Lumentum Holdings Inc. (LITE) Earnings Call Transcript & Summary

[ Audio Gap ] for those of you who may not know this well. And then we'll jump right into some Q&A. So with that, Alan, please go ahead.

Great. Thanks, John, and thanks for having us at your conference. Maybe just a brief update on who Lumentum is. We spun out from JDS Uniphase on August 1, 2015, and it's been almost 5 years as a public independent company and the ride has been a great one so far. I'd say, we look at our business in really 4 different business units. The first being our commercial lasers business, which does industrial lasers for macro machining, mainly for fiber lasers as well as micro machine. So the delicate precision cutting of glass, PCBs and things like that. The second business unit is our 3D sensing business unit, really focused primarily on expanding our available market and growing our business by expanding the revenue per unit shipped, our 3D sensing business has really been a great business for us when that's growing. And I think as we look forward, the pie will continue to get bigger and bigger as more adoption and more revenue per unit is available for us to capture. The next 2 businesses are what we call our Optical Communications business, one of which is telecom, and that's really split into 2 areas. One is transmission, which is basically the lighting up of the fiber over the telecom networks. And the other is the transport, which is basically the routing of the signals through the network. And then finally, our datacom business, which has really transformed over the last couple of years from a module-based business to a highly profitable chip-level business is kind of rounds out our business. So overall, we're very happy with the progress we've made since the integration of the acquisition of Oclaro. I'd say we're probably in the seventh inning of a 9-inning game with regard to capturing synergies and improving our business model and our operating model for that business for our overall business. So we're quite pleased with the progress there. And so with that, maybe, John, I'll turn it back to you.

Great. Thanks very much, Alan. Maybe the place to start is just on the supply side. Coming out of the last quarter and some of the restrictions that you had in place as a result of COVID. If you can just maybe update us on where you are from an ability to meet the demand that's out there, sort of given some of the restrictions that were in place or have been in place for a period upon?

Yes, that's a good question. I think as we said on our earnings call, we were impacted primarily in the third fiscal quarter, so the marketing quarter by a movement control order by the Malaysian government where we have a significant contract manufacturer based in Penang. That happened midway through March and extended through April. And maybe even stepping back from that, as we went into pre-pandemic times, we had significant portions of our product on allocation, where demand was already higher than our ability to supply. And therefore, as we went in through the pandemic and it hit China and then it hit the rest of the Asian countries kind of flowed through our supply chain and exacerbated the supply-demand imbalance, I'd say that since then, we've come back to very near normal. We're actually adding capacity where it's needed from decisions we made 3 and 6 months ago and actually hiring people, both in our contract manufacturers as well as our own factories to catch up with the demand. But I think we're going to be constrained in some of our leading-edge products through the end of the calendar year, and we're trying to rectify that situation with added capacity and added productivity as we've now gotten back to more of a normal state of capacity going forward.

Got it. And maybe just as a follow-up to that, Alan, you talked about obviously adding capacity and not all of that is certainly because of COVID impact. When you look at -- putting that capacity in the ground, right? Optical traditionally has been an industry that struggles with that over its last 10, 20 years as capacity sometimes got ahead of demand or demand that was somewhat more cyclical. As you're looking out over the next several years and you're putting in that capacity to meet it. I guess where do you get the comfort level that that demand is likely to be solid enough over a longer period of time to really be comfortable putting that CapEx to work in that way?

Yes. So 2 things. One is the capacity that's coming online today is from decisions we made before the pandemic. So nothing related to that. We just had incredible amounts of demand that we were ramping up to try to satisfy. I think what's different this time from, as you say, 10 or 20 years ago, is the competitive landscape. And that we have technology and product leadership in several areas of our product portfolio, where we are either sole source or share some business with one other competitor. And where we had several competitors, we've exited that business because the margin profile didn't fit our future model. And so from that perspective, whether we're seeing double ordering or not, it almost doesn't matter from the standpoint of we are the only supplier on a lot of the high-end ROADMs, a lot of the datacom chips that enable both the 5G deployment as well as data center build-outs and 600 gig and 800 gig coherent components. So from that perspective, being that we're the primary, if not sole supplier on those products as we add capacity to meet our customers' demand, I feel very confident that it's a very different situation now, whereas if you look back 10 years ago, there might have been 5 people making tunable lasers and as customers thought they weren't going to get the supply, they would double order from all 5, all 5 would add capacity. And then all of a sudden, they catch up very quickly, and you'd have a mess on your hand. So I think it's a different situation now. And it's really through the innovation engine that we have that momentum to be able to differentiate ourselves from the rest.

That's helpful. And particularly around that double ordering comment, right? There's a lot of concern about the China market, and that's just 1 of them, right, that with some of the restrictions being put in place and Huawei potentially being hampered that they are either making every sort of effort they can to build as much inventory as you can, leading to potentially some drop off down the line. But also how this may impact the industry going forward on a more global scale, if Huawei is unable to compete specifically more on the networking side? How do you look at that situation unfolding for you? And how you think about that market then evolving if Huawei is going to struggle to be a competitor?

Sure. Maybe I can give you my thoughts, and Chris can chime in as well. I would say we already were impacted. I remember the day vividly, May 16, 2019, when the first U.S. sanctions came on Huawei. And while we weren't impacted by that ruling directly, the products where Huawei could get from non-U.S. suppliers, they did it. And so we saw our business with Huawei on a quarterly basis go down 25% to 30%, and that's kind of where it's been. And what they focused on buying from us and what we focused on supplying to them, are those differentiated products where, again, there's no other second source or in some cases, there is one second source where that's a U.S.-based supplier. So I think from that standpoint, we're fairly comfortable with the product we're shipping in. I think they probably have a little bit of inventory and that's okay. And I think they have a bigger inventory of the ICs that I think have been signaled that we're going to get constrained over the past several months. But I'd say that we're fairly comfortable with the products we're shipping in. There's not a warehouse full of them. And then I think additionally, our share of wallet with the non-Huawei customers is much larger with respect to the share of wallet they have with the carriers or hyperscaler. So what I mean by that is if Huawei were to be impacted and the business over some period of time after the interruption were to move to western companies or European companies or even for that matter, other Chinese companies. Our share of wallet there is actually bigger. So over the long run, that wouldn't be a bad thing for us. Chris, you want to add to that?

I think you hit the key points that we really -- the products we're selling in to Huawei. They can't get other places. And at the same time, we also sell those products to the rest of the global customer base in the communications world. And we are capacity constrained on those products. So in a sense, we are limiting the natural desire of somebody put in a position that we Huawei has put in to build an excessive level of inventory. And when we look at that we've been very public about our Huawei revenue levels, which are in the $48 million, $49 million a quarter range at present. That's, if you think about that percentage of our communications business is well below their share of the global market for communications products. Therefore, we're, in a sense, underserving them already. And so the -- when we look at even that on a product line level and say, the amount of ROADMs they're buying, as an example, is not wildly out of line with their market share in the world. And that gives us a little bit of comfort around if they are building inventory, it's not measured in years. It's not measured in a very long time period, it's much more measured. And it's, in a sense, in a certain degree, in our control.

Got it. And maybe just a follow-up on that demand, particularly on the ROADMs side, how does the demand differ maybe within the China market specifically relative to rest of the world? Is it -- does rest of world offer sort of the higher port count versions or things like that and China is a bit low, how do we think about, I guess, that mix of demand for your ROADM business?

Yes. I'd say that the partnership we built with Huawei started probably 5 years ago on developing a MxN ROADM for their future needs, really we launched them into the forefront in the leadership position of adopting those types of ROADMs as well as the high port count ROADMS. I'd say that the Western European companies are designing that into their next-generation architecture. And so we're making sure that they get what they need as they are now through the development phase and into the deployment phase. And so I'd say that while Huawei was certainly the leader in today's future generation or today's current generational leadership ROADM technology, the rest of the world is now adopting that similar technology and architecture and we'll be ramping those up steeply in the coming quarters.

Got it. And then maybe just staying on the telecom side, how do you think about the differences, if you will, once you're sort of back from a capacity standpoint between the transmission and transport side. We've seen, obviously, a fair bit of strong growth in that transport business. It seemed as if transmission is getting set to ramp up a bit. And then I think that's certainly been hurt by some of the COVID-related issues. But how do you think about those sort of growing over the next, say, 12 or 18 months? And does that necessarily matter for your business from a margin perspective or anything along those lines?

Yes. Well, I'd say that the back half of Calendar '19 was actually slow from a ROADM standpoint. We saw rapid growth in the first half and through '18 to get back up to record levels of ROADMs, and then we saw kind of a slowing or a tapering off. But we saw that reaccelerate in January and February as well as through the several -- last several months. So I think that we're going to see the back half of calendar '20 be a very, very strong growth driver for our ROADM business and our transport business overall. But we have said, to your point is very strong transmission business as the ACO business is very strong. We're pretty much the only supplier of 100 and 200 and 250 gig ACOs, but we're starting to ramp up DCOs. But more importantly, I think, is our core technology enabling components and products for 600 and 800 gig coherent modules. And so we are ramping that very strongly. And we're on allocation. We -- our customers want more and more as we are a key enabler of next-generation of transmission. So across the board on our transmission product lines, the demand is very strong. It's now our -- it's coming down to our ability to supply those leading-edge technologies and products to satisfy our customers Chris, do you have anything to add on that? Sorry, go ahead, John.

Yes. I just wanted to add...

And just following up on that, oh, go ahead. I'm sorry, Chris. Go ahead.

Yes. I was just going to add that I think one has to kind of look at this from an overall industry product transition standpoint that over -- we've really been benefiting in the calendar '18 and into '19 from sort of the wave of 100-gig, 200-gig systems going out in the world, and that drove a lot of ROADM revenue also drive a lot of our CFP2-ACO revenue. As we got into late last calendar year, there's this expectation that this calendar year and into the next calendar year are the ramp of our customers 400, 600 and 800 gig systems. Not only do those systems bring a lot of new transmission components and modules, they also bring the next-generation ROADMS, and that's really what we were gearing up for as we headed into this calendar year and then the coetaneous puts some of that activity slightly on pause or at least, there hasn't been as much aggressive deployment of the next-generation systems, obviously, because they require people out in the field testing and qualifying in all of that. But we believe that, that nonetheless, is the long-term trends that those 4, 600 and 800 gig systems are going to continue to ramp for -- ramp amongst the leaders or launch on the guys that are following the leader at our customer level throughout the next 12, 18 months. And that will drive the new ROADM and transmission products. And in between, we continue to have lots of tailwind on the existing products because those are what -- if somebody says I need bandwidth now, it's not going to be about a next-gen system. It's going to be about the system that they've already installed and know how to deploy and can buy more of. So we're seeing a second wind, if you will, in the here and now products, while we continue to ramp up and prepare for the new product ramps coming over the next 12, 18 months.

And we're real -- Chris, that pull in, if you will, of that demand, now pushes out the adoption of some of those? And I guess, ultimately, doesn't matter if it shifts to the right, but you're filling in that gap with more immediate demand doesn't really matter for you?

I don't think it matters. I mean, and I think there's actually just at the end of the day, the reality is we're working at home. Our competitors are working at home and our customers are largely working at home that surely does have a slowing effect on the new stuff coming down the pike. So I think not necessarily the current demand is robbing from the future per se because I think, frankly, the pandemic kind of slightly delayed it, if you will. And we're talking very long delays. It's literally less than a day for everyday kind of perspective, I think. And maybe not even and call it a delay, just call it, more of a smoothing of that ramp of new products out into the future. But that remains to be seen coming up depending on how the world recovers, et cetera. But I don't think it changes. I mean, bandwidth is going up. And it has not gone down because of the pandemic. So the problem only gets worse if you don't deploy the next-generation systems, which have much more scalable from a cost and ability to drive more bandwidth through the world's fiber. So whether -- if it is a rob pull-in then it means that there's going to be a still a steep need for it coming shortly afterwards.

Shifting gears a little bit. If we look at the 3D sensing business, with the difference between Android or even time of play is probably a better way to put it versus structured light. What does that really matter to you from the VCSEL array perspective? Or is it for that world-facing needs a more powerful VCSEL array? So that's better versus a case ID type of application. Just curious how we think about the difference between those technologies and what it means for your 3D sensing business?

Well, maybe I can give you my opinion. And Chris can chime in as well. We really -- it doesn't matter to us. I think what we focus more primarily is how do we enable our customers to be able to have functionality that they wouldn't necessarily have without our leading-edge VCSEL technology. And so I would say, as you point out, the world-facing technology, whether it's structured light or time of flight, mostly is kind of flight, does need a more powerful VCSEL to be able to reach the reaches more across the room as opposed to the length of your arm. And so from that perspective, what we're trying to do is to provide the technology leadership an innovation to be able to provide our customers the ability to come up with those killer applications. And I think we'll start seeing in the coming months.

Yes. And I think that's -- I'm sorry, go ahead, Chris.

Yes. Yes, I was going to say. I think the key point is that regardless of what it means from us from the nature of the chip and how you make it, what's more important is time-of-flight is enabling applications beyond the facial recognition for biometric security, which we think is still a very long-term important application, but it enables probably a more obvious set of applications for a broader set of customers in the short or to medium-term around photography, augmented virtual reality. And when we say augmented virtual reality, a lot of that is entertainment and gaming and things like that as well as education and training and things that the pandemic has put more of a focus on. And so we look at the rise of world-facing and time-of-flight applications is really just being able to accelerate the market where the biometric security gets a little bit intertwined with the operating system and the user experience, which may take a little more time to optimize in the Android world than it did with our customer.

Right. And I guess from that perspective, do you anticipate that world-facing on Android, they filter down to mid-range, low range phones a little bit more quickly as a result of the -- a little bit more application focus then?

I think so. And I think if you look at the cameras themselves, they just -- if you think of the time-of-flight sensor as just being an integral part of the camera subsystem in a phone. If you look at the history of the camera, they introduce a very high-end camera on a very high-end phone, and that becomes next year's mid-range. And so next year after that, more of a low end, right? And so you're seeing things on $300, $400 phones today that you only saw on $1,000 dollar phones a few years ago. So I think there's a very natural progression in that camera road map. And then as those applications arrive over the top of it, not just photography, that will certainly drive -- it's as much trying to at least in some of our customers about driving that ecosystem around the application space, not just selling more hardware units, if you will, around gaming and entertainment, et cetera, photography for that matter that they want to drive it into the higher volume model that reach a broader portion of population who will pay whatever a couple of dollars a month for whatever service they're driving.

Right. And then, I guess, long term, i.e., is the growth in that market? Or is the opportunity set in something like LiDAR or ADAS or just a recognition in the automotive market. Is that a larger dollar opportunity, do you think, relative to this consumer application even if it's lower volume?

We've been assessing that. I think it certainly is a large incremental business for us, potential that is. But I'd say that the number of handsets in the world are going to continue to grow. And we believe that the number of handsets with 3D sensing capable technology is going to continue to grow, whether that be front-facing or for world facing. But I think there are other applications for 3D sensing, and we are deploying those today. And in China for payment kiosks that use our technology to have people pay with their face as opposed to other ways of securely paying. And so I think there's that set of other, and that other pie is pretty big, although it's segmented into little chunks of incremental price. And so I think there's what we have today in the mobile base. There's that other pie that we're attacking. And then I think more longer term, is there's a big chunk of market that could unleash with the automobile or LIDAR in-cabin type of sensing.

And I guess over the near term, how concerned should investors be that one of the key competitors has now been qualified with one of, obviously, your lead customers. I mean, as we look out, particularly into next calendar year and think about how that handset cycle evolves. How should we think about the competitive landscape changing a bit, given some of the recent qualification activity?

Yes. Well, I'd say I'd look back over the last 3 years and say we have had a disproportional share of business that we've been paranoid that we would be losing share for 3 years. And so I think qualification is step 1 in the battle to get up the learning curve, produce high quality, high-yielding, high reliability, and we've proven to not just our lead customer, but all for our customers that we have the capability of doing that. So I think we're going to continue to be the go-to supplier for all of our customers because we've shown and proven that we can not only design the best technology but ramp it and have flawless execution when it comes to getting our customers what they need when they need it and not having a single field failure in the over 0.5 billion units that we've shipped. So I think that's a track record that you can't just say I'm going to catch up because I got qualified, which is milestone 1 in a 9-inning game. So I didn't think we'd be able to keep 90% share forever, but I'm pretty confident in our position. Especially as I think what is underestimated is how big the pie is growing with the adoption of new chips, bigger chips as well as world facing. So I think together, the future is bright for the 3D sensing for the market as a whole.

And then I guess just in looking at this calendar year's handset cycle, you've talked about it being a little bit more back-end loaded in terms of the calendar year because we're getting a little bit of a pushout effect from COVID. Beyond that, is the expectation still that Android is a relative minor contributor in this year, and it's really more of a calendar '21 event for Android?

Yes, I think so. I think it's been a fairly low and choppy business for us. I'd say that it's probably more of a 21 more meaningful business. And we'll see. I think there's a lot of other handset suppliers that are fast followers, and we're working with all of them on next-generation and next-next-generation so that they'll be ready to introduce products winner if they think the market needs or wants them.

Okay. And I want to be mindful of the time. But I do want to squeeze in a question on the industrial laser business, we think the COVID impact aside. Just how do you think about that business for you over the next 2 or 3 years? It's largely been geared towards Amada and the system's needs, but how should we think about that business for you over this interim period, once we come out of this COVID-impacted demand cycle?

Yes. I mean I think one of the things we said on the earnings call was that we saw new levels of solid-state lasers that we haven't seen in over a year. And that's really to address consumer electronics, 5G deployments, 5G antenna processing, flex circuits and things like that. We're investing in next-generation ultrafast lasers that have new applications that will grow that business. And then if you -- to comment on Amada, I think that, that's going to take a little time to come back because they're not exposed to China in any material way. And I think that we're starting to see some business pick up in China with industrial. But I think it's going to take a little longer for North America, Japan domestic take in Europe to come back to the levels where we were before the pandemic. And so that's why we've been setting expectations, said, "Hey, it's going to be at a lower level for probably the rest of the calendar year." But we're going to continue to invest in next-generation technology, both in the micromachining as well as the macro machine fiber lasers so that we're ready for when they come back.

Well, thank you very much, gentlemen. I appreciate the time and the update today. Unfortunately, we are out of time. So thank you again and best of luck for the business going forward.

Great. Thanks, John.

Thanks, John.