Earnings Call Transcript - FN Q2 2024

Operator, Operator

Good afternoon. Welcome to the Fabrinet Financial Results Conference Call for the Second Quarter of Fiscal Year 2024. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions on how to participate will be provided at that time. As a reminder, today's call is being recorded. I would now like to turn the call over to your host, Garo Toomajanian, VP of Investor Relations. You may begin.

Garo Toomajanian, VP of Investor Relations

Thank you, operator, and good afternoon everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the second quarter of fiscal year 2024, which ended December 29, 2023. With me on the call today are Seamus Grady, Chief Executive Officer; and Csaba Sverha, Chief Financial Officer. This call is being webcast and a replay will be available on the Investors section of our website located at investor.fabrinet.com. During this call, we will present both GAAP and non-GAAP financial measures. Please refer to the Investors section of our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation, as well as additional details of our revenue breakdown. In addition, today's discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. These statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise them in light of new information or future events except as required by law. For a description of the risk factors that may affect our results, please refer to our recent SEC filings, in particular, the section captioned Risk Factors in our Form 10-Q filed on November 07, 2023. We will begin the call with remarks from Seamus and Csaba, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady. Seamus?

Seamus Grady, CEO

Thank you, Garo. Good afternoon and thank you for joining our call today. We had a very strong second quarter, which again set new records for revenue and EPS, and also exceeded our guidance ranges. Rapid datacom growth continues to fuel our overall performance, driven by next-generation AI interconnect. Telecom revenue remains impacted by inventory absorption in the ecosystem, but we are encouraged that the magnitude of these declines is getting smaller. Total revenue was $712.7 million, an increase of 7% from a year ago, and 4% from the first quarter. Our strong execution helped to improve operating margins from the first quarter and generate non-GAAP net income of $2.08 per share, a new quarterly record. Looking at the second quarter in more detail, optical communications revenue grew, both from a year ago and the first quarter. Within optical communications, telecom revenue decreased sequentially as anticipated. However, within telecom, we saw increasing demand for extended reach, pluggable optics, which helped soften the sequential decline. We expect that this trend will continue in Q3. When combined with what appears to be a diminishing impact from inventory absorption, we believe telecom revenue could be up slightly in the third quarter. Datacom revenue growth was strong again in the second quarter, driven by AI optical interconnect products. For the first time in our history, datacom revenue exceeded telecom revenue, largely driven by AI programs. We expect to maintain this higher datacom revenue mix even as sequential datacom growth moderates and as telecom revenue trends improve. Our non-optical communications business saw a small sequential revenue decline in the second quarter. This was primarily due to continued inventory absorption from certain automotive programs. We expect this inventory digestion in the automotive market to persist into the third quarter, but we currently anticipate a sequential improvement in the fourth quarter. Industrial laser revenue remained stable in the second quarter. Operationally, we performed very well in the second quarter, with operating margins improving to 10.7%, a 20 basis point improvement from the first quarter. Looking to the third quarter, we are optimistic that we can deliver another strong performance for revenue and profitability. Despite softer near-term automotive trends, we believe telecom is positioned to show sequential revenue improvement, led by growth in ZR. In addition, we expect further growth in datacom revenue, which continues to be driven primarily by strength in AI programs. At the same time, we expect to extend our track record of strong operational execution and profitability. In summary, we are excited to have delivered another record quarter for both revenue and earnings per share, and we are confident that we can deliver another strong performance in the third quarter. Now I'd like to turn the call over to Csaba for additional financial details on our second quarter of fiscal 2024 and our guidance for the third quarter. Csaba?

Csaba Sverha, CFO

Thank you, Seamus, and good afternoon, everyone. Second quarter revenue was above our guidance range at a record $712.7 million, up 7% from a year ago and up 4% from the first quarter. This strong top-line performance led to non-GAAP earnings per share of $2.08, which was also above our guidance range. This record EPS includes the impact of a foreign exchange evaluation loss, which reduced net income by $0.10 per share. Details regarding our revenue breakdown are included in the investor presentation on our website. So my comments today will focus mainly on the most noteworthy areas. Optical communications revenue was $567.9 million, or 80% of total revenue. Datacom revenue was $288.1 million, exceeding telecom revenue for the first time. Datacom revenue increased 19% from the first quarter, driven primarily by 800-gig AI programs. Although the rate of sequential growth has begun to moderate, datacom revenue still increased by over 150% from a year ago. We expect new high data rate datacom programs to continue making significant contributions to our top-line as we look ahead. Telecom revenue was $279.8 million or just under half of total optical communications revenue. Telecom revenue declined 4% sequentially as we continue to see softness due to excess inventory in the channel. Similar to the first quarter, growing demand for 400 ZR programs helped to offset some of this impact. We are optimistic that in the third quarter we could see a small sequential increase in telecom revenue. By data rate, products rated 400-gig and faster grew 118% from a year ago and 18% from the first quarter, and represented two-thirds of total optical communications revenue. Non-optical communications revenue decreased 5% sequentially to $144.8 million and comprised 20% of total revenue. This decline was driven primarily by inventory absorption of certain automotive products as we indicated last quarter. We anticipate automotive revenue will continue to decline in the third quarter but expect to see a return to sequential growth in the fourth quarter. Industrial laser revenue was flat sequentially, and we expect that trend to continue in the third quarter. As I discussed the details of our P&L, expense and profitability metrics will be on a non-GAAP basis unless otherwise noted. Gross margin in the second quarter was consistent with the first quarter at 12.6%. Operating expenses were $14 million, or 2% of revenue. This produced operating income of $76 million, representing an operating margin of 10.7%, an improvement of 20 basis points from the first quarter. With a strong balance sheet, we benefited from $7.7 million of interest income, which more than offset the $3.8 million FX loss from foreign currency assets and liability revaluations at the end of the second quarter. Effective GAAP tax rates were 5.2% in the second quarter, in line with the mid-single-digit level we anticipate for the fiscal year. Non-GAAP net income was a new quarterly record of $76.1 million, or $2.08 per diluted share. On a GAAP basis, net income was $1.89 per diluted share. Looking at the balance sheet and cash flow statements, at the end of the second quarter, cash and short-term investments were $740.6 million, up $69.8 million from the end of the first quarter. The primary driver of this increase was healthy operating cash flow of $84.2 million. With CapEx of $9.8 million, free cash flow in the quarter was $74.4 million. We were active in our share buyback program during the quarter, repurchasing approximately 38,000 shares at an average price of $166.61 per share, for a total cash outlay of $6.4 million. In addition to investing in our growth, returning value to shareholders remains a key capital allocation priority. At the end of the second quarter, $93.6 million remained in our share repurchase authorization. Now I will turn to our guidance for the third quarter. We remain optimistic about our business momentum and ability to execute well. In the third quarter, we expect further sequential revenue growth in datacom, which continues to be driven by demand for optical communications products for AI applications. In the telecom market, after several quarters of declines, we believe that we could see modest sequential revenue growth in the third quarter. We expect this increase to be driven by further stabilization of industry-wide inventory issues coupled with continued growth of data center interconnect products. We foresee another quarter of softness in our automotive business due to inventory absorption in the channel. And we expect that industrial laser revenue will be flat. As a result, we anticipate total revenue will be in the range of $705 million to $725 million in the third quarter. We expect to continue to execute well and anticipate net income of $2.08 to $2.15 per share. In summary, we are excited to continue with our strong track record of exceeding guidance as well as achieving new records for both revenue and EPS. We are optimistic that we are well-positioned to deliver strong results again in the third quarter and extend our leadership position in the market.

Operator, Operator

Thank you. Our first question comes from Karl Ackerman with BNP Paribas. Your line is open.

Karl Ackerman, Analyst

Yes, thank you, gentlemen. I know you don't typically guide beyond one quarter, but perhaps you could discuss the backlog visibility you have on 400-gig and above optics over the next few quarters as well as the breadth of high-speed optical programs ramping. I ask because while a peer of yours indicated a temporary pause in 400-gig and 800-gig deployments in March, backlog visibility appears very good for 800-gig, and multiple hyperscalers appear to be deploying 800-gig this year. So, if you could comment on that, the visibility you have, that would be very helpful.

Seamus Grady, CEO

Thanks, Karl. Yeah. We have pretty good visibility, especially on the newer programs. Typically, in normal steady-state business, we would have rolling 13-week forecasts. But for these newer programs, we have visibility beyond that. As you rightly point out, we just guide one quarter at a time, so I won't get into too many specifics. But I will say we are optimistic about the breadth of the pipeline for 400-gig and above, 400-gig, 800-gig and higher and we have a number of programs and a number of customers in the pipeline that we are pretty excited about, but again nothing to get into too much detail about and we certainly don't want to be announcing any products on behalf of our customers, but we are pretty optimistic about the pipeline that we have for those higher speed, higher data rate products.

Karl Ackerman, Analyst

Great. Thank you for that. Perhaps if I may have a follow-up. Could you provide any update on the timing of building 10? And also if you could address your ability to service what appears to be very strong demand for high-speed optics in datacom, certainly the capacity that's serving telecom were to tighten quickly as well. Thanks.

Seamus Grady, CEO

We opened building 9 a little over a year ago and are already ramping up quickly. Typically, we decide to move forward with the next building once we reach 70% utilization on the last one. We're not there yet, and there's nothing to announce at this stage, but we're getting closer. We're pleasantly surprised by how fast we've been adding capacity in building 9, particularly driven by strong demand for optical interconnects for AI applications. While there's no announcement to make right now, we're very aware of this situation and will be making a decision in the coming quarters. Looking back a couple of years, it would have been hard to believe that we would even be considering building 10 so soon after opening building 9. Regarding capacity additions, we have been adding at a rapid pace and keeping up with demand, which has thankfully not been an issue. Any constraints we've encountered have mostly been related to components, but we've been able to ship a lot despite a few limitations along the way. With new products, especially those ramping up quickly, component constraints can be a challenge, but overall, we are pleased with our growth and the strength of our pipeline.

Karl Ackerman, Analyst

Very helpful. Thank you.

Operator, Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Alex Henderson with Needham. Your line is open.

Alex Henderson, Analyst

Great. Thanks. First, could you clarify whether you expect any currency translations in the March quarter? I know the BOT peaked towards the end of the December quarter and has declined somewhat since then. So are you assuming it will remain flat in your calculations?

Csaba Sverha, CFO

Hi, Alex. This is Csaba. Certainly, we had a revaluation impact in the December quarter, so we are off the peak, but as you know we are continuing to hedge our currency exposure. So, from operations perspective we anticipate a flat FX environment going into Q3. However, obviously, in the March quarter, we do contemplate a certain exchange rate revaluation impact. Again, the BOT has reached the peak earlier, so we are contemplating some reval impact in the EPS, but not in the cost of goods sold environment if that makes sense.

Alex Henderson, Analyst

Great. And the taxes, I assume, are going to be pretty consistent with the first half level and the second half. Is that a reasonable?

Csaba Sverha, CFO

Yes. That's reasonable. We anticipate mid-single digits.

Alex Henderson, Analyst

So, I wanted to ask a couple of questions on operations. Can you give us any sense of what the non-speed products did particularly in the telco space, the ROADMs and OLS type products? And second, can you give us some sense of what's going on with the systems business which obviously has become an increasingly large piece of your business over time?

Seamus Grady, CEO

So, non-speed rated, Alex, in the quarter, maybe Csaba, if you can help me with the exact numbers, and then I'll talk about what's in non-speed raters.

Csaba Sverha, CFO

Yeah. So the non-speed rated business was flat, Alex, in Q2 versus Q1, it was $118 million revenue from non-speed rated, and I'll pass back onto Seamus, but it does include more than ROADM, so I'll let Seamus clarify that.

Seamus Grady, CEO

That's right, Csaba. It was 118, so up 1 million, slightly up from the prior quarter. And for us, non-speed rated includes ROADMs, it's about a third of the non-speed rated business, also fiber arrays, another third, and then the balance is made up of other components, primarily optical amplifiers. So, there's a good mix of products in there, it's not just one particular category.

Alex Henderson, Analyst

Right. And systems?

Seamus Grady, CEO

We do not break out systems separately, but we remain optimistic about our pipeline of new business in that area. There are several opportunities to gain additional systems business over time, both from existing and new customers, and we currently have around a dozen programs that we are considering. The favorable economics are usually easy to present to the customer; however, the sales process can be lengthy and often requires some external catalyst. Therefore, we are being patient, but we are very focused on this aspect.

Alex Henderson, Analyst

Okay. One last thing, then I'll see the floor. On the AI side, I assume that you're still capacity constrained on production, as opposed to any demand issues, and that's probably going to stay that way all year. Can you give us any sense of what the rate of commitment to new production capacity coming on looks like for that AI product line, and whether you expect to broaden your customer base in terms of other AI customers? Thanks.

Seamus Grady, CEO

The pace of capacity additions has been very strong, and we have managed to keep up with demand. Any constraints we've encountered have been at the component level. Occasionally, some components experience very high demand, so the constraints have been more about component supply rather than our manufacturing capabilities. We have been able to meet demand from a manufacturing perspective, and we are continuing to expand our capacity. Regarding additional customers and possibly new products, we see a couple of avenues for growth driven by AI. When we refer to AI interconnect, we are talking about specific, short reach, low latency, low power optical interconnect used specifically for AI products, not general DCI. We have two reasons for optimism in this area. The first is our existing customer base, where we are working diligently to not only meet current product requirements but also to secure follow-on and next-generation products. We are putting significant effort into that. Additionally, we are collaborating with several other customers to develop new products, which might take a bit longer, but we have multiple opportunities we are pursuing. We are actively working to secure more customers in the AI sector.

Alex Henderson, Analyst

So, just to be clear, you had said in the past that 10% to 25% quarter-to-quarter capacity growth was attainable over the next year. I think is that still the reasonable way to think about capacity growth?

Seamus Grady, CEO

I'm not sure we discussed capacity growth in those specific terms. Typically, we collaborate with the customer to ensure we have long-term visibility for these new products so we can effectively increase capacity. It's a complex process involving the customer and equipment suppliers, as some of this equipment has very lengthy lead times. However, we've managed to stay ahead of demand. We haven't faced any demand constraints, nor have we been limited by capacity. While I can't precisely quantify it at 20% or 25%, I can confidently say that we will continue to add capacity ahead of demand.

Alex Henderson, Analyst

Great. Thanks.

Operator, Operator

Please stand by for our next question. Our next question comes from the line of Samik Chatterjee with JP Morgan. Your line is open.

Samik Chatterjee, Analyst

Hi. Thank you for taking my questions. I have a couple. For the first one, regarding your datacom business, you had a sequential revenue growth of about $46 million this quarter. When discussing the guidance for fiscal 3Q, it seems you're indicating a more moderate sequential growth going from 2Q to 3Q. Additionally, the overall guidance appears to be a bit more conservative than what you've experienced in the past few quarters. I'm curious if this is accurate and what the potential drivers might be. Is it related to the component constraints you've mentioned, timing of customer purchases, market share, or any other factors contributing to this moderation? Thank you.

Seamus Grady, CEO

Sure, thanks, Samik. Yeah. A couple of parts to the question and also a couple of parts to the answer. You're correct that the datacom growth, we're certainly calling out some moderation in our guidance, but still very healthy growth. Just to point out our overall growth, if you look, we have a track record, of course, of exceeding our guidance and we always work hard to make sure we do that. Our guidance right now for Q3, at the midpoint of the guidance, if we were to accomplish that at the midpoint of the guidance, we'd see us up 7.5% year-on-year in what has traditionally been a seasonally soft quarter. At the high end of the guidance, we would be up 9% year-on-year. So, if we were to exceed the high end of the guidance, double-digit growth year-on-year is not out of the question in Q3. The quarter-on-quarter, the guidance we've given for Q3 contemplates a number of factors, one of which is the transfer out of the 100-gig Intel business will really begin in Q3. And the impact will really be in Q3 and in Q4. So that's one factor that's, if you like, factored into our guidance. Secondly, growth in datacom will moderate somewhat as our initial AI programs pass the initial part of the growth curve. So, as we get to the point where we're beginning to lap ourselves with four consecutive quarters of growth, that growth will begin to moderate, albeit we're working hard to win the follow on programs and the follow on products and the new products and other customers. But that initial phase of growth will begin to moderate. That said, we do believe we're still fairly early in the overall AI cycle and that will continue to contribute to our performance for a long time. And we do expect datacom to remain our biggest revenue contributor. It's a little too early to call out specific future programs, new programs, and we don't have anything to announce today, but we believe we're very well-positioned to win additional AI programs.

Samik Chatterjee, Analyst

Thank you for the information. For my follow-up on the telecom business for fiscal Q3, my takeaway from your prepared remarks about sequential growth into Q3 is that the growth drivers are the ZR pluggables. Could you provide some insight into whether you see enough pipeline for growth in ZR pluggables to support more sustainable sequential growth beyond the March quarter? Alternatively, are we currently facing limited or moderate inventory-related headwinds that might affect the sustainability of ZR pluggables as a growth driver? Thank you.

Seamus Grady, CEO

I believe you are correct. The growth in telecom is mainly being driven by ZR and DCI. This doesn't imply that traditional telecom is disappearing; rather, it is experiencing an inventory adjustment. However, there is a longer-term trend to note. For the first time, our mix has shifted to having more datacom than telecom, largely due to the significant growth we've observed in AI and the ongoing movement towards the cloudification of telecom. This shift allows telecom companies to utilize elastic cloud computing to adjust their network capacity according to demand. While the growth we're experiencing is returning to a positive trend, it is mainly fueled by ZR and DCI. We have a solid pipeline for ZR, including 400 ZR, along with additional products in development with our customers, making us quite optimistic. Overall, ZR and DCI appear to remain robust.

Samik Chatterjee, Analyst

Thank you.

Operator, Operator

Thank you. Seamus Grady: Thanks, Samik. Please stand by for our next question. Our next question comes from the line of Mike Genovese with Rosenblatt Securities. Your line is open.

Michael Genovese, Analyst

Great. Thanks a lot. Seamus, do you have a sense of your market share in 800G cables for NVLink applications?

Seamus Grady, CEO

We do, but it's not something we would be prepared to discuss publicly. We have a very good sense of it.

Michael Genovese, Analyst

I mean, can you say if it's 100% or less than 100%?

Seamus Grady, CEO

For our main customers, we are the only manufacturer of their custom designed products. They may use other interconnect solutions, but for their uniquely designed products, we are the sole manufacturer. Therefore, it can be said that we have 100% market share.

Michael Genovese, Analyst

Yeah. I guess, I'm just thinking for the very shortest application of just sort of GPU to GPU. I don't know if there's other cables out there. Are you aware of any others?

Seamus Grady, CEO

No, there are two other approved. Again, it's our customer who decides what's approved for that, let's call it the socket. There are two other approved manufacturers, but those two companies have their own designs.

Michael Genovese, Analyst

Okay. Perfect. And then, well, I guess, is there an opportunity here with other GPU makers to make the same kind of product for I guess one or two or three other companies out there that also make GPUs? Is that an opportunity that you're pursuing?

Seamus Grady, CEO

Yes, it is. We believe we are well-positioned. We have a strong track record in producing transceivers, particularly high-speed, low-power, low-latency, short-reach transceivers, and we have a solid reputation in this area. We consider ourselves a leader in service, delivery, and quality, and we believe our costs are highly competitive. Therefore, we feel we are in a strong position to capture more business in this market as other companies enter and start to gain market share; they will all require optical interconnect solutions, and we are well-equipped to support them.

Michael Genovese, Analyst

Yeah. Great. And then last question for me. I guess, is when we think about sort of what comes next as you go from the GPUs to the top of rack switches and then out to other parts of the data center and you need longer cables and sort of discrete 800G transceivers. My question is, do you see yourself participating in that market with direct relationships with the end customer, or should we think about you participating in that market through your more traditional datacom transceiver customers who will clearly need help to ramp up to the volumes they need to get to? How should we think about that? These longer reach datacom transceivers evolving for you?

Seamus Grady, CEO

Yeah. So, we think probably both, both directly with the large consumers of these devices, but also with the optical interconnect companies. So, we think we can support both. We don't have our own products, nor will we have, we're not an ODM, we have no plans to have our own products. So that's one of the things that's a little bit different about Fabrinet is we're not an ODM and we won't be an ODM. But if one of the hyperscalers hypothetically, if they have their own design or if they have a design that they own that they want us to manufacture, we'd be happy to do that. But conversely, the traditional transceiver companies, we're happy to support them as well. We support both. And I think that's something that's quite unique about us. We're able to support both and we don't have any kind of conflicts because we don't have our own products that allows us to support both.

Michael Genovese, Analyst

It seems reasonable to assume that datacom will remain larger than telecom, and we do not anticipate telecom overtaking datacom at any point. Is that accurate?

Seamus Grady, CEO

I think so, yeah. We seem to have crossed over to the point where datacom is larger than telecom for us. And again, it's driven by really a couple of things. The growth in AI, the cloudification of telecom generally, but also this inventory digestion. But the inventory digestion, of course, is temporary. That demand will come back. So for all those reasons, we think that datacom will continue to be larger for us at least than telecom.

Michael Genovese, Analyst

Perfect. Thanks very much.

Seamus Grady, CEO

Thanks, Mike.

Operator, Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Your line is open.

Tim Savageaux, Analyst

Thanks and good afternoon.

Seamus Grady, CEO

Hi, Tim.

Tim Savageaux, Analyst

I’m not sure if you mentioned this, but can you provide details about the impact related to Jabil or their acquisition of the Intel transceiver assets? I understand it has decreased significantly, but it still seems like it could be important. Could you estimate it, perhaps around 10 to 20 million? Can we explore that possibility?

Seamus Grady, CEO

No, we wouldn't be ready to estimate that. I believe that over the next few quarters, you will see a decline in the 100-gig business as it transitions out, but that is already included in our guidance. However, I am not ready to provide a specific number at this moment, Tim.

Tim Savageaux, Analyst

Fair enough. At a higher level regarding AI, you previously described the stage of this market with varying terms to indicate how early it was. It seems we might have lost track of that. I would like to get your update on where you think we stand in terms of market growth now that you've ramped up significantly. Clearly, we're less early than we were, but has your perspective changed over the last six months regarding where we are in the AI data growth stage or market outlook?

Seamus Grady, CEO

I think it depends on what your time horizon is. If your time horizon and the prism that you're looking through is a quarter or two, then yeah, you're probably right. We're probably beyond that initial phase. But if your time horizon is much longer, I think we're in the very early stages of this. So, you can add or subtract as many variables as you like, but I still think we're in the very, very early stages of this. And we're just beginning to see what this explosive growth in AI and the infrastructure that's required to power this network will do and what it will need in terms of optical interconnect. I think it's because optical is the only way that you can get the speed and the bandwidth that you need to get the signals to move around. You just can't do it with traditional interconnect. So, I think there's a kind of a paradigm shift to optical interconnect becoming kind of almost mainstream. And you have to have optical for this. There's no other way to do it. So, I still think we're in the very early stages. I'm still as optimistic as I was six or eight months ago. My view hasn't changed on that. I think it's amazing to see what these products can do and what they drive in terms of technology. And we're just so excited to be a part of it and to be able to continue to produce, again, not just the current products that are powering the data centers, but also to be working on the next-generation products.

Tim Savageaux, Analyst

Got it. And last one for me, and thanks for that. In terms of ZR, any more color on that? Are you back through previous peak levels in ZR? Are we now looking at getting over 10% of revenues or could you try and size that for us or give us any color of where we are now versus what we've seen in the past?

Csaba Sverha, CFO

Tim, let me take this. We haven't returned to the high levels we've experienced in the past. We need to be aware of the inventory management in the industry. However, we are pleased to see that there has been sequential growth, and the outlook looks very promising. Our prepared remarks reflect this excitement due to our return to growth and the initial signs of industry recovery. That said, we are still away from the potential and prior levels we have seen.

Tim Savageaux, Analyst

Okay. Thanks very much.

Seamus Grady, CEO

Thanks Tim.

Csaba Sverha, CFO

Thank you.

Operator, Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Dave Kang with B. Riley. Your line is open.

Dave Kang, Analyst

Thank you. Good afternoon. My first question is on the telecom side. So, it sounds like, Seamus, you're splitting that up, them up between DCI versus a traditional telecom. Just wondering if you can kind of what the mix is between DCI versus a traditional telecom.

Seamus Grady, CEO

Yeah. We haven't actually broken out the mix that way. I guess the point I was making, Dave, was that the growth that we're seeing in telecom is primarily coming from DCI and 400 ZR in our forecast. Traditional telecom is still somewhat flat and digesting inventory. But because the industry categorizes DCI into telecom, we are seeing some growth in telecom from DCI and 400 ZR, but we don't actually break them out separately.

Dave Kang, Analyst

Fair enough. But then is it fair to assume that traditional segment is still larger than DCI? I mean, if you look at like Cienas and Infineras of the world, traditional is certainly bigger than DCI.

Seamus Grady, CEO

Yes.

Dave Kang, Analyst

Okay. Please continue.

Csaba Sverha, CFO

Bear in mind, Dave, that our traditional business includes system business. So, DCI being larger than our traditional telecom business would take a lot of growth. So just another...

Dave Kang, Analyst

Got it. Yeah. And then just sticking with a traditional side, so you're guiding telecom to be up sequentially, but just wondering, I'm assuming that's mostly driven by DCI or ZR. How should we think about traditional? Is it going to be kind of flat or still down?

Csaba Sverha, CFO

Traditional would be still slightly down, Dave. So, the growth we are seeing, a modest improvement quarter-on-quarter is driven by DCI and ZR.

Dave Kang, Analyst

Got it. And my second question is on DZS. You talked about them as new customers last year. Just wondering what the latest is. Have they become sort of a meaningful customer or still ramping? Any color would be appreciated.

Seamus Grady, CEO

We've transferred, let's say, everything that was in the initial list of products that was slated to transfer. We've transferred everything now. So, the business from DZS is baked into our forecast and it's in our actuals for last quarter. So that's already wrapped. There's other business we're working hard on to win and grow with DZS, but that initial phase of business is already ramped at this point.

Dave Kang, Analyst

Got it. Thank you.

Seamus Grady, CEO

Thank you, Dave.

Operator, Operator

Thank you. Please stand by for our next question. We have a follow-up question from the line of Alex Henderson with Needham. Your line is open.

Alex Henderson, Analyst

Give me a moment. So, based on the calculations you provided regarding the non-optical and telco segments, when we compare the remainder to our guidance, it suggests a low single-digit growth in datacom. I have a couple of questions. First, regarding the impact of the Intel business on the datacom segment, where would that be situated?

Seamus Grady, CEO

Yeah.

Alex Henderson, Analyst

And second, within that context, is this a function of supply of components that is causing a fair amount of flatness sequentially that you just can't get the components necessary to ramp that business sequentially on the AI side? Because it implies fairly modest AI growth, certainly not in line with the growth at your major customer on a quarter-to-quarter basis.

Seamus Grady, CEO

The Intel business is in datacom, so any business we transfer out in Q3 will affect our datacom figures. The growth in datacom involves many factors, and I wouldn't suggest it's all linked to one customer. There are several elements at play. Additionally, we lack visibility into our customer's inventory levels. We ship based on their demand, which includes what they have in inventory versus what's directly installed. We don't really see that information. There may also be some inventory normalization happening. Overall, demand is still robust, but the unknown factor is the inventory situation.

Alex Henderson, Analyst

So, if I were to look at the datacom business, it's gluting AI, has been pretty stable at around $40 million a quarter, I believe. And so I could take some stuff out of that for the Intel piece, but it's still a meaningful deceleration in the AI. Is that something that you see is fairly temporary and that the overall growth rate is still on track to fairly high grades of growth for the calendar 2024 year?

Seamus Grady, CEO

Well, we're expecting datacom to be up sequentially in the quarter. I'm not sure I follow your logic, the number.

Alex Henderson, Analyst

If I take the company's guidance and subtract out the comment about slightly up on telco, flat on auto, or down on auto and flat on the industrial lasers, subtracting that out gives you the datacom piece. So the datacom piece is kind of below single-digit growth, I believe, if I do the math right. And sequentially, and certainly there's a piece falling out, but that's a lot slower growth than you had been posting. And I guess I'm trying to get to the elephant in the room, which is why that's the case. And to what extent that that's a temporary lull before continuing a steep ramp in future periods.

Seamus Grady, CEO

It's a combination of the Intel business transitioning and the initial AI programs moving into stable production. They have moved past the initial part of the growth curve, which is why we noted that growth is starting to moderate in Q3. I can't go into specifics about individual customers, but it's a blend of continued AI growth being offset by business transitions and the 100-gig transceiver business.

Alex Henderson, Analyst

Okay. Thanks.

Seamus Grady, CEO

Thanks, Alex.

Operator, Operator

Ladies and gentlemen, I'm showing no further questions in the queue. I would now like to turn the call back over to Seamus for closing remarks.

Seamus Grady, CEO

Thank you for joining our call today. We are pleased to have exceeded our guidance again in the quarter. With another quarter of record revenue and EPS behind us, we are optimistic that we are well-positioned to continue our strong execution track record in the third quarter. We look forward to speaking with you again. Goodbye.

Operator, Operator

Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.