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

Good afternoon, everyone. I'm Samik Chatterjee, and I cover the hardware and networking stocks at JPMorgan. I have the pleasure of hosting Lumentum for the next fireside chat. With us is Chris Coldren, Senior Vice President of Strategy and Corporate Development. Chris, thank you for the time to come to the conference. And Kathy, thank you to you as well.

Chris, I'll start you off with a question we've been asking all of our companies to just sort of give us their forecast of what the end markets look like 12 months from today. So you obviously have exposure to telecom, datacom, some of the industrial exposure as well. Just to help us maybe project forward 12 months from now, where do you expect demand to be for each of those end markets?

Sure. Thank you, Samik, and thanks for having us. We've had a lot of good meetings so far, a little later in the day and a lot of productive discussions. So as we look to the next 12 months and kind of go through the end markets that you mentioned, I'd say that we're probably most optimistic in terms of the data center cloud market where as many investors are aware, photonics are now penetrating into the compute fabric, if you will, not just interconnecting servers the way they have for years but actually interconnecting GPUs, TPUs, et cetera. And that's driving a lot of growth and a lot of expectations of growth. And so over the next 12 months, we can see -- or maybe put it this way, calendar '25 versus calendar '23, I expect the market for high-speed optics to be multiples of what it was in '23. So that's really a lot of upside. And frankly, as I look to the telecom business, I mean it's -- the market is very difficult right now. It's quite slow. But I'm optimistic about the next 12 months, given we are shipping well below end market demand. So even a partial recovery let alone getting back to where we were historically would be significant growth from today's run rates. Industrial is kind of the same situation going through an inventory correction and I think that will work its way through the next 12 months. Probably the only area where I'm maybe more cautious on a 12-month time frame but still excited long term is when we look at some of the consumer market, perhaps automotive, LiDAR, these markets have a lot of potential but a lot of the new product designs at the customer levels have pushed out a year or 2 and new designs are willing to drive growth for us. So I don't think you're going to see a lot of growth from those markets over the next year. But certainly, industrial, the telecom and then really headlining is the data center market.

Okay. Got it. Relative to the data center market and obviously, a lot of interest in datacom, but -- and relative to just AI infrastructure build. Before we get into that, just maybe share your thoughts of what are you thinking in relation to AI adopting it internally within the organization, where can you drive more tangible improvements in the operations itself, time lines of getting some of those improvements before we get into the product areas?

Sure. Probably like everybody that operates in enterprise, we've got the same things of meeting notes and summarizing and translating in different languages as a global company, when underestimate how important that is. But maybe more important as somebody that's a developer and manufacturer of hardware we do have a benefit from coding, copilots, et cetera. So that's a well-covered space. So I'll let others opine on it more but I think that's something that I've been really pleasantly surprised about early results that I think will scale up is employing AI. When we're looking at test data or visual inspection, we make tens of millions or more of laser chips as an example, per year, being able to use AI to be able to correlate back, hey, a chip that looks like this or test data that looks like that, how does that correlate back to performance and yield and really being able to accelerate internal efficiencies that typically would take several years to figure out having AI be able to replace that sort of long human learning cycle is, I think, going to pay big dividends. And I'm sure the same is true for other manufacturers of a wide range of products in the world. So it makes me very optimistic that we ourselves can see tangible benefits and I think others will as well.

Okay. Got it. Turning to datacom. Obviously, that's an area where you're seeing already some tailwinds because of the AI infrastructure build but maybe hit on AI-related demand more broadly across your portfolio, like beyond datacom, how do you think over the spillover effects to telecom, for example, or other areas of your business?

Yes. I mean, certainly, as you highlighted, it's caused a significant increase in demand in the data center products that go directly into data center as well as accelerating the demand for very high-performance products, perhaps adopting them earlier than they would have been now initially and also shortening the cadence of when the next speed and technology will come in. The reason I bring that up is that then the knock-on effect is outside of the data center, you're certainly -- we have an expectation that, that will be a driver of sort of telecom products, for lack of a better word, i.e., data center interconnect transceivers, optical infrastructure that going hundreds of kilometers or thousands of kilometers and that will be a driver of demand there. I mean one of the bigger challenges our understanding of building data centers today is being, well, actually to deliver enough power and being able to do that cause -- or the lack of the ability to do that is causing customers to decide to separate data centers physically, which then means they need to have a lot more interconnects in between them over long distances, driving traditional telecom-like products for data center applications. And then in the industrial space, I think it kind of goes back to what I was commenting how we're using it, that we're seeing a lot of customers that we sell, for example, laser products to folks who build manufacturing equipment and that manufacturing equipment is really taking things into vision systems that are then feeding back into AI engines to be able to either process control or quality control built into the machine tools, if you will, that then drives more value and will drive a cycle of purchasing of new enhanced machine tools that then drive the need for more of our products.

Okay. Let's dive into datacom specifically a bit. And I know we've asked you this question before but still want to view it at it because you have increased your presence in the datacom module business with the Cloud Light acquisition after exiting the business a few years ago, when you now look at how the module business is ramping at Cloud Light, I mean, still maybe go through how do you think the opportunity is different from what you had a few years ago when you decided to exit the business? Is the AI related demand the primary driver of deciding to revisit this module business? Or what does that also assure you in terms of pricing, which was a major concern back when you exited the module business?

Yes. So we had a Datacom business that was basically built around supplying into the historical Ethernet market, the enterprise equipment market may be more precise. And at the time we exited was when there was a big transition between enterprise really driving the market and then cloud taking over. And in that transition, that changed a what customers desire that introduced a brand new level of competitors that at the time we said, wow, either we need to sort of redevelop or adapt our team, and that would take multiple years and a lot of money or do we want to fight that war or sell the bullets. Essentially, we decided to exit selling enterprise-type transceivers and trying to move to selling cloud-based or cloud-oriented transceivers focused on building up a significant component business at the highest end. And what we've seen since then is technology, the speed, the component level technology was essential but it wasn't as critical as now as the speeds have gone from 100 gig to 800 gig going to 1.6 terabit. That component level technology really matters a lot more. The number of competitors or at least the competition is probably consolidated into a few leaders, if you will. And then as you bring in this infusion of our step function at the highest end of the market in AI, drove us to decide maybe this is the right time to reinsert ourselves. And then per an earlier question, also the realization that the same customers buying these transceivers are also increasingly going to be customers for telecom components or telecom modules and other gear that we sell or could sell directly to the cloud operators. So we felt having a more direct relationship was also an important point as at some point, the cloud operators will probably be the largest consumer of telecom gear and important for us to have that direct relationship.

Got it. What about the pricing side? I mean, how do you get comfort that pricing pressure is not going to return to what you were seeing in 100 gig back at that time?

Well, I think that there will always -- this I think will be intrinsically a competitive market. But that said, at the time when you have a gaggle of new market entrants coming in that were really focused on using price as a leverage to get into the market. I don't see that today. I think that there's -- if anything, the transition to higher speeds as sort of concentrated the supply, who's really able to supply those products into a handful of players. It doesn't mean there's going to be healthy competition, prices will come down. But I think previously, I would say it was more for lack of our toxic competition as opposed to, I think, the way that one has to really think about this as price comes down to enable more compute capacity to be able to be delivered to the market. And so in the end, it ultimately means you're going to ship more product but I don't think you're going to see the same level of toxic competition, let's say, that was previously seen but you have to be able to deliver the needed products. At the same time, you got to remember we also supply components into the market and the components, there's even fewer competitors that are capable of supplying the highest end components. And what we can see there is certainly prices do come down with volume and that's necessary for the whole scaling of the ecosystem but it doesn't have kind of -- the kind of same level of price competition that you're talking about 8 or 9 years ago at the transceiver level because it's a -- technology matters, there is differentiation ultimately.

Okay. Okay. Got it. Cloud Light's primary customer is now a 30% customer for the company in the latest quarter. Now Lumentum historically has higher challenges with customer concentration first in 3D sensing. You had also Huawei in the telco business as a sort of a large customer. How are you strategically thinking about diversifying from the customer concentration you have now to this sort of one datacom customer? how realistic also is it that you can diversify beyond that?

Yes. I think it is a very top focus. It was a major sort of element of the thesis of the acquisition that we could help the Cloud Light team get into accounts that as a private company, we're a start-up company based in Hong Kong, we're unable to probably access. And so far, it -- we've got a lot of very good traction with major, major customers, that traction has to translate to revenue but it's been 6 months since the acquisition, and you kind of have to time your -- you have to have a product that matches the customer's adoption cycle, if you will. And so that's why we've highlighted that we do expect, as we get into later this calendar year and then much more so into next calendar year, that's when the opportunity for new customer traction to translate into significant revenue increase. And I believe we have a lot of value we offer customers between what Cloud Light was offering on their own in terms of efficiency, speed, very good products, now part of a U.S. headquartered company, vertical integration and component technology or will be, we're getting ready to do this ramp up in Lumentum's factories in Thailand. All these things are sort of top of mind of customers. And there's, again, a limited set of -- we know the transceiver competition because they're actually our customers for a lot of the components. And that suggests that there's room for another at least supplier to be able to deliver on the volumes and capacities. I mean, again, the 800 gig and above market, we're talking revenue dollars is probably 3, 4x in '25 what it was in '23. So from units, you're talking about something that's even more, that's a lot of capacity the industry has to put in place. And so I think us being able to win a few more customer sockets is something I feel a lot of confidence in but we've got to go do it.

Okay. Got it. So you've acquired Cloud light. So now you have a traditional datacom component business and a module business in Cloud Light. How are you thinking about the growth outlook for the 2 different businesses over the next few years? What sort of -- how do the drivers stay for between the 2?

Yes. I think that they both supply into the same end markets. So I certainly think both have the same strong tailwind driving them forward. Perhaps maybe the differences were a little bit more scale or have more aggregate market share at the component level. So there is continued opportunity to gain market share at the component level but I would argue at the transceiver level is probably a lot more opportunity to gain market share via share gains, not just growing with the very strong tailwind of the market. So that's why I'm optimistic about both growing quite significantly. But I think from a revenue standpoint, there's more long-term upside in the transceiver business, just given more limited market share exposure over the last 12 months, if you will, than at the component level.

Got it. Got it. Vertical integration, when should we start to see that play out a bit more on the margin? And what are the sort of steps you have to take from here to drive that?

Yes. I mean, as acquired, Cloud Light was not using a lot of Lumentum components so there's a large opportunity for component in-feed. I would say the products that we're launching late this calendar year and into calendar '25 will have a certain level of Lumentum component in feeds as well as a certain level of manufacturing in Lumentum factories. So those drive synergies there. But at the same time, I think, over the next 2, 3 years is really the time frame where we'll be able to more deeply penetrate sort of through the entire portfolio because there's certain products where we may not have the component already developed and components do take a year or 2 years depending on the nature of the component to develop to intersect the road map. So I think that will be an unfolding story that we'll see upside in 2 historical performance in each of the next several years.

Got it. Got it. investors seem to be trying to figure out when we put 800 gig, when we put 1.6T together, how much of the technology will be dependent on silicon photonics or CW based lasers, how much is EML versus VCSELs? What's your perspective on which one will emerge with the leading technology within these 3? And where can Lumentum differentiate the most?