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

Here at Barclays. Happy to have Chris Coldren, SVP Strategy and Corp Dev here at Lumentum. Chris, great to have you here.

Great. Thanks for having us, Tom. A lot of good meetings today.

It's been a good day so far. We'll have one more tomorrow. But let's just start off with the recent acquisition you did. It's about a year ago now. You did Cloud Light. You kind of talked about intersecting a market that was really taking off in the data center interconnect space. Can you talk about what's happened since that acquisition and maybe kind of the trajectory of that business going forward because you obviously had a lot of positive things to say at the last earnings.

Sure, sure. I mean I think there's what happened in the acquisition as well as the overall broader data center market over the past year has been really quite amazing, right? The demand is very intense, and we supply a lot of optical components that go into other people's transceivers. And that was our thesis that, okay, how can we get more exposure to this overall market, get a seat at the table with cloud operators directly as kind of being 1 layer removed. Since then, that's proven out. And what I mean by that is not only do we believe we have a nice growth trajectory for the transceiver business, but also by having that seat at the table, a lot more insight into what we should be doing on the component business and a lot more opportunities to drive the technology road map of our component business, which then obviously ultimately will feed into our transceiver business as well. So very, very good and exciting. And as we've highlighted, announced a couple of new customers for the transceiver business and expect over time, we'll announce more.

So before I get into the different customer details, let's talk about the larger market. So you've heard a lot of different forecasts from individuals in the market, some as high as kind of like the 20 million port count number into 2025. Do you guys have a rough approximation of kind of where things set out this year and where things are going this year?

Yes. I mean maybe simple mental math here is that we think of guys that are building large AI clusters are buying about 4 transceivers for every GPU they deploy. So I think 20 sounds low to me and that I expect there'll be more 8 million to 10 million GPUs next calendar year. So that will drive more like 40 million transceiver units. So a lot of growth, a lot of units. And then frankly, a lot of chips that go into those units. So all good.

Okay. So I think like the debate when you guys acquired Cloud Light was that it was primarily a Google provider, right? And they had SiPho technology and you guys are like, look, we can take this technology, we can take these transceivers and we can expand them to other customer bases. Let's start with that Google customer first. So when you did the acquisition, you had talked about a product transition that occurred pretty soon after you did the deal. Was there -- was that a speed transition, a technology transition? Can you give me your best -- well, tell me understand what happened there?

Yes. I would say most simplistically, it was a -- you're further down the road and know how to build better product after having a year experience, a better design. I can't opine on what the customer is necessarily doing in their data centers, but I'm imagining they similarly learned ways to build a better data center. And so that drove a different set of transceivers with better performance, better capabilities that now we're ramping up again. And that's not too surprising. I mean we also look to other customer engagements we have and, hey, can we intersect in this generation of the architecture? Or is it in that sort of the 1.5 version of something before they go to the next generation. The same thing is true.

Got you. And I think that the trajectory from a revenue perspective that you kind of talked about was like an $80 million to $90 million run rate kind of bottoming at that $50 million run rate in the back half of this fiscal year really stepping back up. If you look about 12 months down the road, obviously, all these hyperscalers are expanding. We just talked about how you may see a 40 million port count year. Like what is the right way to think about the trajectory for that specific customer? Can that be double the size of where you acquired the business?

Well, I guess the way I think about it is the December quarter and March quarter were [ clawing ] back up to where we last left off. And certainly, there's the opportunity to do a lot more, both in terms of just share, but as well on they're growing. So I definitely think we can do more. I'd hate to speculate if it's 2x, but I certainly think that's not in the realm of impossibility, but we'll see.

Okay. And then to the customer expansion side, you had mentioned 2 new customers. One customer, you said that you had gotten -- you had an award qualification early next year, shipments middle of calendar year '25. And then on this most recent call, you talked about a second customer, which had been in the qualification process, which you actually shipped to in the December quarter. So maybe talk about your ability to get those design wins. Is that something you were approached on? Anything on speed or architecture type that you can share?

Yes. Yes. And maybe at the start, kind of cleanup and probably a little confusing. It's just 2 customers wanted to sort of engage commercially versus technically in a slightly different order. But at the end, we're now at a spot where -- yes, I think maybe the way to think about our business is we're focused on the highest speeds over the last 12 months, probably 80% of our revenue has been 800 gig, a little bit of 400 gig because that -- the market, there's still 400 gig shifting. And so these new customers also are 800 gig and some 400 gig is what will be ramping up. And it's something we highlighted and it seems like an eternity go, but at OFC earlier this calendar year, we highlighted that there's initial adopters at 800 gig. We know who those folks are. Now there's a wave of other adopters, a sort of second adopter of 800 gig wave. Same thing will happen at 1.6T. There will be a limited set of folks and then a second wave of 1.6T folks adopting. In terms of -- there are -- were existing engagements preacquisition. But I would also say we really changed the nature of the dialogue with customers by effectively taking a private company public, U.S. headquartered, presented a manufacturing strategy, which was really leveraging some of our vertical integration on components, leveraging our large operation in Thailand. It's a big focus on end customers over time to lessen, if not eliminate dependence on China manufacturing. So I would characterize it as we have the right stuff, meaning when suppliers -- or sorry, customers would say, what is it I want in an ideal vendor in this new geopolitical world? But also AI has changed things that product cycles have moved more quickly. It used to be the bulk of the market was kind of in the slightly slower speeds. Now the bulk of the market is at the highest bleeding-edge technologies. So now being a vertically integrated player, being a leader in the component technologies, at least from an optical standpoint, would enable jumping to the next speed. We're an innovator there and then the U.S. company, non-China manufacturing, that aligns with where hyperscale cloud operators ultimately want to see suppliers look like. There's not many of us that look like that. And so I think we're benefiting from that at this point in time. Our strategy is to take that -- the door is open, the seat at the table, execute on what we have taken on. And then what's really, I think, great about our story is what gets me excited about coming to work every day is that what's being shipped today and maybe in the near future is largely technology that's already been in the works pre this big AI search. So we're kind of just supersizing older technology. It doesn't scale as well as you would like it to scale as you look to the future, particularly around power consumption, but to an extent, cost. But we've got a lot of tools in our tool chest to go solve those problems, then bring it to bear previously is like, okay, the meat of the market is not at -- once something becomes commoditized, it became high volume. Now high volume is at the bleeding edge. So it's much more attractive for us and customers view what we can bring to the table very differently. They're not looking for a commodity supplier. They're looking to say, how do I solve this problem that nobody else can seem to solve and it's going to be solved by high-performance electronics, not us alone and high-performance optics.

So U.S. domestic-based vertical integration, leading edge versus potentially [ MIS1, MIS2 ]. The 1 area I wanted to dig in a little bit more on is the technology side. So almost -- I mean, I don't think it's coincidence that SiPho was what the predominant technology was at Google, right? And if you're looking at the market today, you're seeing more SiPho deployments because of a constraint in the EML market, right? How much of your ability to transfer that technology is the driving factor versus that you're a domestic supplier? Like could you rank order like where people are coming to you from?

Maybe I kind of turn around and say that, yes, Cloud Light, their transceiver modules were silicon photonic based -- are silicon photonic. We continue to develop silicon photonic based. So we kind of have all the tools in the tool, VCSELs, EMLs, high-power lasers, silicon photonics, kind of the right tool for the job is kind of the way we look at it. And just pragmatically, they already had existing designs. You can't change something overnight. It takes a couple of years to transition to a new product design. And at the same time, we don't have enough manufacturing capacity. We're sold out on our EMLs. So it makes sense for us to continue to drive the silicon photonic products and road maps, even though there might be some "margin benefit" if you think about it. But then we're robbing from selling something externally, which is a margin loss. So right now, the best thing for us and shareholders is to pursue this path. But the real strategy, if you look out over a longer time period is we're going to be adding a lot of manufacturing capacity for EMLs and lasers. Two, we believe that the technology road map for the indium phosphide-based lasers yields more benefit in terms of higher speeds, lower power consumption over time. And so that you'll see a blending of all the technologies, but maybe a little bit more of a growth in the EML side of things over time. And for us, the logical time to kind of bring EMLs into our transceivers is both one, we have more capacity, which will happen next calendar year. But at the same time, when we have an EML technology inside of the transceiver that truly provides a differentiation at the transceiver level, so maybe disproportionate share or price or some other benefits that we wouldn't get by any other approach, then that's a real win.

Yes, I want to dig into that a little bit. You're always one question ahead of me. It's -- I have to catch up. So EML versus SiPho, you've chosen right now, and you talked about this on the last call about selling the EML product externally. There are gross margin benefits to that. The market is in shortage. In terms of the customer diversification there, are you selling that across a broad range of customers? Or are you really selling to a certain few that are kind of at the leading bleeding edge, just given the product type?

That's the EML.

EML.

Yes, I would say we're supplying to just about everybody. We -- there's not that many EML providers in the world. And certainly, there's even fewer that are at the highest speed. So we provide -- maybe there's a few accounts we aren't in, but I would say just about every major transceiver vendor, including those that have some level of their own vertical integration given both our technical differentiation, but also, I mean, the world doesn't want to be dependent only on 1 person. And so including if that's your own internal supply. So for us, maintaining SiPho also provides a diversity of supply internally for supply stability in addition to technology benefits. So yes, we're supplying very broadly and benefiting from everybody else's success, if you will, as we partner with them on high-performance EMLs.

Because I was going to say, I mean, like if you look at people who have actually announced 200-gig per lane 1.6T solutions, it's actually not that many. And so you have a defined customer set there because you're not using -- well, I guess, some guys could use 200 gig for 800-gig solutions, but I would assume you're probably targeting those of higher value. So, I guess, competitive dynamic is the only other question there. If the market is really good and there are capacity constraints, you guys had a lead at 100-gig EML, you have a lead at 200-gig EML. How far ahead of you -- are you of the competition? When do you see increased competition in the market, we can talk on the supply side a little bit, but...

Yes, I would say that there's a very small group, 2, maybe 3 folks that can make us included 200-gig EMLs. When you talk about the manufacturing capacity, none of us have enough collectively to supply. I would say that if you look at history, the same thing would happen at other speeds, but transceiver product cycles were 4 years. So then there will be some stragglers that eventually would figure out how to catch up maybe 2 to 3 years into the product cycle, and that would bring prices down and competition. I think now with AI driving a 2-year product cycle, being 2 years behind means you're just going to be left behind ultimately. That is yet to happen, but that, I think, is a reasonable thesis. So I do think for at least the next few years, presuming the industry remains on -- I mean, GPU and the AI industry remains on the kind of growth trajectory that supply is going to be a big problem in addition to needing new technology every 2 years to keep up with the GPU road map.

And then at 100 gig per lane, you saw VCSELs really get a lion's share of the market or at least a general size of the market, again, it's very difficult to kind of break down the actual share by laser. But at 200 gig, clearly, VCSELs are behind. So you made the comment you're 2 years behind could mean you're left behind. If there is a technology solution, and you guys have been wonderful VCSEL makers in the past as well, if there is a solution that gets to market, is that something that you think people will use? Or is there a real technology barrier to using it at that speed?

Yes. I think that at 100 gig per lane and what was -- what we've all ramped up over the last years kind of what existed as opposed to what's new. I do think that 200 gig per lane VCSELs will take a while. Eventually, people will figure it out. And then the question will be, do they actually offer any power consumption advantage. And I think there's ways in advanced EML that we can reduce power to the level that they're -- we may have an advantage over VCSEL-based solutions. So we're working it in both ways in terms of we have all the technologies in-house. And frankly, VCSELs will also play other roles in data center over the long run. There's still a lot of electrical interconnect links that are probably going to be pushed towards optical because the electrical world is going to struggle to scale to much higher speed and density. That's a place where even large VCSEL arrays conceptually as we're trailblazed in the consumer world, but all of a sudden you say, hey, I want a high-density multi-thousand or even a couple of hundred interconnect. That's what people are basically asking for to connect literally the pinouts of switch or logic ASICs. So we're pursuing all paths, but we do believe there's a good couple of years here where 200-gig per lane will be EML-based. And then right around the corner, there's going to be 400-gig per lane, not right around the corner, but 2 years out. And if you're 2 years late, you're going to be left behind.

So, I guess, the other end of the question is like you've heard in the transceiver market, either from suppliers of system-based AI architectures and/or from other earnings calls, constraints in the interconnect market that are prohibiting deployments. EMLs is certainly an area that's come up. I'm assuming that there are several areas, but we know that EMLs are a bottleneck. When you talk about your ability to scale capacity, I feel like every 2 years, and this is not your fault, the market is going one way or the other and you're scaling or you bring it down and you're scaling or bring it down. What's the right way to think about your capacity from a quarterly basis or a yearly basis or contextualize your ability to scale capacity from a dollars perspective? And how much are you willing to scale that with the knowledge that like, hey, maybe this is the direction the market actually is going, we can take a risk here and scale a bit more?

Yes. I mean, certainly, as we highlighted in our last earnings call and subsequent discussions that we're adding significant capacity in calendar '25 in a couple of tranches. Now the reality is those capacity -- those decisions were made years ago. made it ways back. And today, we're making decisions to invest because it takes quite a while this -- from building buildings in some cases or acquiring wafer fab equipment, which may have multiple quarter lead times. And so I do expect that as we exit calendar '25 that we will have, let's say, 2x the capacity of what we are exiting calendar '24 at, maybe more than that. And from a revenue standpoint, as it depends on the ratio of 100-gig to 200-gig per lane EMLs because the 200-gig per lane has a higher dollar per square millimeter wafer size, if you want to think about it that way. They are higher ASP chips at a given size. So that also has a revenue uplift aspect of the capacity additions. But we're not done. There'll be more capacity. Our goal is certainly to add capacity as fast, if not faster than the market is growing. And I think, Tom, there's another important thing to keep in mind that transceivers are going to grow as fast as GPUs, maybe slightly faster because as the networks get bigger, they become more transceiver intensive. But another key point is that the number of optical lanes within transceivers is also growing, right? Started at [ 4 ] now there's [ 8 and 4 ] kind of blended between 800 and 400 gig, and it's going to go to all 8 lane and then maybe eventually, there's 16 lane. And if it doesn't go to 16 lane, then you're going to need bigger chips. And so the indium phosphide content is actually growing faster than the transceivers are growing, which puts more pressure on capacity. And something you brought up that I think is also important for investors to understand that even in a silicon photonic-based transceiver, there's indium phosphide lasers. And it kind of turns out the amount of indium phosphate is about the same because, yes, you may use 1 laser to -- against multiple lanes, but the laser might be twice as big to go to 2 lanes. So -- and our analysis suggests that you're using about the same indium phosphide, whether it's SiPho based or EML based. And so because of that, we are very focused on adding a lot of manufacturing capacity for wafers.

I wasn't going to go here, but I thought it was interesting that you mentioned it. So SiPho, obviously, handling multiple lanes potentially with a single light source. There is worry that when you move to 400 gig that you have such a density of light in a given transceiver would cause thermal issues. Is that something that you hear? I mean there's going to be issues with every type of light source, right? There's cost, yield, VCSELs are 2 years -- 1.5 years behind. How do you think about that?

I mean it's certainly -- I think that's more manageable, but I do think it will maybe turn around differently. Our road maps are to focus on reducing the sort of the power consumption to drive these photonic devices at very high speeds. The power consumption goes up as the speed goes up. So really innovating at that level is a way that then we can pack more devices in a given power envelope. So that's certainly in the works. There's not a wall there that's upcoming that I'm aware of. But certainly, we do need to improve to enable the scalability. And again, I go back to that's what makes this exciting because now we're differentiating on performance, availability, it's not price, right, per se. Price is always important because there's obviously, the less they can spend, the more they can add. That's really the logic here. But I think ultimately being able to differentiate, that's where our key expertise is on the ability to drive performance and scalability is what's going to separate winners and losers, I think, over the long run than just who's willing to drop price and go to the bottom.

Okay. Switching gears over to the telecom side really briefly. You used to define the market as transmission and transport, with the transmission side being more the transceiver business and the transport side being more ROADMs. When you look at like what you're seeing from a telecom recovery perspective, I think you used to make the comment like ROADM deployments are a good indicator for broader transmission health. But it seems like in the market today, we're hearing more about these transceiver sales. Could you maybe describe what you're seeing in your business? Where is that return to strength kind of coming from?

Yes. I think there's a couple of factors that maybe kind of muddy it a little, but I think you can't ignore the fact that we kind of came -- coming off of a very large inventory correction. So as we grow, we may be just growing closer to end market demand, even if end market demand isn't necessarily changing, not saying that's the case, but there's a dynamic there. And so what you may be growing just like how much inventory was existing of a particular product. But that said, it's very clear to us that Data Center Interconnect, DCI, is growing rapidly as we supply certain components that play into that. They also play into other things. But you can see that that's where strong pull is, a little less pull, but there is improving pull for some other products. So that's what makes it very clear that today, a lot of what's maybe burning off the inventory and then turning to true end market demand is generally cloud-driven or, let's say, next product -- next-generation products where there isn't a historical inventory levels, that's the next driver. And then the final driver in this sort of order of importance is just reverting to more normal run rates as we've been very depressed compared to customer shipouts. I think that third, though, will continue on, right, and maybe reach some acceleration as we get out into calendar '25. So I feel a lot better about telecom than we have been at least several quarters that we're starting to see things improve. And hopefully, history repeats as things tend to improve, then they tend to improve faster than you expect. And then when they get bad, they tend to get worse than you expect. And we'll let you know when that starts to happen, but it definitely feels good.

Is that in the traditional -- like I've lost track over the years here. Is that in the traditional long-haul metro markets? Or have you really seen that market move more to like the ZR, ZR+ market where it's kind of the hybrid data center environment versus the real long distances. Like if you were to look at your business today, is it entirely modernized because you saw inventory get all the way worked down and new demand is kind of in this new metro long-haul area?

I would say I wouldn't sort of. I would say that what we're actually seeing is cloud driving much more today. I think the service providers will resume and grow ultimately. Internet bandwidth is not going down. So they'll continue to need to invest over time. But it's really cloud driven. But I think maybe where there's a -- not a change right now, but will be a change over the coming year or years is that Data Center Interconnect tended to be focused on maybe shorter distances, but a lot of what is driving -- and that was driven by certain operators' architecture. Every operator is dealing with the fact that at a certain level of AI cluster size, they can't get enough power. And so they will start separating data centers and saying, if I want to do 1 million GPU deployment, maybe it's in 300,000 GPU data centers, which requires massive amounts of bandwidth connecting those data centers. And they probably need to be further apart because the reason why you're separating them is to be on different power sources, which suggest more than 100 kilometers or 50 kilometers of what were typical looking backwards for ZR kind of deployments. So we see a lot more focus on longer distance, 400 gig or longer distance 800 gig, at least that's what we're seeing start to emerge. And we're also seeing pull for the transport, as you described it. I would call it more line system elements because if you're lighting -- putting a lot of bandwidth to a fiber, you need amplifiers and ROADMs and other things that get those optical channels onto the fiber and across the couple of hundred kilometers. So kind of pulling in general, a range of our products, just obviously, there's more products as you look to the broader service provider world that we're not seeing as much strong pull for. Hence, kind of a little bit of fuzzy color we can provide on where the growth is.

All right. Last one for me. So we talked about your existing customer, the addition of 1 customer and then the second customer on the transceiver side, on the datacom side. We talked about a recovering telecom. We didn't really talk about industrial and consumer. We can leave that to the side because I'm pretty sure this is not the answer to this question. But when you look at the $500 million on a quarterly run rate and you build up from where you are today, what's responsible from getting you to point A to point B?

Yes. I think most of the dollar growth is clearly going to be in the cloud-oriented business between chips and transceivers, just given very, very strong end market demand, capacity additions coming online in the chips, new customers coming online in the transceiver side of things. So even if you kind of think about that $500 million, and say, okay, even if industrial tech doesn't change much at all, you can have nothing to a very modest telecom product recovery, and I'm more bullish than that. But I -- even if you assume modest, most of the growth is going to be coming from these cloud opportunities. But I also believe that as we've outlined kind of the number of customers and capacity additions, I think that more than covers what we need. It kind of provides -- not if there's anything going wrong, but it provides upside if all things go as expected or the ability to hit that number a little earlier than we said, but we're not at that point yet. So we'll give an update every quarter of progress towards that. But I think it's -- as Alan likes to say, it's on us, right? The opportunity is there, and we just need to go execute, and we should be able to get there.

Well, exciting times. Thank you very much, Chris. It's a pleasure having you here.

All right. Thank you, Tom. Take it easy. Well, bye-bye. Yes.

Thanks, everybody.