Lumentum Holdings Inc. Q3 FY2024 Earnings Call

Good day, everyone, and welcome to the Lumentum Holdings' Third Quarter Fiscal Year 2024 Earnings Call. All participants will be in a listen-only mode. Please also note, today's event is being recorded for replay purposes. At this time, I would now like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please go ahead.

Thank you, and welcome to Lumentum's fiscal third quarter 2024 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, Executive Vice President and 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 and beliefs regarding recent acquisitions, including Cloud Light and NeoPhotonics, macroeconomic trends, trends and expectations for our products and technologies, our end markets, market opportunities and customers, and our expected financial and operating performance, including our guidance, as well as statements regarding our future revenues, financial model, and 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, particularly the risk factors described in our most recent 10-Q and in our 10-Q that will be filed soon. 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 that 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 third quarter results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. With that, I'll turn the call over to Alan.

Thank you, Kathy, and good afternoon, everyone. This is a very exciting time for Lumentum. We are making excellent progress on the huge opportunities the long-term demand for data center photonics creates for us, driven by the exponentially increasing compute requirements of artificial intelligence, machine learning, and advanced data centers. High-performance photonics are absolutely critical to enabling networks both within and beyond the data center to keep pace with these demands. Lumentum is pursuing a three-pronged strategy to drive significant growth in our cloud data center revenue: First, we are executing on our compelling new product roadmap that expands our offerings and market opportunities. We have multiple waves of product releases beginning later this calendar year and continuing into calendar 2025. This includes new 1.6 terabit intra-data center optical transceivers, optical switching products, and 800G coherent pluggables for data center interconnect, or DCI. This portfolio expansion is a result of our offerings spanning not only leading data center optical components at both 100G and 200G per lane speeds, but also high-speed 800G and 1.6 terabit transceivers that leverage these components across a range of customers. These transceiver product lines address a range of requirements from multiple market-leading customers from short reach to long reach within their data center optical link fabric. Our 800ZR and ZR+ coherent transceivers utilize our photonic integrated circuit technology and deliver differentiated transmission performance and power consumption, critical factors for data center applications. We have already begun product sampling with key customers and our demos and customer discussions at the recent OFC trade show went very well. Given challenges in powering data centers, we expect to accelerate growth of our DCI products over the coming years. In the second prong of our data center strategy, we are significantly expanding our manufacturing capacity in our proven wafer fabs and back-end factories to ensure a secure high-volume supply of our differentiated products to address our cloud customers' strong demand now and into the future. Two weeks ago, I visited our state-of-the-art manufacturing facility in Thailand. I'm pleased to report that our expansion plans are progressing very well and remain on track. We expect to provide customers with qualification units, including 1.6T modules from this facility this summer, and based on current customer timelines, we expect volume production to start later this calendar year and accelerate into calendar 2025 in a meaningful way. Further, based on progress with new customer opportunities since our last call, we have ratcheted up the magnitude of our expansion plans to prepare for continued success in winning new sockets and customers in calendar 2025 and beyond. The third prong of our strategy focuses on partnering with cloud and AI infrastructure customers on new innovative solutions to scale data center infrastructure that leverages our extensive portfolio of in-house photonics and manufacturing technologies. For example, power consumption will continue to be a key limiter in further scaling of compute power in the future. To address this, we are focused on enabling innovative photonic approaches to more energy-efficient data center networks. These include supporting optical switching to replace certain electronic packet switches and new optical transceiver and link architectures, which will reduce the amount of power needed and will move photonics even closer to the processor and the switch chips. By implementing this three-pronged cloud strategy, Lumentum is well-positioned to capitalize on the tremendous growth potential in data center photonics as compute and data center infrastructures increasingly rely on photonics to scale. In our recent OFC Lumentum Investor Technology Event, we highlighted our current view that our cloud photonics opportunity in calendar year 2028 could be approximately $16 billion. Based on this and the progress we've made with leading customers, we believe we can expand our cloud revenue to multiple billions of dollars in the years ahead. Outside of the cloud, we continue to be focused on helping customers scale Internet optical network infrastructure. Over many years, we have solidified our market share and technology leadership positions in this important market. We are addressing the growing bandwidth needs with our high-speed components, but physical constraints, such as the Shannon Limit are impacting the ability to scale capacity by increasing speed alone. Further, networks will need to utilize increased parallelism with more wavelength channels and more fiber transmission bands and more fibers carrying data. These challenges create growth opportunities for Lumentum as higher volumes of leading-edge coherent components and more advanced and complex ROADMs and optical amplifiers are required to enable further network capacity scaling. For example, our high port count and MxN ROADMs are addressing the growing number of wavelength channels, fibers and degrees of connectivity. And our latest ROADM designs integrate C+L band capability, enabling customers to better maximize the available bandwidth in a single fiber. Now, let me move to our fiscal third quarter revenue and product highlights. Our Cloud & Networking revenue grew 9% sequentially and 7% year-over-year, driven by strong data center demand and the contribution from the Cloud Light acquisition. Our revenue from 100G EML laser chips nearly tripled in fiscal Q3 compared to Q2, driven by the expansion of output capacity at our Japanese wafer fab. Our earlier investments in this fab have proven to have been the right decision. As we ramp up production of 100G EMLs with market-leading customers, we are also qualifying our 200G EMLs for use in both 1.6 terabit and lower power 800G transceivers. Early customer feedback on our 200G EML is excellent, positioning this product line to be a key contributor to growth in calendar 2025. Data center demand is also increasing for 400ZR and ZR+ modules for DCI. In addition to providing these modules, we are a market leader in the narrow linewidth tunable laser used in ZR modules. We are encouraged by a notable uptick in demand for our tunable lasers in Q3, as customer inventory of these products appears to be normalizing. We expect these strong cloud demand trends to continue based on the robust double-digit CapEx projections for calendar '24 coming from cloud data center operators. All that said, in the next few quarters, revenue will continue to be burdened by telecom customer inventory challenges. The pace of telco carrier spending has slowed more than previously anticipated. Because we continue to shift below end market demand, customer inventory of our products is decreasing, indicating that we are getting closer to the end of this lower demand phase in our industry. We remain highly confident in our market position and the future recovery and growth of our telecom business. Network bandwidth growth continues unabated, requiring network capacity additions. As fiber transmission approaches its physical limits, network providers increasingly recognize the value proposition of our technologies, which enable continued network scaling. This reinforces our long-term optimism for our opportunities in this market. In contrast to the extended inventory correction, I'm very pleased with the adoption and early ramp up and growth potential of our newest telecom products by our customers. For example, we are ramping up shipments of our new 130 gigabaud and 200 gigabaud coherent components. These enable the next-generation of high-performance coherent transmission systems at 1.2 terabits and 1.6 terabits per second. We've also seen increased customer activity in next-generation high port count and integrated extended C and extended L band ROADMs. Customers are not burdened with excess inventory of these products, and increasing shipments highlight growing end market needs that will drive growth on top of the eventual market recovery. Turning to Industrial Tech, fiscal Q3 revenue was down 34% sequentially and down 42% year-over-year, driven by expected seasonality and increased competition in our 3D sensing business, as well as inventory consumption at our largest industrial laser customer. This decline masks the success we are having on new industrial laser platforms for emerging applications, particularly ultrafast lasers, which experienced a more than 40% sequential growth in Q3. These lasers serve key micromachining applications and industries like semiconductor, EV batteries, displays, PCBs and solar cell manufacturing. We anticipate an improved revenue profile for the Industrial Tech platform in the quarters to come. This is due to two factors: one, the smaller size of our 3D sensing business will have a less significant impact on our overall revenue profile; and two, we expect an uptick in industrial fiber laser shipments after the severe inventory correction experienced during Q3. To summarize, the combination of explosive growth in cloud data center and AI-driven demand, our customer traction and capacity additions for new data center products and strong early demand for our new telecom products makes me confident and bullish about calendar 2025. We expect significant growth next calendar year as our investments in new data center products and manufacturing capacity this year translates into significant new revenues. This, combined with the telecom industry inventory correction abating, makes the outlook for calendar 2025 and beyond very promising. We have multiple cloud customer engagements that will drive meaningful revenue growth and drive total company quarterly revenue to exceed $500 million exiting calendar 2025. Additionally, we expect that significant growth will continue into 2026 and 2027. We are working on several significant opportunities today that we expect will propel our cloud business into a multi-billion dollar annual run rate business in the coming years. Given all of this, it's clear that the future is bright for Lumentum. Before turning it over to Wajid, I would like to thank our employees and our customers around the world for their focus and dedication as they continue to collaborate and partner with Lumentum. With that, Wajid?

Thank you, Alan. Third quarter revenue and non-GAAP EPS results were above the midpoint of our guidance ranges, with revenue of $366.5 million and non-GAAP EPS of $0.29. We're very excited about the contribution that our Cloud Light acquisition had on the quarter and will have in the future, given the technology and capability of the combined companies to address the rapidly-growing AI and ML photonics market. We recognize a record revenue quarter in our cloud data center business, fueled in part by a full quarter of Cloud Light revenue contribution. Q3 gross margins were in line with expectations as the overall product mix included a full quarter of transceiver revenue from the Cloud Light acquisition, while operating margins saw a modest improvement due to lower operating expenses in the quarter as we continued to execute on synergy actions. We remain confident in our market position and compelling growth opportunities across our served markets that Alan discussed earlier, and we are focused on continuing to lower our fixed cost base to accelerate operating margin expansion as revenue recovers. To achieve this, we've made significant progress on manufacturing synergies. Following the closure of two factories in China last December, we have transferred those products to our infrastructure in Thailand. Our Japan wafer fab consolidation plans are on track for execution in the first half of fiscal '25. This will unlock significant synergies in both manufacturing and operating expenses starting in fiscal Q3 2025. In addition, we have implemented initiatives to capture synergy and efficiency opportunities within our operating expenses. Our strong financial discipline drove a $2.4 million sequential decrease in company-wide non-GAAP operating expenses, despite Q3 being the quarter where the annual payroll tax and employee fringe rates reset. Our non-GAAP operating expenses will step down further in Q4 with the actions we have already taken. As I have mentioned in previous earnings calls, we had pre-built product inventory from these two factories in China to facilitate these transitions. In Q3, we achieved a $51 million sequential reduction in Lumentum's overall inventory levels, and we plan to continue to increase our inventory turns during the next several quarters. We are confident that our combined focus on manufacturing efficiency, inventory management, and cost control will pave the way for improvement in gross and operating margins as telecom revenue recovers and cloud revenue grows. We are on track to achieve our $100 million annualized synergy target from the NeoPhotonics acquisition. To date, we have secured approximately $70 million in annual run rate savings and expect to capture the balance of the $30 million as we execute the remaining actions of our plan. We will continue to provide updates as we reach key milestones. Net revenue for the third quarter was $366.5 million, which was approximately flat sequentially and down 4.4% year-on-year. GAAP gross margin for the third quarter was 16.2%. GAAP operating loss was 31.3%, and GAAP diluted net loss per share was $1.88, with a large portion of the GAAP net loss due to acquisition-related charges, restructuring charges, and amortization of acquired intangibles. Third quarter non-GAAP gross margin was 32.6%, which was flat sequentially and down year-on-year driven by product mix. Third quarter non-GAAP operating margin was 4.1%, which was up 60 basis points sequentially and down year-on-year. Third quarter non-GAAP operating income was $15 million and adjusted EBITDA was $41 million. Third quarter non-GAAP operating expenses totaled $104.3 million, or 28.5% of revenue, down $2.4 million from Q2 and down $0.6 million from the year-ago quarter, despite the additional operating expenses from the Cloud Light acquisition due to tight expense controls and continued synergy attainment. Q3 non-GAAP SG&A expense was $38.1 million. Non-GAAP R&D expense was $66.2 million. Interest and other income was $8 million on a non-GAAP basis, driven by interest earned on our cash and investments. Third quarter non-GAAP net income was $19.6 million and non-GAAP diluted net income per share was $0.29. Our fully diluted share count for the third quarter was 68.1 million shares on a non-GAAP basis. Our cash and short-term investments decreased by $353.1 million during the quarter to $870.9 million. This was primarily due to the $323 million in cash used for the repayment of our 2024 convertible notes, which matured in March. In addition, we incurred approximately $30 million in restructuring, integration and manufacturing consolidation charges in the quarter, as well as $23.8 million in CapEx. Turning to segment details, third quarter Cloud & Networking segment revenue at $313.8 million increased 9.5% sequentially and increased 7.1% year-on-year. Cloud & Networking segment non-GAAP operating profit at 14.6% increased sequentially and decreased year-on-year. Our third quarter Industrial Tech segment revenue at $52.7 million was down 34.2% sequentially and down 41.7% year-on-year. Third quarter Industrial Tech non-GAAP reporting loss was 5.1%, which was driven by declines in our 3D sensing business and a fiber laser inventory correction at our largest industrial laser customer as expected. Now, let me move to our guidance for the fourth quarter of fiscal '24, which is on a non-GAAP basis and is based on our assumptions as of today. We expect net revenue for the fourth quarter of fiscal '24 to be in the range of $290 million to $315 million. This Q4 revenue forecast includes the following assumptions: Cloud & Networking to be down sequentially. This decline includes an approximate incremental $40 million reduction at the midpoint due to the recent broad-based demand softness in telecom. And Industrial Tech to be up slightly sequentially with increased industrial laser shipments partially offset by typical 3D sensing seasonality. Based on this, we project fourth quarter non-GAAP operating margins to be in the range of negative 3% to positive 1%, and diluted net income per share to be in the range of negative $0.05 to positive $0.10. Our non-GAAP EPS guidance for the fourth quarter is based on a non-GAAP annual effective tax rate of 14.5%. These projections also assume an approximate share count of 68.5 million shares. These projections also exclude certain unusual expenses, including factory under absorption due to factory consolidations and transitions, restructuring, other synergy attainment and integration activities, and inventory reduction activities related to prior acquisitions and the COVID-19 pandemic. These expenses are related to one-time events and we expect these will in general decline over the coming quarters. These expenses for our third fiscal quarter can be found in our GAAP to non-GAAP reconciliation tables. With that, I'll turn the call back to Kathy to start the Q&A session.

Thank you, Wajid. Before we start the Q&A session, I'd like to ask everyone to keep to one question and one follow-up. This should help us get to as many participants as possible before the end of our allotted time. Now, let's begin the Q&A session.

We will now begin the question-and-answer session. Our first question comes from Simon Leopold with Raymond James. Your line is now open.

Thank you. Thank you very much for taking the question. First thing, I wanted to see if you could clarify the commentary on the Cloud & Networking incremental $40 million reduction. Because in the prior quarter, you talked about roughly $30 million decline due to a product transition that was occurring in the Cloud Light business. And I want to understand, is that $30 million part of the new $40 million number you cited today? Just help us unpack that a little bit? And then, I've got a follow-up.

Sure, Simon. This is additional information regarding the datacom module transition we discussed during the last call. There has been a change in the outlook for telecom spending, specifically carrier spending, over the past three months, which is affecting our ability to reduce inventory in the channel and with our customers. This adds to what we discussed previously.

Thanks. And then, in terms of your ZR business, it sounds like that's gotten better. But I think we don't really have a good sense of what the baseline is. So, could you help us understand how much revenue are you generating through ZR and ZR-related sales, selling lasers to others as well as your own products? And where do you see that going over the next, let's say, two to four quarters? Thank you.

The narrow line with tunable lasers saw significant growth last quarter, as we mentioned in the script. We believe that our customers have depleted their inventory due to the strong demand for ZR, which has increased over the past several quarters. As a result, we are back at the level we were at before the pandemic with narrow line tunable lasers. Regarding ZR and ZR+, it currently contributes a small portion to our overall revenue. However, we anticipate growth as we gain traction with the 800-gig ZR and ZR+, and as we start deploying those products more significantly.

Thank you.

Thanks, Simon.

Thank you for your question. Our next question comes from Samik Chatterjee with JPMorgan. Your line is now open. Can you try once more for me, please?

Yes, I think, Victoria, we can take the next question unless Samik says something right now.

All right. We'll go ahead and move on. Our next question comes from the line of George Notter with Jefferies. Your line is now open.

Hi, guys. Can you hear me?

Yes, we can.

Yes.

Can you guys hear me? Hello? Okay. Great. Super.

Yes, we can.

All right, thanks. Hey, look, I am interested in better understanding the manufacturing expansions here. Alan, I think you said that just in the last three months, you guys have increased your expectation for the size of the manufacturing operation. Can you talk a little bit more about what you're doing down in Thailand? How much capacity are you adding? What's driving that incremental requirement to expand manufacturing more than you previously thought? I think obviously a lot of folks are looking for the opportunity to win additional cloud customers with the Cloud Light business. Is that an element of what's driving the incremental outlook there? Thanks.

Certainly. I recently visited Thailand to observe our progress. We are currently establishing a qualification line there, while we continue to produce transceivers in China. Many of our clients are eager to expand their operations outside of China, which has prompted our initiatives. The qualification line will be set up on the first floor of our existing building that hasn't been utilized for other products yet. Additionally, due to the growing interest from cloud and AI infrastructure customers, we have commenced construction on a new building that will be developed in phases. This new facility will feature three stories, with plans to complete the first floor and leave space for the second and third floors as necessary. The increasing customer demand and traction have instilled confidence in us that we are building the appropriate infrastructure for their needs.

Got it. And then, are you adding that floor space on spec, or are you adding it based on new customer wins? What's driving the incremental investment?

No, I think we definitely have some orders and customers that we're currently working on increasing capacity for in Thailand. However, much of this additional capacity is geared towards new and diversified customers in both the cloud and AI infrastructure sectors. The challenge is a bit of a catch-22; if we lack the floor space and capacity, we won't secure the orders. Conversely, if we receive the orders but lack the space, we won't be able to fulfill them. Therefore, we are collaborating closely with our customers to ensure that we are making the right investments at the right time, so we don't overextend our capacity while also building confidence in the growth they anticipate for 2025 and beyond.

Great. Thank you.

We are having customers visit to see what we're doing, and so far the feedback has been extremely positive regarding the facilitation, line setup, and level of automation. We feel happy and confident about our future expectations.

Thanks, George.

Thank you for your question, George. Samik dialed back in. So, our next question will be from the line of Samik Chatterjee with JPMorgan. Your line is now open.

Hi. Can you hear me now?

Yes, we can hear you.

Okay, great. Sorry about that. So, I had a couple on datacom, and I'll start with the more near-term question, if you don't mind. I know you've talked about the product transition for Cloud Light with its primary customer with revenues in the March quarter about sort of $90 million going to $60 million in June. Just want to clarify if that's still holding true in terms of your engagement with your customer there? And any thoughts in terms of the magnitude of the rebound as you ramp with the new product in the September quarter? And I have a longer-term question on datacom after that. Thank you.

Yeah. I'm not going to comment on any specific customer, but I'd say that the transition is playing out as we had expected in the last call.

Okay. Alan, I know you talked about the datacom business being a...

Sorry. No, I was going to answer the second part of your question about September. We expect some incremental increase in the September quarter, but that's still yet to be seen on the datacom side.

Okay. And for my longer-term question, Alan, I know you talked about the datacom business being a multi-billion business in the future. Wondering if you can give us a few more milestones, be your medium-term milestones to track that by? For example, like when you think about fiscal '25 over '24, does this business double in size? Or even when you reference the $500 million of revenue for the aggregate company exiting calendar '25, how much of datacom business should be expect in that mix? Any thoughts just to give us more medium-term milestones on that ramp? Thank you.

Yeah. I'll give you my thoughts on it, then I'll ask Chris to chime in. I'd say that the milestones are really the qualification samples that I talked about earlier, getting into our customers hands and having them test them. So, we're in control of a lot of that, but at the same time, we're still relying on third-party suppliers of DSPs and other components. And so that's a little bit out of our control. And so, I'd say summer qualification samples qualification sometime in the December quarter and ramp starting really in the December quarter and into calendar 2025. As far as your question on $500 million by the end of next calendar year, I would say that we would certainly be disappointed if we don't more than double our datacom business by then from today's or from the Q3 run rate.

Yeah. I think the only thing I would add is just to highlight that each of the individual customer opportunities we're chasing are very significant, so that one or two customers' sockets essentially can double revenue. And so that's what confidence that as we win, there's a lot more than one or two customers and one or two sockets out there. So, our ability to win new and materially move the revenue upwards is ample, as opposed to a type of application or market where we need to land hundreds of customers, for example.

Thank you.

Thank you, Samik.

Thank you for your question. Our next question comes from the line of Meta Marshall with Morgan Stanley. Your line is now open.

Thank you. Building on Simon's earlier question, I'm trying to understand the $40 million challenge from the telecommunications sector and how that's being discussed with customers. Do you have a better idea of their inventory levels? Are there specific areas where they've managed their inventory better than others? I'm looking for clarity on when some of that business might return. Additionally, could you specify the contribution of Cloud Light for the quarter? That's all from me.

The $40 million headwind is primarily due to a slowdown in carrier spending and a longer duration for the inventory burn-off, as they are not spending as much. In the March quarter, we did observe a decline in inventory levels at our customers, but there are still areas where inventory remains, which will likely take this quarter and possibly into the September quarter to fully consume. This situation varies by product and the specific customers involved. Notably, products aimed at the cloud are depleting inventory much faster than those targeted at carriers. The telco carriers are moving more slowly than we anticipated three months ago.

And whether there was a Cloud Light specific contribution you guys were calling out as part of datacom?

Yeah. No, we're not going to break out the specific products, but certainly it was a full quarter of production, and so it was more than the prior partial quarter.

All right. Great. Thanks.

Thanks, Meta.

Thank you for your question. Our next question comes from the line of Christopher Rolland with SIG. Your line is now open.

Hey, guys. Thanks for the question. Mine's around DC. So, the 200-gig laser market, seems like there's a bunch of things that might be slowing that down now. Can you remind us when you would be capable of supplying 200-gig lasers? I assume EML at launch. And then, when you think others in the supply chain might be able to ramp? I'm just trying to get a sense of what a realistic timetable for this true 200-gig lane ramp might be.

Yeah. We're shipping qualification units last quarter and feedback from customers was extremely strong and very positive. So, they need to then take those lasers and put them into transceivers. And again, they rely on third-party DSPs in most cases. So that's going to take a couple of quarters. And so, I would say that by the December quarter, those should all be in place, and ramp up of those EML chips should begin really in our fiscal Q2 and then in a meaningful way into calendar '25.

Excellent. And then, Alan, while I have you, you said a meaningful increase in your calendar 2025 revenue. Maybe you could put a finer point on meaningful? Are we talking single digits, double digits? Any color there would be great.

We expect to finish the calendar year 2025 with revenue exceeding $500 million. Currently, we're at a midpoint of just over $300 million, so that's a significant increase. However, the growth won't be linear as we still need to burn off some inventory in telecom and complete qualification work for new datacom sockets. Regarding the 200-gig per lane products, many of these will be launched from our Nava facility towards the end of calendar 2024 and into 2025. We do not anticipate significant volume in the December quarter but expect more substantial growth in the March and June quarters as we ramp up these qualified products.

Thank you so much. That does. Thank you, Alan.

All right. Thanks.

Thanks, Chris.

Thank you for your question.

Great. Thanks, guys. Can you guys hear me?

Yes, we can.

Thank you, Kathy. I have two questions. First, regarding the path to achieving the $500 million run rate, it seems that your core telecom business also requires a significant recovery. Given that customers are taking longer to place orders, I would like to understand where you anticipate seeing growth in the core telecom segment. My second question is about the strong performance in datacom. How will this impact gross margins, especially since the new manufacturing capacity appears to be focused on datacom customers? Are we still aligning our perspective with what Wajid discussed at OFC? I'm looking for some clarity on this. Thank you.

I will address the telecom question and then let Wajid discuss the gross margins. As I mentioned, we expect a few quarters of telecom inventory burn-off, which has been worsened by the slower spending from telecommunications companies. However, we have no inventory for our new products, such as the higher speed 130 gigabaud and 200 gigabaud, as well as highly-integrated ROADMs. For example, as the three major carriers in China launch their next-generation networks, those projects are progressing well without the burden of existing inventory. Our telecom business has two main aspects: the new products that are ramping up now, starting from a small base but growing quickly, and the older products still in the supply chain, which we anticipate will be resolved by the end of the calendar year. This gives us confidence in the strength of our telecom sector for calendar year 2025 as the inventory is depleted. Wajid, would you like to add anything?

Yeah. No, from a gross margin standpoint, pretty much what we laid out at OFC contemplated the type of product mix we were expecting to get to a nearer-term model as well as a longer-term model. So, I think that those gross margins that we laid out pretty well hold under what Alan spoke about with the $500 million a quarter exiting run rate for next year.

So, the shift in telco out a little bit doesn't have an impact? Just trying to think through that.

I believe the timing of the telco return, along with the significant increases we expect to see in the datacom area, will align well. We may experience a slight advantage because the 200G revenues will come in before the transceiver revenues, due to the qualification cycle differences between the two products. Therefore, there could be a quarter or two where we exceed the higher end of our forecast. However, once the revenues from the transceiver products start coming in, we will begin to see a return to the margin levels we discussed at OFC.

Yeah. I think just to echo what you said earlier, Wajid, the consolidation of our two Japanese wafer fabs in the first half of fiscal '25 will certainly help gross margins as well.

Thanks, David.

Thank you for your question. The next question comes from the line of Ananda Baruah with Loop Capital. Your line is now open.

Good afternoon, everyone, and thank you for taking my question. I'd like to ask two quick questions about datacom. With the capacity expansion at your Japan facility, could you provide any insights on where you see that business heading compared to your expectations before the inventory adjustments made a couple of years ago? I also have a brief follow-up. Thank you.

We are continuing to expand our capacity. Last quarter, we achieved a record shipment of EMLs. As we increase production of the 200-gig per lane product, we expect to see revenue growth without necessarily increasing unit sales, although we do intend to boost unit sales as well. There is potential for that product line to reach a run rate of $300 million a year or more, as we will be supplying both EMLs and CW lasers, along with VCSELs for multimode transceivers.

That's more context than I expected, Alan. I appreciate it. My follow-up question is regarding the $500 million guidance for December 2025. How many qualifications with Tier 1 or Tier 2 companies do you think would be necessary? I'm trying to understand how conservative your qualification assumptions might be for that $500 million. Thank you.

Are you talking about datacom or telecom?

Datacom. Yeah, how many incremental hyperscalers...

I mean, it doesn't take many. If we land three, I'd be very, very happy, and we're working with more than that. So, I think from my perspective, we have to bet $500 million on the engagements that we're in. And I think we're positioned to do quite a bit better than that given the customer pull and the desire to have a U.S. headquartered company with manufacturing outside of China. That's why we're being aggressive with respect to putting in place the capacity needed for these customers.

That's great. I appreciate it. Thanks a lot.

Thank you for your question. The next question comes from the line of Tom O'Malley with Barclays. Your line is now open.

Hey, guys. Good afternoon. Thanks for taking my question. I wanted to focus on just what's built into the ramp here on the datacom side. So, you guys have talked about some big opportunities that you could potentially win that gets you to that $500 million run rate through the end of this year and into next year. But I want to understand what you have visibility to right now. You talked on the last call about a transition at your existing customer. And I know that you're saying that the datacom downtick is related to telecom. But are you seeing further weakness there? Are you baking in a return to growth with that customer? And how good is your visibility with the existing customer such that you get comfortable around the growth profile that you're laying out already?

Yes, Tom. We won't comment on specific customers, but I can say that we expect a slight increase in datacom revenues in the September quarter, with a more significant rise in December and into 2025 as our new 1.6T products begin ramping up late this year and into 2025. While we don't have everything confirmed, there are strong signs of interest, with customers engaging with our engineering teams and visiting our facilities in Thailand and Japan. They wouldn't be doing that if they weren't looking to partner with us, which gives me confidence. Once we have purchase orders, my confidence will grow even more, but that's our current status.

Helpful. And then, my second one is kind of a broader question just on the evolution of 200G per lane and 1.6T. So, you're talking about the lasers coming first, which kind of aligns with what we've been hearing, but like in terms of the broader systems, it seems like it's more middle of '25, maybe even second half of '25. And there's really only two customers that can do that even in that timeframe. So, can you talk about why you would be able to ship in the kind of December quarter? Do you see actual production shipments of 200G per lane in Q1 of '25? Or are you just seeing kind of token shipments in Q4 that really get to volume maybe in the second half of '25? I just want to understand your view of the timing of 200G per lane. Thank you.

Yeah, Tom, let me try to help out here on maybe confusion of fiscal year or calendar year here. Certainly, we have today, as we've highlighted, the laser components, other optical components that are in qualification with other either transceiver manufacturers or AI infrastructure providers. Those qualifications will continue and we expect that those customers will be in a position later this calendar year, so i.e., the beginning of our fiscal '25, they will be in a position if all other parts of the ecosystem are able to start ramping up. Even if they do start ramping up in that timeframe, obviously, it doesn't overnight become the predominant set of volumes. And so, we do expect through calendar '25, a continual ramp of both the components and the transceivers. The components may lead transceivers for two reasons. One is you are earlier in supply chains in general, so you're shipping a quarter or two ahead ultimately of when transceivers are shipping. But secondly, the nature of who the customers are maybe the most early leading adopters maybe folks that built transceivers themselves and need components. And I think as Alan alluded to, all these timelines are clearly dependent on whether it be DSPs, switching silicon, processor silicon, things that are beyond our control, we are closely monitoring, we are unaware of anything that impacts the timelines that we're outlining here based on those other elements becoming available either late this calendar year or the beginning of calendar '25.

Thanks, Tom.

Thank you for your question. The next question comes from the line of Karl Ackerman with BNP Paribas. Your line is now open.

Yes, thank you. I have a clarification question and a follow-up. For the clarification question, does the $40 million headwind from telco reflect any broadening impact from the chip supply band beyond the initial telecom products you outlined last quarter?

Somewhat. As of today, we're not shipping to that large customer and there were some shipments in the March quarter. So that has some impact, but not a meaningfully large impact relative quarter to quarter. Now year-over-year, major impact of the U.S. restrictions on our ability to sell to that customer.

Yeah. Okay, understood. And then, you spoke about some updated views on the timing of EML shipment. Would you have any update on the timing of 100-gig VCSEL? I think last quarter you indicated that you would start production in the second half of 2024. I'm just curious if there's any update on that. Thank you.

Yes. We're making continued progress on our 100-gig VCSEL. Now with having Cloud Light be part of the Lumentum team, we have an in-house way of getting our VCSELs tested in transceivers and hopefully qualified in, as you said, in the second half of the calendar year in these multimode transceivers. So, continued progress, but I'd say we're still on track for really the end second half of the calendar year for 100-gig VCSELs and VCSEL arrays.

Thanks, Karl. Victoria, I think we have time for just one more question.

Of course. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Your line is now open.

Great. Snuck in there. I want to compare your 1.6 terabit opportunity or at least ask a question about. For 800 gig, we seem to have seen the very short reach kind of within the rack connectivity market developed first, and then, broader market maybe for switch to switch transceivers inside the data center appears to be developing now. As you look at the 1.6 opportunity, I guess, is there any reason that would develop differently? It seems like most of what you're targeting are traditional transceivers versus short reach cables or what have you. But I'd just be interested in your perspective on comparing and contrasting what we've seen at 800 and what you expect at 1.6 terabit. Thanks.

Yeah, Tim. It's a little bit of nuance, but I would say that something we highlighted at the OFC presentation and point investors, there's a little more detail in that slide deck that we had shared. But the key point is that as you go to higher speeds, the distances you can go decrease very rapidly. So, we do anticipate as we move to 1.6T and beyond that you'll see more single mode in the mix than you've seen historically. Maybe these are simpler single mode, the DR-type spec transceivers, whether they're using silicon photonics or EMLs. And so, therefore, a lot more single mode, where maybe perhaps there would have been multimode historically. It doesn't mean multimode is going away. It just means that we will see more single mode in those sockets and, therefore, right out of the gate.

Tim, did you have a follow-up?

Great. I do want to clarify this. Alan, did you mention that you are aiming for a 50% share of the 1.6 terabit market to reach your goals, or was that comment about something different?

No, that was a comment about not needing to succeed in all of the opportunities. For any given opportunity, we won't capture 100% of it. I was expressing that we are actively working on qualifications and engaging with customers to reach our goal of $500 million by the end of 2025. We don't need to excel in every area we are currently pursuing. If we succeed in more than half of them, we'll generate even more revenue than projected. Ultimately, our success will depend on outperforming our competitors and delivering a compelling value proposition that encourages customers to buy from us.

Okay. Thanks very much.

Thank you, Tim.

That concludes today's call. Thank you for your participation, and enjoy the rest of your day.