Good day, everyone, and welcome to the Lumentum Holdings' Second Quarter Fiscal Year 2023 Earnings Call. All participants will be in listen-only mode. Please also note that today's event is being recorded for replay purposes. At this time, I'd like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please go ahead.

Welcome to Lumentum's fiscal second quarter 2023 earnings call. This is Kathy Ta, Lumentum's Vice President of Investor Relations. Joining me today are Alan Lowe, President and Chief Executive Officer; Wajid Ali, Chief Financial Officer; and Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer. Today's call will include forward-looking statements, including statements regarding our expectations, regarding our recent acquisitions, including NeoPhotonics, such as expected synergies, and financial and operating results, macroeconomic trends, trends and expectations for our products and technology, our markets, market opportunity and customers, and our expected financial performance, including our guidance, as well as statements regarding our future revenues, our financial model, and our margin targets. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings. We encourage you to review our most recent filings with the SEC, including the risk factors described in the quarterly report on Form 10-Q to be filed for the quarter ended December 31, 2022, and those in the 10-K for the fiscal year ended July 2, 2022. The forward-looking statements provided during this call are based on Lumentum's reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements, except as required by applicable law. Please also note, unless otherwise stated, all financial results and projections discussed in this call are non-GAAP. Non-GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with GAAP. Lumentum's press release with the fiscal second quarter 2023 results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. This includes additional details about our non-GAAP financial measures and a reconciliation between our historical GAAP and non-GAAP results. With that, I'll turn the call over to Alan.

Thank you, Kathy, and good morning, everyone. Our second quarter financial and operational performance was very strong, led by robust demand from our Telecom and Commercial Lasers customers. Operating margin and earnings per share were both above the high end of our guidance range, with revenue above the midpoint. Wajid will cover this more in detail in the next section. As expected, sequentially higher revenue from Telecom and Commercial Lasers customers in the quarter offset the anticipated reduction in revenue from certain cloud customers due to inventory digestion and at a major consumer customer due to reduced smartphone unit production. As discussed over the past several years, share normalization has occurred in our consumer business, lessening our exposure to this cyclical market. Nearly 90% of our total revenue is now derived from infrastructure markets, which are driven by durable, long-term secular trends in which we serve with highly differentiated products and technologies. Lumentum lights up the optical fiber of the most advanced cloud, carrier, submarine, and 5G mobile networks across the globe. The technology we provide enables compute, data, and communications infrastructure to scale from a performance, cost, and power consumption standpoint. We enable higher-precision new materials and cleaner and more energy-efficient processes to be used in the microelectronics industry. The type of lasers we supply are key to the manufacturing of electric vehicles, energy storage solutions, and solar cells. Our technology leadership position is stronger than ever due to successful investments in developing new products and technologies, as well as the two acquisitions we closed this past August. We are now six months into integrating these acquisitions and tracking ahead of plan in realizing overall cost synergies, which contributed to our profitability and earnings per share results being above our guidance ranges. Our technology capabilities and manufacturing scale make Lumentum the innovation partner of choice for our customers. We have the communication industry's broadest photonic capabilities, including high-bandwidth coherent and direct-to-tech optical components and modules, ultra-narrow-linewidth tunable lasers, advanced optical amplification and ROADM solutions, coherent DSPs and RF-integrated circuits, as well as silicon and indium phosphide photonic integrated circuits. In close partnerships with our customers, we enabled the deployment of the industry's latest high-capacity 400, 600, and 800G cloud and cord network solutions. In addition, due to the escalated data traffic at the edge of the network, customers are deploying our products originally developed for core network applications at the edge or access part of the network. Revenue from edge networking products was up 40% year-on-year in the second quarter and is now a major component of our Telecom business. We are confident that our technology leadership position and solutions for advanced compute, data, and communication infrastructure will continue to provide a tailwind for Lumentum's long-term growth. Now, let me provide some detail on our second quarter results. Telecom and datacom revenue was up 44% year-on-year driven by organic and inorganic growth in Telecom. Within this, growth from Telecom customers was substantially higher but partially offset by inventory digestion at certain cloud customers. Revenue growth continues to be limited by supply shortages of ICs from third parties. We have made significant progress over the last year on closing supply gaps, which has enabled our growth to date. At the end of the second quarter, remaining IC supply shortages resulted in approximately $60 million of unsatisfied customer demand. This is a modest improvement from the $80 million gap articulated in our last call. Revenue was especially strong in products which play into the industry's transition to 400G-and-above speeds in next-generation networks, including narrow-linewidth tunable lasers, tunable transceivers for network edge applications, high-speed coherent components and modules, as well as our latest ROADMs. We achieved a new quarterly revenue record in narrow-linewidth tunable lasers which are key enablers of all coherent transmission solutions, including 400 gig ZR and ZR+ modules, and our customers' latest 600 gig and 800 gig transmission systems. We also set a quarterly revenue record with our tunable transceivers for network edge applications where a growing set of cable, MSO, and wireless network operator customers use our modules to expand data bandwidth in metro access, fiber deep, and wireless 5G fronthaul applications. Coherent components serving 400G-and-above applications also achieved record revenue with approximately half of the quarterly revenue in coherent components coming from the highest data rate applications at 600 and 800 gig. Second quarter ROADM revenue grew 45% in the same quarter last year due to continued strong demand and improved access to critical ICs. Shipments of MxN ROADMs grew 78%, and high-port count ROADMs grew over 70% from the same quarter last year, representing a broader adoption of these next-generation ROADMs with market-leading customers. As anticipated, inventory digestion at certain cloud customers and their module manufacturers resulted in a sequential decline in Datacom's laser chip revenue. As highlighted on our last call, we expected the hyperscale customers to reduce their inventories of our laser chips during the second quarter. And now, we expect that this will continue throughout most of calendar '23. Looking ahead on the technology roadmap, cloud datacenters will be designed for artificial intelligence and machine learning applications which bode very well for us as we extend our technology leadership to even higher speed laser chips. We are on track with our 200 gig per lane EMLs for 1.6 terabit per second applications and expect to enter production as we exit fiscal '23. We are also broadening and diversifying our product portfolio for intra-data center applications with differentiated high-speed VCSELs, DMLs, and high-power CW lasers and receiver photodiodes for silicon photonic solutions. For example, we expect to ramp production of our new 100 gig per lane VCSELs during fiscal '24. This is a major new opportunity for us and addresses the accelerating transition from copper to optical fiber in shorter-reach datacenter applications, especially those for machine learning and artificial intelligence. Turning to industrial and consumer, Q2 was down from Q1 as expected. During the quarter, we saw incrementally weaker overall demand for consumer VCSELs. We continue to focus on ramping new automotive and industrial sensing applications for our technology. In the second quarter, we recognized approximately $3 million in revenue from automotive and IoT applications, and we expect this revenue to grow significantly in the coming years as these opportunities ramp. At this year's CES Show, we had strong customer engagement across all applications of 3D sensing and LiDAR including from numerous automotive customers. We have a broad multi-prong approach to solicit LiDAR in automotive with a wide range of design wins with market-leading customers who are pursuing a variety of in-cabin and LiDAR approaches. In the second quarter, commercial lasers revenue was up 7% sequentially and 16% from the same quarter last year. While fiber lasers for metal cutting and welding continue to be our largest commercial lasers product line, products for emerging high-growth applications in solar, display, and electric vehicle manufacturing are becoming more meaningful. And we now expect them to increase in our mix in the coming quarters. Underscoring this, ultrafast laser revenue in the quarter more than doubled from the same period last year due to expanded use cases. Our FemtoBlade laser was recognized with the 2022 Innovator's Award at Laser Focus World due to our innovative design which enables faster processing time in micro machine applications for all LED displays, semiconductor ICs, printed circuit boards, and solar cells. We are very excited about the lasers product roadmap, which will expand addressable market further in the coming years. I am very confident about Lumentum's future given our differentiated portfolio of innovative products and technologies, our strong foundation of intellectual property, and our significant opportunities for long-term growth in the cloud, networking, and advanced manufacturing markets. I am also very confident in our ability to grow into adjacent markets, extend product leadership, and expand profitability over the long term. In addition, we have made tremendous progress towards achieving our corporate responsibility goals including our drive to a net-zero carbon footprint by 2030. Lumentum has also been named by Newsweek as one of America's most responsible companies for a second consecutive year, in recognition of our achievements in ESG. Finally, I would like to thank all of our employees around the world for all their hard work and resilience as they continue to execute upon our strategy. With that, I'll turn it over to Wajid.

Thank you, Alan. Net revenue for the second quarter was $506 million which was above the midpoint of our guidance range. Net revenue was flat sequentially and up 13.3% year-on-year. GAAP gross margin for the second quarter was 32.8%. GAAP operating margin was negative 4.3% and GAAP diluted net income per share was a net loss of $0.46, primarily driven by one-time charges related to acquisitions and restructuring activities. Second quarter non-GAAP gross margin was 44.9%, which was down sequentially and year-on-year as expected, primarily driven by product mix including NeoPhotonics revenue. During the quarter, we incurred $11.7 million in extraordinary charges to acquire IC components from various brokers to satisfy customer demand. These incremental charges were excluded from non-GAAP gross margin as disclosed in our filings. Second quarter non-GAAP operating margin was 23.1%, which decreased sequentially and year-on-year due to product mix including from our recent acquisitions, but was above the high end of our second quarter guidance range. Second quarter non-GAAP operating income was $116.7 million. And adjusted EBITDA was $133.4 million. Second quarter non-GAAP operating expenses totaled $110.3 million or 21.8% of revenue. SG&A expense was $45.9 million. R&D expense was $64.4 million. Interest and other income was $5.1 million on a non-GAAP basis due to higher interest rates on our cash and investments. Second quarter non-GAAP net income was $104.1 million. And non-GAAP diluted net income per share was $1.52. Both of which were above the high end of our guidance range provided on our last call. Net income for share performance was in part driven by accelerated acquisition synergy attainment, a cost savings action taken late in Q2, and higher interest income on our cash and investments. I will provide more color on our structural cost improvements in the guidance section of my prepared remarks. Our fully diluted share count for the second quarter was 68.6 million on a non-GAAP basis. Our non-GAAP tax rate remains at 14.5%. Moving to the balance sheet, we ended the quarter with $1.68 billion in cash and short-term investments, which was up $55.5 million from Q1. During the quarter, we had some one-time restructuring costs as we accelerated the attainment of acquisition synergies and drove some structural cost reductions. Turning to segment details, second quarter Optical Communication segment revenue at $448.8 million decreased 1% sequentially, primarily driven by a decline in industrial and consumer which is mostly offset by growth in Telecom and Datacom. Optical Communication segment non-GAAP gross margin at 43.9% decreased sequentially and year-on-year, primarily due to product mix and the impact of the NeoPhotonics acquisition. Our second quarter Laser segment revenue at $57.2 million was up 7.1% sequentially, and up 16% year-on-year. Second quarter Lasers gross margin of 52.4% was approximately flat sequentially. Now, let me move to our guidance for the third quarter of fiscal '23, which is on a non-GAAP basis and is based on our assumptions as of today. When we acquired NeoPhotonics, we highlighted $50 million in synergy opportunities with $20 million in annual operating expense opportunities within the first fiscal year and then another $30 million cost of sales synergies as we exit the second fiscal year. We have already exceeded our $20 million cost savings target in annual operating expense synergies over the last six months of integration activity. We have executed well on our operating expense reduction plans and are confident we will exceed our initial synergy targets. In December, we took additional actions that will structurally improve the long-term operating costs of the company. The benefits of these actions are reflected in our diluted net income per share guidance for Q3. As we execute on our integration and synergy plans, I will provide more details in future quarters. Our Q3 guidance reflects our expectations for reduced cloud and consumer end market revenue. Supply constraints on Telecom products and a few million dollar sequential decline in laser revenue. We expect net revenue for the third quarter of fiscal '23 to be in the range of $430 million to $460 million. Our Q3 guidance incorporates approximately $60 million of impact revenue driven by continued shortages of third-party components. Based on this, we project third quarter operating margin to be in the range of 17% to 19% and diluted net income per share to be in the range of $1 to $1.15. Our non-GAAP EPS guidance for the third quarter is based on a non-GAAP annual effective tax rate of 14.5%. These projections also assume an approximate share count of 69.4 million shares. Turning to our annual outlook, due to substantial structural improvements in our operating expenses and tight cost controls, we anticipate fiscal '23 EPS will be above the midpoint of our previous fiscal '23 outlook of $4.65 to $5.65 per share to a new range of $5.15 to $5.45 per share. We expect that our fiscal '23 revenue will be at the low end of our previously articulated annual outlook of $1.9 billion to $2.05 billion. This implies Q4 revenue will be approximately flat from Q3, given our assumption of growth in our Telecom and Datacom business offset by seasonally lower consumer revenue. We expect that Q4 will still be constrained by IC supply. I'm extremely pleased with the progress our team has made in synergy attainment, and we are now in an excellent position to exceed our $50 million synergy savings target.

With that, I'll turn the call back to Kathy to start the Q&A session.

Thank you. Our first question comes from Simon Leopold of Raymond James. Simon, your line is open. Please go ahead.

Thanks for taking the question. I wanted to see if maybe you could build a bridge or unpack a little bit more the outlook for the Telecom and Datacom segment being down in the March quarter, because I guess there are a handful of things I'm contemplating as factors, but just want to understand better in that I know you've got some seasonal slowing from the Chinese New Year, simply the factory workers going home. I'm wondering if maybe there's incremental supply chain issues baked in or whether we can attribute the decline more to the weakness you're seeing from hyperscale, just looking to unpack the drivers. Thank you.

Yes, thanks for the question, Simon. Yes, our guidance for Q3 has Telecom and Datacom coming down really mostly because of the slowing end cloud customer and the supply chain that goes into the cloud. And we are still continuing to have challenges with semiconductors as we indicated in the script, that we still anticipate $60 million of unsatisfied demand primarily in Telecom as we exit the third quarter.

Thanks. I would like to follow up briefly.

And, Simon, did you have a follow-up?

Yes, and it's pretty simple. You did mention earlier cross-synergies coming out from the acquisition. And you exceeded your own guidance on earnings. I'm just wondering what you had baked in when you provided the original forecast for the synergies and how much you exceeded them by, and, roughly, you were about $11 million-$12 million below our OpEx assumptions, and I'm trying to just make sure I understand where it's coming from?

Yes, Simon. For the fiscal quarter Q2, we managed to reduce operating expenses by approximately $5 million to $7 million more than we anticipated at the start of the quarter. Regarding total synergies, the first-year synergy targets we set have been achieved within the first six months. This has benefited not only our fiscal Q2 but also our outlook for fiscal Q3 and Q4, particularly as we are operating at the lower end of our previously stated revenue expectations. This is the current situation regarding synergies.

Thanks, Simon.

Thank you. Our next question comes from Tom O'Malley of Barclays. Tom, your line is open, please go ahead.

Good morning, everyone. I appreciate the opportunity to ask a question. I wanted to inquire about the industrial consumer market, specifically regarding 3D sensing in December. You've mentioned a normalization of market share for some time, so I would like to get an update on that. Do you perceive this market as evenly divided, or do you believe you're losing additional market share? The numbers suggest that the share has shifted, so any insights on what you define as normalization of share and its current status would be helpful. Thank you.

Yes, I'll give you my thoughts on it, and Chris can chime in as well. We've been talking about share normalization for years now, and it is finally coming. If you look at our reduction in 3D sensing revenue year-on-year, we're cut in about half. And so, that's what we would have expected. I can't comment on what our competitor is saying or doing, but everything is coming in as we expected. Chris, you have additional comments on that?

Yes, I would just echo it's difficult to compare to competitors, but certainly they sell more than VCSELs and sell into more than just 3D sensing in the sensing application universe. And as Alan highlighted, we expect it 50% down in the first half of this year, and that's what's happened. And that baked in our expectations around share, as well as other normal year-over-year price-downs, and things like that.

Got it. As a follow-up, during the December quarter, some of your end customers exceeded estimates significantly and mentioned supply chain challenges. Could you discuss your outlook for the Telecom business as it heads into the March quarter? What does the supply chain situation look like with your end customers? Is there inventory on their balance sheets? They are performing well on the revenue side, but they are also indicating a decrease in backlog. Any updates on the overall health of that ecosystem would be appreciated, especially since you expect a decline in March and a flat outlook for June from a total company perspective. Thank you.

Yes, sure, Tom. I'd say our network equipment manufacturing customers' backlog are continuing to be very robust. Of course their inventory is growing, as you say, and we can see it on their balance sheet, but their demand on us is extremely strong. I'd say the soft part of the market that we see is where the end customer is the cloud service provider. But given the backlog at our customers, I don't see that as a huge concern over the long term as the carriers are continuing to have to invest to meet the ongoing continued growth in bandwidth demands.

Yes, and I would add only that to, Tom, your suggestion that, well, revenue going into the fourth quarter may be, at the company level, flat, as we said in the prepared remarks. Obviously, there's additional seasonality in 3D sensing. And so, we expect Telecom to go up into the fourth quarter or Telecom and Datacom in the aggregate impact.

Thanks, Tom.

Thank you. Our next question comes from Christopher Rolland of SIG. Christopher, your line is open, please go ahead.

Thanks for the question, guys. I guess my first question is around gross margin. So, if I look at Optical Comms in particular, you guys were kind of mid-50s a little over a year ago, mid-40s now. Can you talk about the trajectory as we look forward? Is this now the trough, and what is that kind of recovering gross margin look like, and when might we be able to get north of 50 again for that business?

Yes, it's Wajid. I'll begin by addressing that. You're correct that our gross margins have decreased year-over-year mainly due to our chip businesses, including Datacom and 3D sensing, which traditionally had higher margins compared to other telecom and transmission product lines. We have observed a mix shift, and we indicated early on with the NeoPhotonics acquisition that we would experience a change in gross margins. Fortunately, we have been able to counterbalance some of this as we move forward with our synergy actions. We're progressing on the $30 million synergy initiatives we mentioned at the start of the acquisition, and we anticipate that the majority of the benefits will be reflected in our OpComm gross margins as we proceed with factory and backend consolidations. We have already initiated most of the planning, and as we implement these actions in fiscal '24, we expect to see the associated benefits. Additionally, we are actively addressing inventory digestion within our Datacom product lines over the next few quarters. As this improves and our revenue levels rise, we should also observe a positive effect. This represents our strategy for enhancing gross margins in our OpComm business.

That's fantastic. And then just following up on OpComms as well, two other lines of questioning, first of all, I wanted to follow up on your Datacom. So, I believe you pushed out that weakness from the first half to the full year. Was wondering did you just get a fresh view on the amount of inventory at cloud customers; I'd like to know why that was pushed out? And then also, if you could perhaps talk about this migration from 400 to 800, does that play into this as well? And then finally in OpComms, ROADM, anything on that market, and would you believe your supply normalized with demand at this point?

Yes, that's quite a follow-on. So, I'd say the change in Datacom outlook in duration of the digestion was twofold. One is inventory; we knew the inventory was there. Secondly, is the cloud growth and the CapEx spending of cloud providers, as their growth slows their need to deploy more datacenters and the interconnections of those datacenters lessens. And so, that's why we wanted to set expectations that it's going to take a few quarters to get through that inventory. I'd say that the migration to 800 gig is just economically the right thing to do for those cloud providers. And so, they're very excited to make that transition. And as we've said, that transition will happen late this fiscal year, and ramp through fiscal '24. And then on ROADM supply, I'd say that's the primary area, ROADMs and ROADM line cards, where we're being impacted the most with respect to the supply chain challenges in ICs that we have. So, I'd say 70% year-over-year growth on high-end and contention with MxN is a pretty good indicator that those are the products that are leading the market. And we expect continued growth in that market as new networks get deployed. So, we're really excited about the progress on ROADMs and in next-generation ROADMs that we expect to come out in fiscal '24. Chris, you have anything to add on any of those topics?

I would say that the addition of 800 gig is not really a transition, as I believe 400 gig will continue to grow over the coming years. The introduction of 800 gig enhances our opportunities. As mentioned, this presents an exciting opportunity for us, and we are already involved in some emerging 800 gig architectures that are just starting to enter the market. The launch of the 200 gig EML enables a more cost-effective 800 gig architecture, which is a significant opportunity for us. Additionally, there is limited inventory available since this is a brand new product, meaning it should lead to incremental growth.

Thank you, Samik.

Thank you. Our next question comes from Alex Henderson of Needham. Alex, your line is open. Please go ahead.

Thank you. I was wondering if you could discuss the pricing dynamics. Normally, the March quarter sees price declines of about 10% to 15%. Are we observing that this year? I've heard pricing seems to be more stable compared to previous years. Additionally, what are you experiencing on the supply chain front? You've mentioned $60 million in constraints, but how is this affecting pricing and margins related to the supply chain? Could you provide some insight on that? Also, as we look towards the June quarter, do you anticipate any inventory corrections or non-seasonal pricing changes? Thank you.

Yes, Alex, I would agree with you. The pricing environment we have with our customers is very different from the 10% to 15%. In some cases, prices are actually increasing. However, we are focused on the long-term relationships with our customers and aim to help them succeed in the market, which in turn allows us to establish long-term supply agreements. Therefore, the pricing dynamics are quite different and, as you pointed out, much flatter than usual. I would also say that pricing from our suppliers has eased compared to the price increases we experienced about a year ago. That being said, we are still sourcing from the broker market to meet customer demand, which means we have to pay spot buy premiums that have a significant impact on our cash flow. Fortunately, we have noticed less of that recently, but we are still dealing with it for a while longer. Regarding your question about inventory digestion in the June quarter, are you referring to Datacom or something else?

Well, the question is ultimately as things start to normalize, given the flatness of pricing over the last two years, does that pricing start to creep back into the equation as a downward pressure maybe on a non-seasonal basis but rather on a cyclical basis?

I see, okay. Yes, like I said earlier we are working with our customers to try to satisfy their short-term needs for price reductions but also our longer-term needs to have agreements in place that extend a year or two. And that's what we're working on a win-win solution with our customers that would then ensure that we have set prices with them. And we have set share agreements with them that extend beyond the short-term. So I'd say that as inventory or as supply becomes available, that $60 million or $70 million of unsatisfied backlog will be satisfied. But we don't see that happening in the June quarter, we see continued challenges as we need to get the semiconductors in house by April in order to make the shipments for June. And so we're still seeing challenges and think it's going to go into the early into the second half of the calendar year.

Second follow-up question is on the technology front, there are a couple of moving pieces that I was hoping you could address. So, the first one is that we've heard that there's a new module going into the primary 3D sensing customer that in the new additions that is pretty meaningfully changed from the prior-module. And I'm wondering if that is a function of your design or somebody else's? And then second, you talked about delays in the timing and the ramp on the Datacom. I'm assuming that that is not a real relation to any missed windows on getting the new products up. And then third off of this a broader question. AI is taking off in most of the Cloud customers, is there an impact from changing the architecture of the Datacom, Telecom network for AI impacting your business? So, can you address the technology side of those, those key pieces? Thanks.

Yes, so thanks, Alex, great question. Maybe kind of start with the Datacom and then circle back around to the 3D sensing. So in the Datacom side of things, the period of extended digestion is not driven by any missing any product window, I think it just is generally driven by cloud CapEx trends and perceived probably economic outlook by customers or end customers. In terms of the AI architecture, yes, I think it's a tremendous opportunity for Lumentum and folks like Lumentum, because not only talking about transitioning to higher speeds, but you're looking at copper move to optical, and it's very interconnect dense or rich architecture. And therefore, we expect an acceleration in volumes. And as we highlighted in the prepared remarks, we're broadening our technology, or product offering, within the Datacom portion of our Telecom and Datacom business, we've been really focused on EMLs and DMLs that's what we had, when we got out of the module business, but over the past couple of years, expanding the axial photo diode, high power lasers for silicon photonics and CPO architectures to live a broader product offering as that plays into this very rapidly expanding interconnect dense or rich AI architecture. Circling around the 3D sensing, not sure what is being referenced. But I don't think it's appropriate to comment or speculate on a specific customer program or what's going to happen next year, we remain focused on being the innovation partner and a best-proven supply partner for our customers. And we remain very competitive in that space.

Thank you, Alex.

Thank you. Our next question comes from Meta Marshall of Morgan Stanley. Meta, your line is open, please go ahead.

Great, thanks. I know we've kind of circled around it. But I guess I was just surprised to see the broker fees increase kind of pretty meaningfully this quarter from the past couple of quarters. And so just wanted to get a sense of, was that some acute increase in fees towards the end of the quarter, just as some of the China reopening pieces made the environment a little bit more acute, or just kind of what led to kind of that pretty dramatic step-up and then just, it seems as if you're saying they'll step down, but just we expect to kind of go back to some of the more normalized like, when is your view that we get back to less dramatic broker fees being paid. And then maybe this follow-up question for me just any update on kind of the DSP development efforts? Thanks.

Meta, I will start off with the broker fees. And then Alan can talk about the DSP side of it. Basically, what you saw happening is, as inventory was being flushed out with the increased supply, the broker charges were a little bit higher. And so the reason they were lower last quarter is not because our purchases were lower, but it was really just the time that it took for it to go through the lead time offsets in our manufacturing process, pick up the rest of the components that were needed in order to ship the final product. And so, with the improvements we saw in fiscal Q2 in our ability to actually deliver to our customers, you would see a corresponding increase in that charge simply because of a swing from inventory into cost of sales. So it's more of an accounting matter rather than a business issue. We have actually seen our purchases for broker-bought inventory decreased and we expect it to decrease in the coming quarters as well as it's just a couple of components suppliers that we are now struggling with to fulfill our demand, Alan on DSP.

Yes, thanks for the question. Very excited about the team that we brought on from the IPG acquisition, not only on DSPs, but also RFIC's from NeoPhotonics and what both companies, both acquisitions brings to us on silicon photonics. But on the DSP front, we're focused primarily on getting the tape out done for our first DSP, and continuing to drive our roadmap, but primary focus is get the tape out done, get the product into our ZR and ZR+ module. And then we'll see what happens from there. Our primary focus for the DSP is internal consumption, to really drive the cost of the ZR type module down to the lowest possible cost point. And the DSP was the last piece that we needed. So we have all of the other components. If you look at ZR, the tunable laser, the modulator, the receiver, the RFICs and the DSP, we've got it all. So we are the broadest range, or broadest provider vertically integrated on those modules. And so as we finish up that DSP, I think we'll have a very, very competitive offering at 400G. And then we're going to, we're going to continue to work with the merchant market on the next generation DSPs. But we are filling out our roadmap and building up a team to be able to do more than one DSP at a time, so very, very exciting time.

Thanks, Meta.

Next question comes from George Notter of Jefferies. George, your line is open. Please proceed.

Hi, guys, thanks very much. You mentioned you made some organic cost reductions in the business. I guess I'm just curious about what segments of the business you're taking cost out? What types of costs, anything you can tell us that would be great.

George, it's mostly on the G&A side, a little bit on SG&A. But primarily, the reductions that we saw during the quarter were on the G&A side, where we see a little bit of opportunities from a product rationalization standpoint, we're doing that as well. But any savings that we're getting from that, we're reinvesting into R&D. So that's really the way to think about it.

Got it. Okay, thank you very much. And then any sense for what the NeoPhotonics contribution was in the quarter in terms of revenue impact? I know you guys gave us a number for last quarter. I think it was $73 million over two months, but just curious what that looks like now?

Hey, George, this is Chris. Well along in many of our integration plans, we're not going to be breaking out any separate NeoPhotonics contribution. The teams are one team working together, products are beginning to be rationalized. So it's a little difficult to say what is NeoPhotonics, what is Lumentum at this point for all Lumentum.

Thanks so much, George.

Thank you. Our next question comes from Ruben Roy of Stifel. Ruben, your line is open. Please proceed.

Thank you. Thanks for letting me ask a couple of questions here. I had a follow-up for Chris, on the commentary around 3D sensing. I just wanted to make sure I understood this correctly, Chris, when you think about the drivers of the downtick in the business, you've got overall demand, you've got share which you talked about in pricing, I believe you said pricing and pricing environment is normal. And you did talk about the share kind of being kind of where you thought it was going to be. So the way to think about I guess, for this fiscal year is demand, obviously lower. But as you look ahead with consumer now down around 10% or so of revenue, do you think the pricing environment is going to be similar for next year? Do you think we're going to grow off of that level? Any detail there would be helpful. Thank you.

Yes, I would say, as you highlighted the year-over-year performance is primarily driven by the share normalizations we've talked about, we've had an outsized share position for many years, and so it was really just a question of when and how steep that reduction would come now that we're more normalized. I think that that is largely behind us. Pricing, as you indicated is normal, there's nothing unusual going on there over the past five years of this prices have come down in general, unless there's a change in architecture, if you will, where a chip gets bigger or smaller, that causes an adjustment in price. And then from that point forward, there tends to be more year-over-year price downs, like we get from our IC suppliers, and very normal as volumes go up. This year obviously, in the past near-term, the last quarter, and looking ahead, there's obviously more going on there with regards to supply chain disruptions that are customer and perhaps lower consumer demand. But I think as we look ahead, our focus is on one, continuing to do well and the customers innovation partner of choice in the consumer space, but as well broadening out into other new applications, we've got extended reality, we've got automotive, and then what's perhaps even more exciting over a longer timeframe is in the industrial markets, where sensing technologies will impact manufacturing factories, warehouses, and that's an area where not only can we supply lasers, but we can supply modules and subsystems leveraging a much broader base of technologies that Lumentum offers. So, I think there's a lot of tailwinds more broadly when we start talking about these expanded use cases, in new applications, these new applications, perhaps of higher dollar content, and things like automobiles as an example, or even extended reality headsets tend to add more sensors per a given device. So that amplifies the dollar opportunity per unit. Does that answer your question?

It really does. Thanks for all that detail, Chris. If I could just ask a very, I hope a quick follow-up in terms of the initial revenues being recognized out of auto, IoT, et cetera. How would you characterize those revenues, are those sort of still proof-of-concept revenues, I guess what I'm trying to get at is, is their line of sight to an inflection in some of those non-consumer markets for 3D?

I'd say it's more than proof-of-concept as, especially in China, the adoption of LiDAR is becoming a reality. And so I'd say that inflection point isn't in the very short-term with respect to ramping, but I'd say that these are going into vehicles that are going out on the road. And so I'd say that fiscal, by the end of fiscal '24, we should see a meaningful pickup in that business. And we're excited about the broad range of customer engagements that we have and the design wins that we've been awarded. So, it's more of a long-term investment that we've continued to make and in the coming years, it should be more meaningful.

Thank you, Ruben.

Thank you. Our next question comes from Ananda Baruah of Loop Capital. Ananda, your line is open. Please go ahead.

Hey, thanks guys. Good morning and thanks for taking the question. I guess two quick ones, if I could. Chris, you had mentioned with three, it was mentioned in the slide deck with regards to 3D sensing that the demand was softer than anticipated. So was there a production component to that as well and a demand and market component to that as well, and then just a quick follow-up, thanks.

Yes, on our end, I don't think there was any production component limiting us, it was generally focused on customer demand. And I think the factors that we've highlighted around customer supply chain disruptions, that really impacted the second quarter being a little bit below where we had originally thought, if you recall, these disruptions maybe began slightly before our last earnings call, but they continued, if you will, through the remainder of the year.

Got it, helpful. And how would you guys characterize the transceiver business right now? And sort of demand is transceivers into end customers and I guess the impact from transceiver inventory that you're seeing at end customers, and that's it for me, thanks.

Are you referencing Datacom transceivers, Telecom transceivers?

It sounds like we lost Ananda. Well, to be clear. Please go ahead.

I am back, yes, I was trying to get it NeoPhotonics specifically.

Yes, so I would say that, you're probably referencing. Yes, ZR transceivers coming out of and DC modules and things are going well on that front. We participate in the transceiver market both by supplying to other transceiver vendors. And that's the bulk of the revenue participating that market today. But as Alan highlighted, we have our own ZR, ZR+ business with the NeoPhotonics acquisition, good design wins. And our big focus today is leveraging the combined company's capabilities to bring costs down and drive more design wins. And we anticipate that will be a tremendous growth opportunity for us over the next couple of years given that that ZR, ZR+ markets, going to be a multibillion dollar market, and especially as a transition to 800 Gig long-term tailwinds.

Thanks, Ananda.

Thank you. Our next question comes from Vivek Arya of Bank of America Merrill Lynch. Vivek, your line is open. Please go ahead.

Thanks for taking my question. I'm trying to understand whether your commentary about Datacom demand being soft, is that Lumentum specific single customer or single product, I think, or is it a broad commentary on Datacom demand being softer as an industry across the board for most of the year?

I would say that it's more end market softness in the cloud providers. And so for Lumentum, we sell Datacom chips to both the cloud providers as well as the module manufacturers. And as the cloud, as the cloud providers slow the deployment to data centers, they slow the deployment of consumption of Datacom modules. And so, what we're seeing is, is that inventory being depleted, but the slower growth of cloud that has been very public from those end customers basically slows the consumption of what was originally thought to be much stronger. And so our view on this is it's a temporary issue that that we'll get through and very excited about the broadening of products, as we address AI and machine learning. So, I wouldn't say it's Lumentum specific, it's more of end market change that we've seen that's temporary.

Understood and for my follow-up, realistically, does your 3D sensing business start to grow with a normal seasonal pattern from September onwards? Or we should still be looking out for any sequential share shift that could prevent that from happening? I just want to make sure that at this point, from what you see, has shares normalize or is there any more to go on a sequential basis as they get to the better second half calendar half of the year? Thank you.

Yes, I mean I think that that business will continue to be seasonal, if you will. So we expect going from third quarter into the fourth quarter would decline, and then fourth quarter going into the first quarter would grow. So yes, we would expect that seasonal factors will become more significant than they have in the last couple of quarters where the normalization process has unfolded.

Thank you, Vivek.

Our next question comes from Mike Genovese of Rosenblatt. Mike, your line is open. Please proceed.

Okay, fantastic. Best for last, I want to ask somebody else has asked about the commercial lasers business. It was up to $57 million all-time record, guiding it sequentially down. Can it get bigger than this, can it eventually get into the 60s, what's the medium-term outlook for commercial lasers?

Yes, we're very excited about lasers. And the growth year-on-year, our laser business grew 30% in the trailing 12 months. And so we're gaining share in lasers. And that's really given the innovation and new product introduction, as we talked about the new markets that we're getting. And so I would fully expect this to continue to be able to grow over the long-term as we introduce new products, especially in our ultra-fast lasers, which is getting great adoption by these new markets. So yes, we're excited about the long-term outlook of organic growth in our lasers business.

Okay, great. And another question is just on Telecom. As you think about again, the medium term or couple of years, two, three year outlook for Telecom, is there still a confidence that this is a sustainable double-digit growth market for multiple years?

Yes, I'll give you my comments.

Well, I think certainly macro headwinds and uncertainty have us not thinking that every year we're going to be at 10%. Every year, I'd say long-term growth of bandwidth requirements. And if you look over time, it grows at 10%. And so I think over the midterm to your point, setting aside what happens in the economy, the trend rate, or the growth rate should be 10% in Telecom. Chris, you have anything to add?

Yes, and I think the only thing I'd add is that, on a pro forma base, the Lumentum plus Neo had we been together a year earlier, the Telecom and Datacom business is certainly up in the teens percent, if you will, in the first half of our fiscal '23 compared to the first half of fiscal '22. So, the growth has been there, despite the supply chain challenges and softening or the digestion of inventory coming from the cloud end market. So I think that's demonstrated and our customers having tremendous backlog is also very encouraging. So, I think that opportunity is there. But obviously, as you pointed out, there are macro factors that loom out there that yes, I don't think anybody has seen impact at our customer level at this point, but very difficult to handicap as we look out the next year or next two years. Thanks, Michael.

Thank you, Mike.

Unfortunately, this is all the time we have for the Q&A session today. So I'll hand that over to Alan Lowe for any closing remarks.

Great, thank you, Charlie. I would like to leave you with a few thoughts as we wrap up the call. I'm very excited about the tremendous opportunities ahead of us as we scale our business to serve the exponential growth in network bandwidth in the artificial intelligence, machine learning, mobile, carrier, and cloud computing markets. We have a proven playbook to win with our best-in-class products and technologies and to leverage these technologies in other markets. We're committed to investing deeply in innovation and our manufacturing capabilities to deliver on customer needs today and into the future. With that, I would like to thank everyone for attending, and we look forward to talking with you again at LITE 2023 Lumentum's Investor Technology event on March 7 at the OFC Tradeshow. You will find registration information about this event and other upcoming investor events on our website. Thank you very much for attending.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.