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

Good afternoon. My name is Fahad Najam. I am the senior comm equipment and networking analyst at MKM. Today, I have the pleasure of welcoming Alan Lowe, CEO of Lumentum; and Chris Coldren, who is the Chief Strategy Officer at Lumentum; along with Jim Fanucchi, who's the Director of Investor Relations. I would ask Alan with a big picture question. I have a very positive outlook in -- for optical communications in general because I think the world is shifting from electrons to protons, and that should benefit Lumentum as one of the premier optical component supplier in the industry. That said, let me ask you a question about COVID-19 and how calendar '21 is shaping up to be. It looks like we might have a vaccine in hand -- at least we have it here in New York City. So fingers crossed, maybe '21 is going to be a normal year. I don't even know what that looks like anymore, but hoping that things turn back to normal. I want to ask you, Alan. How do you think COVID-19 and calendar '20 impacted us? And what's permanent? And how did it impact Lumentum? And what do you think is permanent?

Yes. I think a lot of change, right? And I'd say that calls like this are driving bandwidth even faster than the normal 30% per year compounded annually. And so there's been a stress on the networks that have been tried to be satisfied with some of the older existing technology when we had expected by now to really be deploying 400, 600, 800-gig in massive scale as well as our very, very high-end ROADMs in massive scale outside of China. I'd say that COVID has really pushed that to the right. To your point, once the -- once the vaccines become more prevalent and we're able to get our technicians and our customers' technicians into central office, deploying new types of networks, I think that the future is really bright for calendar '21 and probably around the spring time, where travel will become easier and deployment of new networks that need a little bit extra handholding will be deployed in a more meaningful way. And I think what we've seen to date is really that pause before the storm in that networks are being added too, but new networks have not necessarily been fully deployed to the extent we would have expected prior to COVID. And we have the capacity. So we're ready to go. It's just a matter of when are our customers and the network providers ready to deploy these new networks. And so we're pretty optimistic about the future.

I asked one of your customers, Ciena, which we had on our conference yesterday. That's -- a similar question was, look, take Ciena has done very well with the [ res ] scale segment in calendar '20. And that is in light of the fact that none of these hyperscalers have been able to build new data centers, sent people to go out and populate those data centers. So calendar '21 is proving out to be even more stellar, strong growth for them. Obviously, they've been very conservative, but I'd like to get your sense on what you are hearing from your OEM customers. What is their feedback to you from what they are hearing from their end customers?

Well, similar to what you indicate, right? I mean the bandwidth demands are not slowing. They're accelerating. And there's a bunch of tailwinds that will help demand for the next several years, including this pent-up demand that we're all causing as a result of these types of interactions. And I think when or if we get back to normal, this is going to continue. So this is not going to slow down. I think that we are in the first inning, maybe the top of the first inning in 5G deployments, and that's going to drive an extreme amount of need for data to get from one's handset back to a hyperscale data center or to another data center. And that's going to drive bandwidth requirements at a new level that we haven't seen in the past. And so I think there's a lot of things that are driving the need for our leading-edge technology and our customers' leading-edge technology that will drive revenue growth and a tailwind in revenue for multi-years as we look forward.

And Alan, the sustained one is COVID making impact. So how good is your visibility relative to when you started? Just before the start of this pandemic and through to the trough of the pandemic and now where we are coming out of this pandemic, hopefully? How is your visibility?

Well, I think visibility to bandwidth growth is very clear. It's going to be up and to the right. The question is, how does that get satisfied? Does it get satisfied with existing products that are able to be deployed relatively simply? Or do they get satisfied with new products, and that's the 400, 600, 800-gig as well as the higher port count and MxN ROADMs that allow network providers to have future-proof, if you will, of their ability to be able to meet the demand in the future. So I think -- I don't have a crystal ball, but I think as bandwidth continues to grow, it has to be satisfied. And it's, to your point, it's not being fully satisfied to the extent that the bandwidth is growing. And so from that perspective, I think, across the board, from data -- inside a data center, our datacom chips are going to be -- continue to be very, very strong. We've got 3 quarters of backlog on those products. I think inside the data center is going to continue to grow. I think data center interconnect is going to continue to grow strongly. And then I think the core metro regional and at the edge of the network is going to continue to grow quite strongly. So I think across -- from handsets, all the way back to the data centers, it's a lot of growth drivers that are fueling our business and our outlook.

So just to be clear, I don't want to put words in your mouth. But before this COVID-19 pandemic even started, relative to now, you are more confident about the visibility and the direction of the industry overall, given all that has now transpired?

Yes. I'd say -- I was going to say nothing has changed, but lots has changed. But the demand for bandwidth has not changed. In fact, it's accelerated. And it has to be satisfied. So I think I don't have a crystal ball that says when we're going to get everybody vaccines so that people can get out and fly and deploy new networks. But it's seeming like it's coming, right? It's coming quickly. So I think from that perspective, yes, I'm more optimistic now than I was certainly in March when I didn't know what the future was to bring. And so I think the scientists that have come up with vaccines in record time have done a phenomenal job, and I think that makes me more optimistic about '21 and '22 than I was 9 months ago.

All right. I'm going to switch topics. I'm going to focus on 3D sensing, which is a very exciting new business segment that potentially can catalyze even more than many of us in the investment community seem to appreciate. So on the 3D sensing side, on the consumer, let me first get out your rather conservative fiscal second quarter guidance. And you're sharing now more incremental data points from the Apple supply chain that it appears to be Apple iPhone, the 5G phone is tracking really strongly. Are you still being conservative with your forecast when you offer your outlook that's been 30 days ago? Or do you think you've been -- you've had such a high concentration with this customer that you're going to be conservative or be erring on the side of conservative?

Well, I think we want to make sure that we don't disappoint. And I think as you saw in the September quarter, right, we gave guidance specifically to 3D sensing, and we outperformed that guidance as a result of us having the ability to satisfy customer demand. And that's -- I would much rather do that than disappoint and say, "Gosh, we didn't do what we said we were going to do." So I think from that perspective, we guide to what we think is going to happen. We have contractual obligations to have finished goods available for our customers when they want it, if they want it. And that's what happened in the September quarter. They took more than they told us they were going to take. I don't have a crystal ball that's going to say, is that going to continue this quarter or into next quarter. It does feel like the March quarter is going to have more strength than a typical March quarter. But until that comes, it's really hard to predict. Now Chris, do you have any more color on that?

No. I mean I think the point is, as Fahad mentioned with high customer concentration, one has to -- you're likely going to be wrong, and so you would rather be wrong on the low than the high side. And everything since the time we've guided seems to point in the direction that things are on track and going well. Obviously, that with one customer, things can change at some point. But the outside factors in terms of what you read and whether it be popular media, financial press, et cetera, seem to indicate that we're -- our customer's doing well and that this product cycle should do well. And it's shifted certainly from prior years and with the staggered product launch that tends to lead to a more of a broadening, if you will, of a delay in broadening, which creates a little less of the up and then ramp down perhaps than we've seen in years past. So, so far, so good.

And kind of staying with this concentration issue, I think can you speak to the developments you're seeing in the Android camp? Yesterday -- well, let me ask you that question first, and then I'll ask you a follow-up on that topic.

Yes. So we're seeing a lot more renewed or aggressive design-in activity. Certainly, we've been underwhelmed by largely the Android space over the past few years. I think that's got a multitude of factors. I mean I say underwhelmed, we had a -- one customer do very well from a product standpoint with it that happened to be Huawei. So obviously, there -- that's become -- they're facing challenges with the U.S. government, and so that impacts their demand for 3D sensing. But really, applications to date, trying to do what our lead customer have done have been challenging for Android because the front-facing face ID is a more challenging application from the user experience standpoint. It has to work extremely well, very rapidly, which tends to mean you need to control hardware, software, ASICs that you make yourself. And that's not as accessible to the broad range of Android suppliers, maybe only the largest. But things are very different as we've -- as world-facing technology has been introduced, which we hear about augmented and virtual reality, which I think is in very early innings and a key application. But right now, the killer application is photography, just playing a role in this dual, triple camera system that high-end smartphones universally have. And as we've seen for 10 years, every year, camera performance increments up, whether that was sort of the megapixel wars and then moving to dual cameras and triple cameras. And when you're having a dual and triple camera, it's really a camera system that the image is created in the microprocessor by software, computational photography. And Android customers across the board are already doing computational photography. Bringing 3D sensing in is more incremental to them, say, than they were originally doing on the front side, in that it's more data coming into their computational algorithm. So the barrier is a bit lower, and the application is far more clear. And I think what's also a very interesting situation going on in Android is Huawei had been really gaining a lot of share in the Android market. And now they're presumably very crippled by what's happened with the U.S. government. That means there's a big chunk of share up for grabs that the other market participants have to find a way to distinguish themselves and step ahead. And our largest customer in Cupertino has taken their stab at it with a very brand-new platform and with incredible camera. Others are bound to do that. Near term, we always comment that we're cautious on the Android outlook just over the next quarter or 2, given they're a little behind where our lead customer is time-wise. And also, Android sells to a broader customer base that's perhaps a little more price-sensitive, particularly with where things are going in the economy right now. But as we get into the second half of calendar '21, we're very optimistic on the design-in activities that are underway that we will start to see material Android revenue in that point in time.

Can you remind the investors, how many Android design wins you have today?

Well, we don't disclose specifics given -- it's not like there's 1,000 Android phone manufacturers. But needless to say, or maybe alternatively, there's not many people that are able to make the kind of lasers that we're able to make and there's nobody that has the kind of volume experience and credibility that we have. So you can imagine that we're very well engaged across the Android base. Hard to imagine why somebody would not want to work with us.

Yes. I think our -- just to add on to that. I think our focus has been being the development arm for 3D sensing for all of the Android ecosystem as well as other types of applications of 3D sensing. So that if or when they decide to put it into a device or proliferate it across a product line, they choose us because we're there for them, and we've been there for them for many years. It's just a matter of making sure that we're there for them when they decide to make it into a meaningful part of their product line. And that, so far, has worked well for us.

We had one of the other technology suppliers into the ecosystem, Viavi, and the CEO from Viavi mentioned that they have a number of Android customers who have designed in a kind of light sensor for their camera systems. But they shelve those designs just to wait to see how the iPhone adoption cycle goes. In many cases, these guys -- these Android makers don't want to create the market. They'd rather have someone with a big marketing budget like an Apple create the awareness. And so he was very optimistic that we have very strong demand out of the Android ecosystem. Do you share that view that Oleg has? And if that's right, can you tell us a little bit more about the content that you have with the time-of-flights and just how we expose of VCSEL content is in the time-of-flight sensor?

Yes. I share the optimism that Oleg has. And I think, again, we're focused on providing the technology and componentry for when they do it. And we've been down this road and thought that they were going to do it on a broader range of devices. It just hasn't happened yet. But to your point, now that I think this has come out, there's going to be a fast following that is going to occur. And that's why Chris kind of said the second half of calendar '21 looks like it's kind of the time frame for those types of introductions.

All right. Now I want to quickly switch to automotives. And that seems to be another emerging opportunity for you guys. Any positive developments in the automotive segment?

Sure. The automotive segment, obviously, it's in some ways, the polar opposite of some of the mobile device space in terms of time constants and -- right, it's a very long-to-evolve type market, whereas, obviously, the consumer space is very rapid product cycles. So we continue to anticipate that you're going to see over -- even over the next couple of years, some level of revenue into the automotive space for us but really doesn't inflect until you get out into the calendar '23, '24 time frame. And that's just due to the time scale associated with design into automotive applications. And that's what's very important. We highlighted on our last earnings call of having qualified a VCSEL product through a partner for automotive applications that we expect will initially find use in in-cabin for driver monitoring systems, which in Europe, there are some regulations that new model vehicles need to have driver monitoring systems if they have any other kind of driver assistance systems, which new models will likely have. And so it's a -- it's our focus in automotive today is to ensure that we plant a lot of seeds from a laser device capability standpoint within the module manufacturers because there's a lot of them pursuing various different LiDAR strategies that require very differentiated lasers. And given our breadth of capabilities, whether that's VCSEL, edge emitter, what the wavelength is because there are several different wavelengths folks are interested in, that's really where we're in our element. We do have capabilities in principle to move up and be in the module space, but we don't think that's necessarily the right strategy for us so over the next couple of years, per se. And the reason for that is then you're kind of competing with the folks that are at that module level. And it's not entirely clear which module technology is going to be the ultimate winner. And because of that, we want to make sure that we're supplying as broadly as possible and our technologies will see the light of day, regardless of who ultimately wins at the module level.

Can you speak to the content, the dollar per content, in the automotive application you see? Mixed in your car side or your...

Yes. So I think the easiest that -- what we will sell may be it various levels of integration, meaning whether it's a chip or package. But if you think of it just really at more of the simplest laser level, we would expect that there's going to be multiple lasers per automobile. And therefore, the content can be measured in the tens of dollars kind of range. Obviously, if there's more level of integration, it's towards the upper end of that. But we want to really make sure that we're enabling folks who can make a couple of hundred dollar LiDAR modules. Could LiDAR modules sell for more than that? Perhaps. But when we kind of go several runs up and talk to the end-to-end customers, they really feel like if LiDAR modules can be in that few hundred dollar range, then they will see mass adoption in every vehicle sold. And so we -- our goal is to make sure we can supply lasers at price points that enable the module manufacturers to be successful at those price points, and that generally will result in multiple LiDAR modules per car, multiple tens of dollars for Lumentum lasers.

All right. I'm going to ask this question because I have both the CEO and the Chief Strategy Officer from Lumentum here. So I want to ask you about industry consolidation and the big picture. Alan and Chris, you've already had a significant successful track record of acquiring companies, especially Oclaro, and the integration has come phenomenally well. Do you expect more consolidation in the optical component space?

I think so. I mean I think when we look at M&A, we look across all of the markets we participate in. And you can imagine, we look at companies that could possibly be a supplier of ours or vertical integration upwards. And so I think that there are plenty of opportunities. I think it's been a healthy change in transition for the industry as a whole where having scale allows you to invest in the R&D and differentiate your products. And at the same time, it also allows you to have some visibility into the future, given the customer dynamic is very different now. Given we provide a product that no one else can provide, our customers want to make sure that we have the capacities and the commitment on pricing and conversely, that we have their share commitment to us and so that's what we're going through. And that's why I'm pretty confident in '21 and '22 because we planted those seeds 3 years ago and 2 years ago, as the industry became a very different industry than it was, say, 5 or even 10 years ago, where there were 7 suppliers into a given slot, and every 6 or 12 months, it was an auction of who's going to lower their prices. And so I think that's a dynamic that's very, very different.

How do you think about the role of coherent DSPs? We've now seen Acacia be acquired by Cisco. Marvell just acquired Inphi. How critical is it in your road map and your strategy to have at least some kind of a DSP capability in house?

Well, I think our -- well, first of all, they haven't been acquired yet. They've announced acquisitions that are pending. But our strategy to date has been to make sure that we have the absolute best coherent component technology and whether that goes into a module with an Inphi DSP or a Acacia DSP or someone else's DSP or a vertically integrated network equipment manufacturer, that's our strategy. Now we have partnered with DSP manufacturers to ensure that we have access to those so that we can make our own modules. We're shipping today 200-gig DCOs. We've sampled 400-gig DCOs with both our best technology from an indium phosphide coherent component technology incorporated into a module. So I think our focus is to make sure that we have the best-of-breed so that everybody wants to buy our technology in the new speeds. And that's why I'm pretty bullish about 400, 600, 800-gig into '21 and '22. We have products that support that technology, and everybody needs a laser. So I think from that perspective, having access to a DSP is important. Whether you have it in-house or not, unless -- I think it's less important, but really to be able to have access to it is important.

I share your view that having the best-of-class in photonics with the best-of-class of DSP, you probably have best modem solutions. I think one of the biggest challenges as an engineer, I notice, is the -- at the higher end of the speed, you have DACs and ADCs that become really bottlenecked. They become a challenge. And there aren't many merchant suppliers addressing that space. So you definitely see opportunity in vertical integration, both up and down as well as in adjacent areas as well? Or it's just...

Yes, absolutely. I mean I think there is a -- as you said, as speeds go up, there's more intimacy between the optics and the electronics. But I think kind of leveraging the comments around the DSP, et cetera, I think it really depends on who the customers are, right? We have customers that make their own DSPs, in some cases, make their other electronics, and it's very intimate partnership. On the other hand, if ultimately, there are customers that want to buy a more complete module or subsystem solution, then that drives an ecosystem of suppliers, us, perhaps folks that provide the electronics, et cetera. And if ultimately, over the longer run, if there's a logic for us joining forces with those folks, then that's certainly something we're open to and focused on. But today, the most important thing is solving our customers' problems, and we have not had sort of an impediment or a missing piece of the puzzle. And from a strategy standpoint, obviously, we want to anticipate not just what's here today but what's off in the future, and that will drive our M&A and other strategic road map actions.

And I have a lot more questions to ask to go but we only have 1 minute left to go. So let me ask you a big picture question again on the industry level. Do you see that the industry cadence is increasing? If our checks are correct, [ Keyshare's ] probably going to start to bring their 1.2-terabit solution to market sometime in first half. And if our checks are further correct, CNO is going to introduce something to compete with that solution set. Are you seeing a step-up in cadence in the industry overall? Are you thinking that we're coming in -- the solution -- the system vendors are introducing faster speed solutions faster and faster into the market? And how does that affect your business?

I think there's an element of that. And I think it goes to -- really, there's a sort of a range of customers our customers are chasing that have -- they're not -- no longer selling a one-size-fits-all solution to their customer base. A cloud customer, as an example, has a very different need than an AT&T and a Verizon. It has a very different need than a small service provider in a small country, if you will. And because of that, there are certain customers that really need an incredible amount of bandwidth over shorter distances, and that's what's causing this desire to push as much speed as possible. But on the other hand, in a different way, we have customers in larger, more complex networks that are driving our customers and us to build very sophisticated optical switching products so that they can more efficiently operate and scale their networks because they're adding incredible number of wavelengths, multiple fibers connecting point A to point B that requires the switching capacity. So yes, the industry innovation is accelerating, and it really matters because it's kind of not really a Moore's law of optical, if you will. And so costs can be very challenging as speeds go up. So for folks like us that can come up with innovative solutions to deliver a lot more network capacity and scalability for incrementally more money is a huge win for our customers and our customers' customers. So that plays into our strategy and capabilities, most definitely.

All right. I think we're out of time. I want to thank you gentlemen both for your answers and to you all for joining today. Wishing you all a very healthy and healthy new year. And hopefully, the vaccine works and we all go back to normal soon. We're all wondering.

We'll survive. Happy holidays to everybody.

Thank you. Take it easy.

Yes. Happy holidays. Be safe.

Bye-bye.