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

Thank you, everyone, for joining us today, and welcome again to day 2 of our tech conference. My name is Papa Sella. I'm the U.S. Optical Networking Analyst here at Citi. And I'm very pleased to welcome Wupen Yuen with the President of Global Business Units and prior to the President of Cloud and networking. And of course, we have at who you know very well, the VP of IR of Lumentum as well. First of all, I'm very glad to still have you now. I wouldn't be surprised if you cancel the last minute to secure more capacity at this on.

Well, this is important. This is very important.

Yes. Thank you for joining us. And maybe to get started, -- and I will ask questions and then we'll leave the last maybe 10 minutes for your questions as well if you have any. To get started, up and Katy, I guess given your role into AI, I'm curious, first, have your take around but also optical and networking is playing a more and more important role into this AI infrastructure. So just if you can touch on that as well before we touch on the company in general.

Yes, let me jump in here. I think the AI really is we're at the very beginning of AI, right? If you look at the whole industry here, yesterday, we're selling this article talking about Astrapak in a year, signed up $517 billion worth of compute, right? So today, the demand of AI way exceeds that of supply. And we're not seeing it changing. It's very different from the past cycle of optical, which is really for infrastructure, for communications. This is really for the intelligence, the generation and also serving the intelligence. So the demand is just absolutely crazy. And then we don't see that changing for the next at least couple of years, if not longer. And as a result, right, is AI making progress into faster throughput, bigger models, more specification, the agenetic AIs, the connectivity requirement is also increasing, every generation of GPUs or TPUs getting more and more bandwidth. And then with copper running into the limitations of physics, the more of the optical has to be used for interconnecting this and therefore, we're seeing the demand for optical activity is also increasing generations goes on. Therefore, we feel both the demand side and also the technical requirements continue to escalate and all this actually is good for the optical world we're in today.

And Papa, if I could just add on to that. Thank you again for hosting us at the conference. It's been a fantastic conference for us. really appreciate that. I'll just add on to what Wupen just said. If we think of data center interconnect or the telecom market being sort of a 1x multiple. What we're seeing now for scale across is probably 10x of what we saw for DCI. What we're seeing now for scale out is probably 10x of what we're seeing for DCI. What we're seeing for scale up, starting in the second half of for the first instance of CPO going to scale up is probably a 3 to 4x above the 10x that we're seeing for scale-out, and then when all of scale up goes optical, it's probably a full 10x above the 10x of scale-out. So there's many multiples of optical bandwidth that we are needing to deploy in data centers. And we're not yet even talking about scale in. I think you may have a question for us later on scale in there's another 10x multiple there. So it's mind boggling in terms of what we're enabling in terms of enabling the compute.

Absolutely. It's been quite a fascinating journey and I'm curious on -- I guess, it's been not too long since last earnings, but just curious on the state of supply demand gap at this point, where are we -- is it extending -- any general kind of update on that front?

Yes, I think it's still extending, right? So today, we're still short everywhere, right? The laser, for example, were short, EMLs short, several lasers short. And then we don't see the shot going away right? I think 2017 is going to be another major year. People forecast just the scale out module is going to be doubling the volume on '26 to '27. Laser supply is not really catching up to it, right? And in PA, the scale up is going to happen. That's going to drive yet another 3 to 4x of increase of demand. So we really don't see the laser supply demand gap actually close within the next couple of years. And then we're doing the very best we can. To this day, we're still allocating capacities in some cases, like is on pricing, right? Expedite fees, and things like that in order to make sure that we serve to the most profitable opportunities. That's the case today. The pricing remains very healthy. All the deals we're making today are equal or higher pricing than the escalated pricing that we already had. So overall, we're seeing the pricing environment to be -- continue to be very favorable. And that is kind of a signal that the supply-demand gap still remains.

Maybe before diving deep into different kind of segments, Kathy, maybe 1 question for you. Recently, you updated your 2020 target to $40. I think it probably came earlier than most expected because you typically do that, I think, at us on the timing and.

Yes, sure. Again, thanks for the setup there. So since our last earnings call, we learned that we have more opportunity in OCS than we previously had understood. That visibility in OCS enables us to be very confident about for the first time, I think, ever, putting out a fiscal year '28 guidance on EPS of $40. So the upside that we're seeing from OCS enables us to get there and that OCS upside is coming from our largest customer, and it's a function of more units, more units that we need to ship to them, and it probably is in large part due to their success in the market and our success with them in enabling their success in the market as they begin to sell hardware.

I will probably circle back to OCS. But just a quick follow-up. I guess -- is that more back loaded kind of more 27, 28? Or is that kind of every single quarter, you are seeing more demand for OCS?

I think it does layer in as we move through the fiscal quarters of '28. So this is a $40 EPS in fiscal '28 and it kind of pertains to all of the quarters of fiscal '28. You should probably think of it as layering in linearly and increasing as we move through calendar -- or fiscal '28.

Got it. Very helpful. But maybe perhaps I can start with the part, and then we'll get back to OCS. I think during last earnings, the discussion was around CPO particularly for your main customer demand is coming even faster and stronger than expected. I was wondering you can -- I was hoping you can pull the curtain a little bit and discuss it in more unit than expected. Is it kind of the wins are coming faster? Or is the customer pulling forward is time line? Just any color on what's driving that sentiment?

Yes. I think from the -- that's a great question, right? There's a lot of noise about the CPO NPO story. First of all, on the CPO piece, right? What we're seeing here is the schedule is the same, schedule is not changing, but demand is higher, right? Your per state is more demand for the CPO. First, it's going to be a switch, right, the scale out switch later in the second half 2017, as we talk about, it will be for the optical scale up, right? We're seeing both actually going up in volume. No change in timing, but intensity is actually increasing, which is a very good sign that CPO is doing well, right, getting traction in the market and technology is continuing to ramp well.

Yes. No, that's very helpful. And it seems like recently, NPO is even more popular than CPO, which is very hard to do, right? But I'm curious, I guess, if you take 27, 28, 29, is there a year in which you can see NPL potentially be bigger than.

Okay. Let me take the minute we describe the story. So let me sit straight, describe this, right? So if you look at the -- first of all, why is NPO even there in the first place, right? At the oversea time, we talked about the CPO. We thought the CPO, okay, what's going to be a 1 customer only story, right? And that's going to be 1 customer scale up story. Everything that we found out here really is that the optical scale up is now industry-wide story and to support the level of volume and demand for optical scale up in the time frame -- the industry is needing to use both TPO and MPO approaches to serve optical scale up, okay? So if you look at the overall market, we think it looks like the following: CP will be half of the market. Is the other half of the market, right? So I would say just from the volume point of view, it's kind of 50-50. Now look at what we serve. We serve in the sialic source, high-power lasers, right? We see the CPU world being an exclusive external life source market. And then for the NPL market, half of that will also go with external iSource okay? And the remaining half the customer are discussing between iOS or integrated life source verticals, but there's more and more of movement toward external icare. The reason is very simple because we have such a high optical density at with optical engine being placed so close to the heat-source which is the accelerators. There's a great concern what happens to the laser when so close to the heat source, right? And therefore, to ensure ability being strong, there's a strong desire to move the laser outside. And so that you don't have to worry about the laser being a rebillimiting factor, right? So we're seeing that, and we discussed also in the earnings call, this is really why we believe that the NPL is a net addition to our opportunity. because when we're thinking about the CPO before, we didn't think about the NPO being a mechanism for the industry to jump on the bandwagon of optical scaleup. I hope that explains the situation.

No, that's very, very helpful color. And kind of just to double click, on NPO specifically, I think you discussed before, there are 2 versions, 1 in which delayed his insight, more of a 10 millitwat kind of lasers needed also and then outside more of a 400. I'm curious kind of -- and then you mentioned it seems like most will be outside. But -- is that like 75%. And the reason I'm asking is I think there's a lot of discussion around China competition and being able to do the 100 kind of version of it. Just curious if you can kind of being...

That's a great question, right? So let's go to the 25% overall market of the IRS piece, right? Even for the iOS, you really don't want to use low power laser. Why? Because imagine, if you look at an NPO engine, is the size of like this big, 1 inch by 0.5 inch, right? It will pack 6.40 inside. Compared with a 1.6 module today is half of your iPhone size, right? So optical densities are a lot higher inside is a little package. And therefore, you rent to use too many lasers inside. We want to use a few laser as possible, but it doesn't fail, right? So therefore, there's a very strong push to also use high-power lasers. It's not going to be 100 million laser, it's going to be 150 million lasers or 200 million waters, right? And so therefore, I will category say that for the entire NPL CPO applications going to be $120 million, $150 million and above of high-power lasers, which is not the traditional 70 million at laser, which is used in today's pluggable market, right? So a lot of the chatter about the CW laser supply on China, in particular, it's really targeted today to serve the pluggable market, which we talked about earlier is short. But for the NPL CPO, what we see really is a strong push towards less lasers, more power and then to feed both the EOS or IRS applications.

And even in the U.S., I assume partially for the 400 ones, you don't see many competition at all.

Yes, we see the 1 competitor, right, who's coherent that MBItalso signed LTA with, right? And we're really not seeing anybody else in the high-power laser area.

No, that's very helpful. Now that we -- I guess, for the CPO P, you set a very clear picture on the demand front. I guess now the question is supply. And 1 important kind of aspect of that is the Greensboro, which is supposed to come in late 2028. I guess any potential kind of drivers for that in Bora to come in faster. Any color on the time line, what would pull it forward?

That's a great question. I think I may give you a holistic picture on how fast -- how we're thinking about ramping our ashore high-power laser for CPO and NPL, right? So first of all, we're all ramping today in our single right? We have a minor side to ramp from today all the way through 2027. So that's the first ramp. Second ramp is we're ramping the supply powders also in our U.K. fab. That will come in, in second quarter 2027 will continue to ramp through 2028. That's the second ramp. The third ramp is our Greensboro fab, it will out to ramp in second quarter 2028 or mid-28 as a third ramp, right? So in composite, you can imagine there is a the wave of a ramp that continue to support the UHP laser for both the MPO and CPO application, right? What can change that? Really, I think it's -- so far, we're on schedule for all these different ramps. And what can really change the schedule is the qualification timing, right? We have to submit the PC for a customer to qualify the product. If we can actually accelerate that qualification of the product, we can actually put it in and vice versa. So that would be the biggest variable, but we're definitely working really hard to ensure we get all the quality, all the data ready but that the PC approval can be a predose process.

And I'm curious on particularly the fab that exists already, I'm sure you are using it to some capacity or so for, let's say, telecom and so on. So I guess it must be a very tough decision because demand is strong everywhere. So I'm curious on how you think about allocation? Are you kind of giving priority where margin is strongest? Are you also looking into the future on let's say, CPO or NPO could be a bigger time than other one?

That's a great question. So we are in principle, we're adding capacity. We're not taking away, right? For example, when we're ramping our UV laser in autos, we're adding capacity. So we can actually keep our current product, which is also ramping and also in the U.K. We're adding a clean room. We're putting the new equipment, the latest and greatest state-centthat clin and ramp up is that way. So we don't sacrifice our current products. So that's how we think about it really is to ensure -- because -- all the products are ramping at the same time. The telecom scale across is also ramping as Kathy just talked about. And therefore, we don't want to sacrifice those, right? We'll add new capacity, 6-inch capable capacity to ensure we have the highest efficiency possible when we start to ramp these products, right? So by and large, we do sacrifice we add.

And then beyond laser as well, now you are also doing ELS or are you planning to do more ELS as well. I guess how large do you see that opportunity relative to the laser longer term? And -- any color on -- is it 1 customer mainly currently? Or is it pretty diversified? Do you want to take that question?