificial intelligence, machine learning, mobile, carrier, and cloud computing markets. New industrial applications are emerging for our imaging and sensing products, and our commercial lasers are expanding into high-growth applications beyond our traditional markets. We are committed to investing deeply in innovation to deliver on our customers' needs today and in the future. With that, I would like to thank everyone for attending, and we look forward to talking with you again at investor conferences and upcoming meetings in the coming weeks. Thank you all for attending.

Operator (participant)

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.