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

All right. Good afternoon, everyone. Welcome back to the conference. Thanks for joining us. I'm Rod Hall. I'm the hardware and networking analyst here at Goldman Sachs. I've got the pleasure of having Lumentum here with us today, Alan Lowe, the CEO; and Chris Coldren, the SVP of Corporate Development. So welcome to both of you. Thanks for joining us.

Thanks for having us, Rod.

Thanks for having us.

Virtually anyway, it would be nice to see you in person, but...

Soon.

Good to have you virtually. Yes. So Alan, I guess, I'd like to kind of hand over to you, maybe make a couple of opening comments. And then we'll jump into questions, if that's okay with you guys?

Sure. Sure. Well, first of all, thanks for inviting us, and thanks for taking the time to talk with us today. I'm very excited about what the future brings to Lumentum and how well our team has performed in the past and put us in such a great position to have the kind of outlook that we have on the business. You couple on top of that, our announcement of the acquisition of Coherent and I think bringing those 2 teams together in an environment that we have today, where a lot, a lot of tailwinds are hitting the different markets that we participate in, and it really makes the future very, very bright for the combined company. So we're excited about that. And why don't we just jump right in.

All right. Well, let's go to the favorite topic, 3D sensing. That's the one that we get asked the most about. But of course, there's a lot of other things going on in the business. I want to make sure we touch all of those. But your -- so your 3D sensing market share was the primary focus of this last earnings report, a lot of people saw the commentary and the combination of the guidance is evidence you're losing more share than expected in 3D sensing. Can you clarify how much of what you're seeing in 3DS is due to overall unit demand? And how much is due to share loss? And then maybe also talk a little bit about how the share compares to your own expectations?

Yes. I mean, I think if you look back in time for the last 3.5 years, as we've been in the volume ramp for our 3D sensing, our lead customer that is, we've had a disproportionately high share and have been the go-to supplier for our lead customer. And for that matter, or even the Android customers, to a lesser extent. I'd say that for the last 3 years, we've been saying, "Hey, this is not normal. We're not going to have 90-plus percent share." But we've got the benefit of that and generated a lot of cash as a result of that and generated a lot of experience that is unmatched in our ability to ramp at high volumes, at high yields at high quality. So I wouldn't call it a share loss, I would call it a share equalization that we had expected to happen 3 years ago that has now finally happened. I will say that looking forward -- well, let me back up. If you look at what we call share equalization, and you look at our revenue in our fiscal '21, which ends in June, compared to our fiscal '20, which ended last June, our business for 3D sensing is going up, and it's going up double digits. So that's a result of the market growing substantially, the content per device going up substantially and the number of devices that are utilizing 3D sensing going up substantially. So you put all that together and you have a share equalization to the point where we are today, I would say that the future is right for us in 3D sensing going forward. Now if you look at the new products, as our lead customer introduces new products, we get a disproportionate share of that business. And if you look at what we did on world-facing for the calendar '20 ramp, we have a disproportionate share of that. And then if you look forward, as new products come out, and we expect some new products to come out either this year or next year, we will get a disproportionate share of those as they ramp. And so my expectation is, well, we have share equalization today, we are going to gain share as we look forward as new products and new technologies enter the market because we are the supplier of choice, if you will, and the design house of choice for our lead customer as well as the Android market.

Okay. And one of the things that I think it'd be nice to hear from you guys on is just the technological opportunity in 3D, both the world-facing and the facial recognition side of things. I mean, it seems like facial recognition has been through a couple of generations now. How mature is that technology? And then world-facing seems like there's a long ways to go. Like that seems like it's really nascent, like I've used it a little bit on -- I've got it on a couple of devices here, and it still seems like there's a lot of improvement to be made there. But could you just talk a little bit about the technological evolution of both of those things? Where are we in terms of maturity?

Sure. I'll start, and then maybe Chris can chime in as well. If you look at where we are with front-facing or face ID, the chips that we have been making for the last 3 years are not substantially different than what we made in the initial launch. Those are going to change. And our competitor now has caught up with the technology that we launched 3 years ago. So we'll give them that. I think as we look forward, there'll be more functionality brought into the chip itself. And I can't really talk about what that entails, but you can imagine making it easier to make a camera module because we put more functionality in the chip. So those are the kinds of things that we're looking at doing. And then on the world-facing side, to your point, yes, we're in generation 1, but there's a lot more that can be done and will be done on the other side of the camera, not just for our lead customer, but for the Android customer base as well as other devices in the world, when you look at AR and VR, for example. So I think to your point, there's a lot of opportunity in front of us. And maybe, Chris, you can talk specifically maybe about the world-facing applications that we see today and in the future.

Yes. Well, maybe even before going to the world-facing, I think even on the front-facing, I think it's probably pretty obvious to folks that there's a strong desire on phone manufacturers globally to -- currently, the technique is -- requires a notch or some significant real estate on the front end of the phone, and it kind of spoils the beautiful display you got, et cetera. And so there's a lot of innovation required to either shrink or eliminate that intrusion, if you will. And so that requires innovation at the chip level, as Alan said, to integrate more functionality onto the chip to minimize packaging and other things that go around said chips as well as perhaps switching to other technologies that don't require as big a notch or ultimately, the holy grail, I think it's some time off, but being able to go under display to be able to not even have to have a hole, if you will, for the light to go through for the front-facing application. So there's a long sort of road map of technologies needed to, ultimately, at the chip level, to drive that front-facing road map. And then when you turn it around on the world-facing side, obviously, more resolution, further distance, lower power consumption, if you will, so that the technology is used for more than just a -- the photography application that is used today, where it's turned on and off relatively quickly. Could you imagine using a video application, like we here are on Zoom today, that requires a lot more innovation at the chip level. And then I think, on top of that, world -- well, whether it's front or world-facing, depending on how you define this, as 3D sensing penetrates beyond smartphones is very important as it goes into wearable devices, laptops, other devices. Biometric security is both about high security, ease of use. Laptop cameras are, I think, underwhelming until, all of a sudden, people realized they're going to be using them, too, for their daily life and work. So that provides ample opportunity to go into other devices that, frankly, have different requirements. Laptop is very different environment with a very, very thin clamshell design may require very different laser technology and chip innovation.

Yes. Could you say -- on laptops, it just seems obvious that, that -- we've seen it a little bit. We see it with some Microsoft laptops now, but not very many units. When do you think that becomes more of a unit volume driver more broadly adopted? It seems like a no-brainer, but yet, it hasn't happened yet.

Well, I think we've seen it in a big way on tablets, for sure. And the next logical conclusion is that notebooks and other computers should be able to have 3D sensing enabled. So we see it coming. We're working on a lot of next-generation chips that we have no idea of the application used for, because our customers certainly don't want that to get out. But we can expect that to be coming in the relatively short order would be my expectation.

And Chris, I wanted to go back to a comment you made on video, too. I didn't really understand what you're talking -- you're talking about world-facing scanners related to video. Could you elaborate on that a little bit? What's your meaning by that?

Well, yes, not restricted world-facing, just the reality is that, as you can imagine, sort of the computational photography that is used today to generate more interesting images. Or if you follow folks in the Zoom world, the holy grail, aside from wanting to have some virtual background, which I don't think many people really want, but at the end of the day, to be able to do that in a way that doesn't look like you have some weird halo around you, but perhaps even more important is the conversation we're having here to be able to have a lot more focus on the person and their face as opposed to the background, using more depth mapping technology. So whether you call it world or front-facing, but the camera that is facing somebody that's talking to you or facing you, as you talk to somebody else.

Yes. I live in fear of interlopers walking into my background here constantly in this conference. What about autos? We -- that seems like an opportunity that's out on the horizon, but it's been out on the horizon for a couple of years. Kind of seems like a place where world scanning type chips should make their way in. But what's -- where are we on that? What's the time line on autos looking like?

Yes. Maybe I can give you my view on things, and Chris can chime in as well. We really look at it at really maybe 3 different markets within auto, first being in-cabin, that's starting to happen now. And with the European regulations coming, I think it's going to really take off in a more meaningful way in the short term. And those devices look a lot like a 3D sensor you might find on a mobile device or a mobile phone. So that's relatively straightforward to do. It does take time for the automobile manufacturers or the Tier 1s to design them and put them in, but that's happening. I think the other areas are fully autonomous vehicles, that's a ways out still. And -- but we are working on several different designs in that area. But the other more interesting one to me is really that last mile delivery vehicle that is autonomous. And we see that coming sooner rather than later and doing some unique designs that enable that last mile of delivery to happen without a driver or a delivery person. So I think from that perspective, really 3 different applications, and there's also the -- what used to be called robo taxis, I think that's more in between that delivery vehicle and that fully autonomous vehicle. But this is kind of a phase-in of different applications that will grow demand or drive demand for 3D sensing-type applications from in-cabin to full LiDAR applications. Chris, do you have any?

Yes. I mean, I think adding to that, we are -- our focus is supplying laser chips into -- or not just laser chips, but lasers, laser modules, laser chips, laser modules into folks building these sensing or LiDAR solutions. And we've secured design wins for more nearer-term applications that may start in the calendar '22 time frame. And I think, as Alan highlighted, the delivery vehicles and/or what used to be called robo taxis, if you will, those are different kind of timescales because they're -- essentially, the companies doing that would roll out fleets, if you will, relatively quickly. So they kind of have more of like a consumer electronics dynamic of a steep ramp-up because there's a lot of penetration within that customer very quickly as opposed to the kind of vehicle that you or I would buy to drive on a daily basis, that tends to have the more automobile refresh cycles that take 5, 7 years to ramp up. So it kind of provides this nice blending of more shorter term, steeper product ramps over the next couple of years, while that longer-term, much larger passenger vehicle market evolves over time.

So one thing I wanted to clarify, when you talk about the last mile delivery vehicles, are we talking about wheeled vehicles on roads? Or are we talking about drones? That's one thing. And then the other question would be, how much content are we talking about in these things? I guess it depends on which of those 2 things it is.

Yes. Well, certainly, it can be both. But these days, I think when people are thinking about last mile delivery vehicles, they tend to be kind of replacing the truck driver going through the neighborhood dropping off or you can imagine in a more urban environment where it's difficult for a truck to be zipping around and delivering to, like in a corporate campus or an urban environment. And so yes, the dollar content, I don't want to get too clear there, it's an evolving market, a new market, but let's just say that there's a lot of value in those vehicles in that it's another case of automation, removing the human element from that. And so as a kind of a commercial vehicle that has a probably more limited lifespan, but -- so will be in the shop being replaced fairly frequently, but also very expensive, there's a lot of room for content to be fully autonomous, if you will.

Yes I was going to say because my standing of autos and that kind of vehicle would be there'd be multiple chips, and the chips would be larger size as well. So they'd be more expensive chips and a lot -- quite a few of them. Is that the right way to think about it?

Yes. For an autonomous vehicle, especially a delivery vehicle, you're going to need 360-degree coverage of sensing, if you will, and then obviously, longer -- some amount of longer distance as well for collision avoidance. And particularly, there's also not just -- you think of a traditional passenger vehicle or whatnot, you're driving on roads, you kind of know where you're going, whereas a delivery vehicle trying to find its way through an apartment complex or a corporate campus, if you will, may not be as well mapped, if you will. So having sensing to be able to figure out and identify, "Hey, there's a door." I can identify the sign for the company we're looking for, if you will, that kind of image recognition combined with the 3D sensing to be able to sort of locate within space where you're trying to go.

Right. Yes, let's hope it works because I've got to stay up my bicycle, if not. So let me get on Coherent. We get a lot of incoming questions. Well, aren't they just buying Coherent because they're losing share and it's a good time to point attention somewhere else or diversify? I guess, I think I know the answer to that, but it'd be interesting, maybe, Alan, if you could talk about the genesis of that deal? How long have you been thinking about it? How did it come about?

Sure. Sure. I mean, we've been thinking about it for years. And the timing of the announcement of the deal had nothing to do with trying to distract investors by any means. And in fact, if you saw -- if you read the letter that one of our friends at MKS wrote to the Board of Coherent, you can see they were engaged for over 1 year. So one can imagine that there was a force in function that got us engaged over the last few months. And that will all come out in the proxy, and it will become clear, and mine is purely speculation, but also reinforced by the letter that MKS wrote a few days ago. So I think it is the gem of the laser industry and one that we really feel will provide value to the Coherent shareholders and value to the Lumentum shareholders. And putting the 2 great teams together, I think will drive innovation even faster and further. If you look at our lasers business, we are underserving the laser industry, and it's the smallest part of our business today. With Coherent, it fills that out. And so if you look at our lasers business, fairly small, and their lasers business, it's very complementary from a product standpoint. And so from that standpoint, we put in place a very confident agreement with Coherent to breeze through any kind of antitrust issues. And so our agreement is pretty much we'll do anything. We'll go hell or high water for that matter in any jurisdiction other than China where we said, "Hey, we would divest up to our lasers business that we have to get the deal done." So from that perspective, it's a very clean deal. There should be no concerns with respect to closing it in a relatively short period of time. That's why we're confident that our deal today is superior to anything that others could put forth, because of the cleanness of the deal and the surety of closure.

Yes. It sounds like you contemplated on the MKS deal when you made the bid. So that's interesting. What about synergies? You talked a little bit about -- I know you've said the $150 million of cost synergy, but what about revenue synergies? Are there any? And how conservative is that cost synergy number? I mean, in Oclaro, it turned out to be very conservative, so that's why I asked.

Yes. I mean, I don't want to show you behind the curtain, but we're not one to overpromise and underdeliver, put it that way. And so I think that there is a tremendous amount of cost synergy from public company costs to manufacturing and supply chain costs and other costs. So we'll attain those synergies plus some. So from that perspective, that's a done thing and -- not done, but we know how to do that. We did it with the Oclaro deal. We'll do it with the Coherent deal. But I'm more excited about the team. The team that we're getting is -- I mean, they are the best of the best of the lasers business. And getting together with them and watching how, together, the 2 teams can innovate and drive innovation for their customers and our customers, I think, there, we'll get a revenue synergy from the standpoint of we'll innovate faster to get to market faster. They also bring a very wide range and large sales force in lasers that we don't have. We have a pretty consolidated customer base. We have some great products, but I think we'll get some revenue synergies because they have the footprint of sales globally that then can take advantage of our products and technology and grow from there. So it is exciting across the board.