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

Good morning. Welcome back to the Barclays Global Virtual TMT Conference. I'm Tom O'Malley, SMid Cap Semi and Semi Cap Equipment Analyst at Barclays. Happy to have here Lumentum, Alan Lowe, CEO and President; Chris Coldren, SVP of Strategy and Corporate Development; and Jim Fanucchi, IR. I just wanted to kick off this morning first off and say thank you for joining us, guys. But I guess the first one I have is really for Alan.

Things are really good for light, from a financial perspective, amidst the broader pandemic and some restrictions this year, you've managed just to contract slightly for the year where your midpoint of guidance is. You put up record revenue at your biggest customer and you've moved the product portfolio to a lot of higher value solutions. So where I want to start is, talk about how this year went, and how does this get better in 2021 and beyond? In what areas are you most excited about going into next year?

Well, that's a lot of questions this early in the morning, Tom. No, I think the team has done really a good job. And I think it was catalyzed by the acquisition that we closed 2 years ago of Oclaro and the work -- the hard work that the team has done to really drive operational efficiency, but also to work on divesting some of the core margin product lines and the combination of synergy attainment, divestitures of core margin product lines has really put us in a position where our margin profile is as good as it's ever been. I do think that there's a future improvement on margins as we continue to go forward and differentiate our products and continue to invest in R&D to really make sure that we are indispensable to our customers. And being indispensable to our customers allows us to get those kinds of margins and reinvest to continue that ball rolling forward. Looking forward, I'm most optimistic about basically all of our markets that we're participating in, have great tailwinds to growth. And if you look at each one individually, I think telecom is at a low point today. And we have -- as we get through the pandemic, I think we're going to see an uptick and driven really by leading edge ROADMs on our side as well as the transmission products from a coherent perspective in 400, 600 and 800 gig rolling out. So telecom is in a good position. Datacom chips. We've been on allocation for quite some time since the acquisition and divestiture of our own module business, and we're adding capacity. So we think we're going to see datacom growth as hyperscalers continue to build data centers and 5G rollout becomes more prevalent across the world. And commercial lasers, we're in an all-time low. And I think we're starting to see signs of life, and we think that throughout calendar '21, our lasers business is going to continue to grow. And then 3D sensing, we've really tried to be cautious in our expectations for Android business, but I do think we're going to continue to drive our innovation there. And I think in the latter half of calendar '21, we're going to see some growth outside of our main customers. So across the board, pretty exciting times, and we're positioned pretty well.

Right. So it's a helpful overview. I think a good place to start with all of those moving pieces is really -- we had Ciena report this morning. I think results were a little lighter than some wanted on this side. But generally kind of in line with some seasonality that you normally see into the March quarter. You guys have made the point this year of talking about. There's a unique light transition within Ciena, where you guys are levered a bit more to their high-end equipment. Could you just square away a slowing revenue or a disappointing revenue trajectory from Ciena and December quarter and which you guys are actually seeing some pretty nice strength in the telecom business?

Yes. I mean I can't specifically talk about individual customers, but I'll say that as I talked about, the 400, 600, 800 gig products, those have been somewhat delayed, and you saw that in some of our customers' earnings announcements that has provided us some strength in some of the older products, and that's how we've been able to continue to grow our telecom business. And I'd say that we are seeing that the investments our customers and we have made together on next-generation networks is starting to pay off. And I think we'll see that grow through calendar '21. And so I think, as I said before, it's all about being indispensable to our customers and providing them a differentiated product to allow them to win. And I think that's what we're going to see in calendar '21.

Great. So another kind of overhang for this entire group this year has been restrictions, both from China perspective and then also just the geopolitical environment that has been tough. Can you remind us what you said about what your percentage of Huawei revenues today? Where is that headed in the next couple of quarters? And obviously, there's different situations with different companies, and I respect what you guys have said publicly on what you can and cannot ship, but can you talk about what you're doing that can offset that exposure with other customers, and how that ends up not being as big of a headwind as just a percentage of revenue?

Sure. Chris, you want to take the Huawei question? I guess not. What we said -- I'll take the question as he works on figuring out how to un-mute. If you look at 2019, when the first sanction came, we were shipping Huawei, $80 million a quarter-ish, and that has declined substantially since then to become about half of what we were shipping 1.5 years ago. So they're below 10% now, and we expect as the new sanctions that went into effect in the middle of September in calendar '21, what we guided was that Huawei would be less than 5% of our revenue. And so we're continuing to work to make sure we adhere to the restrictions, but at the same time, we're also looking at what else we can do to help Huawei. But our investments with our other customers is really important. And I think it will take time for network operators to shift from a Huawei-based network to a western customer of ours network, but when that happens, our share of wallet with those other customers is much larger than with Huawei. And so I think while it's a short-term speed bump, if you will, I think in the long term, the share of wallet at the other customers really is another tailwind for us as that transition happens. It's going to take time. It's not going to happen overnight. But I think what we'll see is that as operators do shift and do deploy new greenfield networks, they're going to have to make that decision. And as they make that decision away from Huawei, if they do, it's a good thing for us.

And from like a technology perspective, you guys have made the comment in the past. There are some of the highest end ROADMs that you guys ship were to Huawei. From a competitive perspective, is there value that you're losing out on where one of their competitors may not be as complex as Huawei, so you're not giving them the same product? Like how far off are other operators to get to the point where they're consuming the same type of equipment that Huawei once was?

It's a matter of timing, Tom, if you can hear me now.

Yes. I got you.

The reason why Huawei was the initial customer for the high end ROADMs was domestic or in China domestically that did not historically deploy ROADMs in their networks, and they had made a decision to kind of leapfrog, if you will, and jump to what's next. Whereas in the western customers, at least over the past several years have been living off of the technology investments made several years ago. And late in calendar '19, we started seeing a slowdown on that in the western customers, which is why Alan highlighted, we're kind of at a trough in the telecom market. Then obviously COVID hit and delayed and pushed out the new stuff. But we fully anticipate that the rest of our customer base will be ramping up to high end -- or what is the new high end, if you will, in the ROADM space. And real reason for that is there's not -- I mean, network operators, whether they're in China, whether they're in any other geography of the world or solving the same problems with bandwidth going crazy and really kind of running out of capacity in any given individual fiber that you can only turn speed up so much. You add more wavelengths, but eventually, run out of the number of wavelengths you can add, you start adding more fibers. But that adding of more wavelengths, that adding of more fibers means you need a more complicated, larger ROADM to be able to switch wavelengths between fibers and fibers between fibers, if you will. And that's very universal across every geography in the world. In fact, ironically, in addition to the high end, ROADMs are being pushed further out towards the edge of the network where maybe we weren't using sort of switched wavelength technologies because even at the edge of the network as 5G kind of opens the spicket at the edge of the network is driving much more bandwidth inwards. We'll start seeing low end, if you will, ROADMs since we've done a lot of work in engineering low end ROADMs, to make them cost effective to eat to our cannibalize non-reconfigurable fixed wavelength elements at the edge of the network. So we kind of see high end getting higher and then ROADM technology proliferating out towards the edge of the network as well.

Great. And this is for you again, Chris. So obviously, the comment is made several times. Telecom is kind of bottoming generally. You're capacity constrained on the datacom side. In a shorter-term view here, you talked about your December guidance, where you're seeing some strength in both of those segments there. I think that you -- where people have probably relentlessly hit you over and over again during the quarter here is on the industrial consumer side, which you guided flattish to slightly up. Your content gains at your large customer pretty well publicized, you've talked about them a lot. And it seems like just from the Street's perspective, you built in a decent amount of conservatism. Obviously, the swing factor being units here but is there any reason why that conservatism won't prove to be a bit too cautious, just given the fact that you've seen your peers across the industry really seen some strong trends on the unit side, and you've highlighted your content gains as well. Any thoughts there are helpful.

Well, I certainly think that there's always very concentrated in a single customer. And so that adds a lot to a lot of upside or downside as we've seen historically. And as you've said, we try to be cautious and take a slightly different approach to guiding this portion of our business compared to other portions of the business where we perhaps have more customers. But certainly, I think you hit the nail on the head that a couple of factors, one that given this product cycle seems to have gotten started later, and our customer has more of a staggered launch. We expect that, that leads to a probability that there's a broadening of what would perhaps almost be a sort of a -- if you looked at it on a monthly basis, say, ramping down through this quarter into the March quarter of actually having sustained strength through this quarter and some seasonality but perhaps less seasonality in the past, but we don't obviously provide more than 1/4 guidance, given especially in the case where we've got one customer that can swing their demand around a bit, but things seem to be pretty good so far.

Great. That's helpful. And then on those opportunities that you have at that biggest customer, to be honest, I feel like this is a question for both Chris and Alan. But I have the new phone and the LIDAR application, is not really promoted by any app. There's a measuring feature. But do you think that there are going to be -- there's going to be an adoption curve that encourages others to kind of take this on? And furthermore, at this customer, you clearly have a refreshed front-facing module and a new world-facing module. Where are there opportunities outside of those existing sockets for your company to potentially grow in that customer and in others?

Well, I think, Tom, I think one of the first -- I mean, certainly, you're highlighting kind of augmented and virtual reality applications, which are very much in their early stages. And I've seen demos from folks of perhaps more exciting applications around, particularly, at least for me, what was exciting was seeing a sort of a geo location application where the GPS and mapping application kind of gets you there, but it doesn't really point you to the exact whether you're looking for a store or restaurant. These days, it's -- you may not be doing that for a little while. But at some point, those kinds of applications actually taking in the store and showing you where you need to go and identifying the shelf that you're looking for something, if you're buying it at a store. But I think what you may be missing, as you said in today is, it's integral to the photography that the photographic performance that's coming out of the cameras today with the dual and triple camera, being able to take low light photography and being able to stitch together images from the 2 different focal length cameras, those are all contingent on that time-of-flight 3D sensor or LIDAR sensor, as you said. And we see the android world, in particular, very excited about that and a lot of design in activity precisely because it's part of the camera, which is the killer app, frankly, for driving smartphones over years, right? that every year, we're seeing the more megapixels, now more cameras. And ultimately, hidden [indiscernible] more sensors, 3D sensor, color sensor and all of that adding to create more data, if you will, going into computational photography.

Yes. And also speaking recently with a lot of LIDAR companies, there's talk of these massive VCSEL arrays on the amount of 20,000-plus VCSEL arrays in a single solution. Can you talk about the -- realistically what the time is for those kind of solutions to be in the market? Obviously, I'm sure you're in communication with a lot of customers today. There's 1 million different LIDAR solutions out there. In terms of percentage exposure to those, are you involved in most of those types of designs? And when do you see that market actually becoming a reality?

Yes. I mean, we -- our strategy with regard to the automotive space is to make sure that we're -- we have every kind of semiconductor laser technology that's under consideration or folks are using, whether that's VCSELs, whether it's edge-emitters, whether that's wavelengths that are in the 800 or 900 nanometer range or out in the 1.3, 1.5 microns. And so our strategy is really to plant as many seeds in that space as possible with various laser technologies, kind of staying at the lower level as opposed to moving up into the LIDAR modules, if you will, essentially competing directly to go into the auto manufacturers. And as such, I -- and the reason for that logic is there's not that many auto manufacturers, and there's also aside from auto manufactures, there's large sort of online retailers that are building out their own delivery fleets with either autonomous trucks or even smaller last mile vehicles to deliver to folks home that all will have LIDAR or 3D sensing technologies in them. But there's fewer of them than, frankly, folks chasing at the LIDAR module level, but there's not many people that have the laser chip technologies that we have. So that's why we want to stay at the lowest level, at least initially over the next couple of years, proliferate our technologies into -- to everybody and then not all of them are going to be successful, but at least we feel we'll be in those that are. And as you highlighted, there's very large VCSEL arrays, so the dollar content opportunity relative to consumer electronics per unit is substantially higher, obviously, not as many units as smartphones, but you're still talking 100 million kind of unit volumes, if you will. And from a timing standpoint, we're shipping modestly today into folks really doing prototyping or trials, if you will, because there's not a lot of autonomous vehicles on the road or LIDAR-based safety systems maybe in some very high end automobiles. Probably the first real deployments of consequence are driver monitoring systems because Europe has mandated starting in 2022, cars with any kind of driver assistance features need to have a driver monitoring capability. That's much like what's in mobile phones, a in-cabin shorter distance. But as we get out to '23, '24, '25 time frames, really the inflection for the outside cabin for ADAS systems. And so you can imagine long-range LIDAR as well as LIDAR around the periphery of the car for collision avoidance.

That's helpful. I want to change gears here briefly back to just a broader optical question. This may be more appropriate for you, Alan. But you hear a lot of companies talk about coherent deployments and how the network is really changing to more of a DCI style deployment versus traditional long-haul metro deployments. Can you talk about what this means for traditional optical equipment vendors in terms of ROADMs and line cards? And how do you see this transition affecting Lumentum? Is this a positive or negative? And can you just walk through kind of the puts and takes? Obviously, you supply a lot of the incumbents, but you're pretty well positioned in the new market as well. Anything there is helpful to kind of hear.

Yes. I mean, I think we actually don't care. I mean, what we focus on is providing the technology and the capability for any types of deployments, whether they're long haul, they're still going to be long haul. And actually, we're seeing strengthening in submarine network buildouts. So there's still a need for that type of application. But again, as Chris talked about, the ROADMs at the edge, there's still going to be a need to switch light at the edge, especially as 5G really pushes bandwidths all the way to the edge. And so from our perspective, providing -- whether we provide ROADMs at the edge of the core or long-haul cut networks or the coherent transmission that really is going to proliferate not only to the edge where it hasn't been before, but also within data centers, as the costs come down and the volumes move up, we're seeing data center interconnect using high-speed coherent optical components and modules, we can envision that going inside the data center as well. So I think from our perspective, whether it's, as you say, the metro kind of pluggable market or long-haul chassis with high-speed blades, we're just focused on being the enabler of that technology, whether it be from coherent lasers or receivers or modulators. And that's what we're focused on, being indispensable for any of the kind of applications that need our technology.

That's the perfect segue way really into the datacom side. You've been having a lot of success there, but almost a detriment where you're not able to meet a lot of the demand just given the capacity constraints. I think 2 quarters ago, you made a point of laying out some company-wide goals, doubling wafer fab capacity, expanding some of your 3D sensing efforts. Can you talk about how that's going? And also kind of in tandem with that, I know it's another question I'm tacking on, but you're hearing a lot in the semi market today about supply shortages from a component perspective. Are you seeing any of that today as well as you're trying to ramp-up these facilities and get product to your customers?

I'd say, you're right, 2 quarters ago or so, we pulled the trigger on incrementing our datacom fab capacity. That equipment was ordered. It's showing up. We're bringing it online. We're qualifying it, but that takes time. I mean when you add reactors to a fab, it is a 12 to 18-month effort, and we're now in that effort. And so we've been able to grow our datacom business without that incremental capacity through efficiency improvements, yield improvements and things like that. And expect that by the end of calendar '21, all of that capacity will be online. It will give us some flexibility to be able to support our customers better. To your point, I mean, we have some customers that are beating this up consistently. I'd say -- I just want to highlight one thing that we talked about briefly on the earnings call a month or so ago, which is the 5G market in China, which was driving a lot of the datacom chip business has taken a little bit of a pause. So we've pivoted our capacity to really try to catch up with some of that demand in the hyperscale space as a result of that pausing of 5G. I do think that 5G is going to take off again, and it's going to really be a growth market for us in calendar '21. And as we add that capacity, to your point, we'll be able to satisfy both the 5G market as well as the hyperscale market where our leading-edge EMLs and DMLs are really in extreme high demand. And quite frankly, this little pause in the 5G market in China has helped us be able to try to satisfy more of those customers in the hyperscale space.

That's really helpful. I just wanted to ask one more. I think we have time for one more quick question. And I know it's always a trap to go down this road. But the optical industry for the last 6 months has just been very hot with consolidation and M&A. You've seen larger players clearly see the value in this area and do big acquisitions. Two parts. One, do you think that light as a stand-alone entity today needs to bolster on inorganically? And 2, where do you think the next wave of consolidation really takes place in this market, given that optics is becoming increasingly important in networking as a whole?

Yes, sure. I'll answer the first question, which is do you think -- do I think we need it? No, I don't think we need it. I think we have an organic path and an investment in R&D that allows us to continue to grow and grow both our top line as well as our bottom line. That said, I do think that the competitive landscape has changed dramatically over the last 3 years. And I think we were probably the beginning of that as we announced the acquisition of Oclaro, and then there's been subsequent acquisitions since then. So the competitive landscape has gotten better. And it will continue to get better as more acquisitions happen. I think that we look at potential targets all the time. And when we have something to talk about, we'll talk about it. But I do think there needs to be a willing seller and a willing seller at a right value for our shareholders. And that's what we're working on. And it also has to fit in our strategy, and it has to have a cultural fit. We think we did the Oclaro acquisition very well, got the synergies, got the product portfolio to the right spot, and that's what we're working on. What is that right acquisition if we make one that can do that kind of thing, again, where we can get the synergies, we can figure out the right product portfolio and grow with our customers and enable them to win.

Great. I think with that, we are out of time. I really appreciate it, Alan, Chris and Jim. Thank you for joining us today, and have a good rest of the year and hopefully a better 2021 for us all. All right.

Great. Thanks, Tom.

Thank you, Tom.

Great. Buh-bye.