Earnings Call Transcript - LITE Q3 2023

Operator, Operator

Good day, everyone, and welcome to the Lumentum Holdings’ Third Quarter Year 2023 Earnings Call. All participants will be in a listen-only mode. Please note, 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.

Kathy Ta, Vice President of Investor Relations

Thank you and welcome to Lumentum’s fiscal third 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 synergies at recent acquisitions, including NeoPhotonics, financial and operating results, macroeconomic trends, trends and expectations for our products and technology, our market opportunities and customers, and our expected financial 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, including the risk factors described in the quarterly report on Form 10-Q to be filed for the quarter ended April 1, 2023. 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 2023 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.

Alan Lowe, CEO

Thank you, Kathy, and good morning, everyone. Third quarter results were within the range we announced in April, and we believe we are currently under shipping end market demand across our business. Customers who had built up large inventories due to supply concerns are bringing down inventories as supply risks and constraints are easing. I’m confident about our overall competitiveness and market share positions in our optical communications and commercial laser segments and believe that mid to long-term demand trends are very favorable. Data traffic will continue to grow at a relentless rate, and networks and data centers will need to keep pace with a double-digit increase in data capacity each year. Lumentum’s ability to both functionally and vertically integrate photonics is a key differentiator for us and will enable our customers in the coming carrier and spatial division multiplexing era as more and more optical fiber is lit up across the globe. New automotive solid state LiDAR and industrial applications are emerging for photonics, where we lead in reliability, performance and manufacturing scale. Our commercial lasers business is expanding beyond our traditional applications into high growth areas such as solar cell, advanced semiconductor, electric vehicle and display manufacturing. In the nearer term, we are prioritizing expense controls, accelerated attainment of acquisition synergies and cash generation, while we continue to deliver our new products and technology roadmaps and customer satisfaction. Now, let me provide some detail on our third quarter results. Telecom & Datacom revenue was down 24% sequentially, but up 20% year-on-year with sequential declines across most major product lines due to customer inventory digestion. I see supply did not significantly limit our revenue during the quarter. While there’s a mixed outlook among our markets and product line, current visibility indicates that Telecom & Datacom demand will start to recover from this customer inventory correction late in the second half of the calendar 2023. We have a growing set of cable, MSO and wireless network customers that are turning to our tunable access modules to expand data bandwidth in metro access, fiber deep and wireless 5G fronthaul applications. This is a significant multi-hundred million dollar per year market opportunity for us, which we expect will play out over the coming years. In the third quarter, revenue from these products grew 17% sequentially and doubled year-on-year to a new quarterly revenue record. Our new 25G tunable access module will be a key enabler for customers upgrading legacy fiber nodes in metro access networks leveraging next generation distributed access architecture. However, as we transition customers from 10G to 25G in the coming quarters, we may see some revenue lumpiness. Our advanced ROADMs are key enablers of our customers’ next generation network architectures that are just starting to be deployed, giving us confidence in continued market share growth and future demand. While third quarter ROADM revenue was down sequentially due to the customer inventory digestion I discussed previously, it was up from the same quarter last year. Year-over-year growth was driven by broader adoption of next generation ROADMs by market leading customers along with improved IC supply. The adoption of coherent pluggable modules by network operators is another significant long-term opportunity for us. We are highly vertically integrated across the photonics and electronic components that enable high speed pluggable form factors. At OFC, our 800 G ZR product demo was very well received by our customers. Cloud data centers are being designed to support artificial intelligence and machine learning applications, which bodes well for us as we extend our technology leadership to an even broader array of products that enable higher capacity and lower power consumption and latency as we highlighted at OFC. We are on track with our 200 gig per lane EMLs for 800 gig and 1.6 terabit per second applications and expect to enter production in the second half of calendar 2023 and ramp throughout calendar 2024. Our high-speed VCSELs are starting to be deployed for short reach connections within data centers where optical communications are replacing copper connections due to data speed requirements. Also, as we highlighted at OFC, Lumentum is uniquely positioned to develop new photonics solutions, including high power laser array engines in coordination with leaders in the high-performance computing market. Given the fast pace of innovation and the increasing demands placed on photonics technologies, we expect that the photonics market for AI will rapidly grow, reaching the size of the existing Ethernet photonics market within the next five years. Turning to Industrial & Consumer, Q3 was down from Q2 and down year-over-year as expected, due to smartphone seasonality and end market demand. Beyond the smartphone market, we continue to ramp new automotive and industrial sensing applications for an expanding set of customers. Third quarter revenue had approximately $3 million of automotive-related applications. Our current automotive revenue reflects significant contributions from early adopters of automotive LiDAR in China. Recent engagements with a global set of Tier 1 customers give us confidence in new LiDAR revenue opportunities over the coming years, as well as our confidence in our ability to significantly grow our revenue in this market. We expect our fiscal year ‘24 3D sensing revenue will be lower than that of fiscal ‘23 due to our expectations around 3D sensing end market demand, pricing and the possibility of an additional competitor on a certain socket opportunity in fiscal ‘24. In the third quarter, commercial lasers revenue was down 16% sequentially and down 6% from the same quarter last year. We achieved over 70% year-on-year growth in ultrafast laser revenue, which was more than offset by lower fiber and solid-state laser shipments. Our growth in ultrafast lasers is being driven by new applications, particularly in solar cell manufacturing. We expect that as these new laser applications grow, we will gain further share in ultrafast lasers. Based on the latest customer forecast, we expect commercial lasers demand to be softer over the next several quarters due to the macro factors impacting end market and customer inventory digestion. Although we expect the overall demand environment is likely to be challenging in the near term, I’m very confident about Lumentum’s mid- to long-term prospects given fundamental end market and technology trends driving our growth expectations are unchanged. Lumentum is uniquely positioned to serve our customers at scale with our functional and vertical integration capabilities, our robust pipeline of design wins and leading product road maps, and we have financial and structural resilience built into our business model. In the near term, we are focused on expense controls while maintaining crucial R&D to continue to drive the forefront of innovation. Before turning it over to Wajid, I would like to thank our employees around the world for their focus and dedication as they continue to execute upon our strategy.

Wajid Ali, CFO

Thank you, Alan. Net revenue for the third quarter was $383.4 million, which was down 24.2% sequentially and down 3% year-on-year. During the quarter, we had two greater than 10% customers, both in the telecom market, and there were no 10% customers in the consumer market. GAAP gross margin for the third quarter was 29.2%, GAAP operating loss was 13.4% and GAAP diluted net loss per share was $0.57. Third quarter non-GAAP gross margin was 40.8%, which was down sequentially and year-on-year, primarily driven by product mix and lower revenue. IC purchases at third-party brokers declined to nominal levels in the quarter. Third quarter non-GAAP operating margin was 13.4%, which decreased sequentially and year-on-year due to product mix and lower revenue. Third quarter non-GAAP operating income was $51.4 million and adjusted EBITDA was $77 million. Third quarter non-GAAP operating expenses totaled $104.9 million or 27.4% of revenue. Non-GAAP operating expenses were down $5.4 million from Q2 with tight expense controls and synergies that more than offset seasonal increases in operating expenses. Q3 non-GAAP SG&A expense was $42.8 million, non-GAAP R&D expense was $62.1 million. Interest and other income was $9.2 million on a non-GAAP basis due to higher interest rates on our cash and investments. Third quarter non-GAAP net income was $51.8 million and non-GAAP diluted net income per share was $0.75. Our fully diluted share count for the third quarter was 68.7 million shares on a non-GAAP basis. Our non-GAAP tax rate remains at 14.5%. Moving to the balance sheet. We ended the quarter with $1.67 billion in cash and short-term investments. To accelerate the integration of NeoPhotonics products into our global manufacturing footprint and attain synergies without impacting customer deliveries, we plan to carry elevated inventories for a period of time. However, we expect inventories to decline by approximately $40 million exiting calendar year 2023 as we continue to focus on cash generation. Also, we expect a moderation in CapEx spending over the next few quarters. Turning to segment details. Third quarter optical communications segment revenue at $335.1 million decreased 25.3% sequentially, primarily driven by the inventory dynamics that Alan already discussed. Optical communications segment non-GAAP gross margin at 40.8% decreased sequentially and year-on-year, primarily due to lower revenue and the impact of NeoPhotonics’ product margins. Our third quarter lasers segment revenue at $48.3 million was down 15.6% sequentially and down 5.7% year-on-year. Third quarter lasers gross margin of 40.4% was down sequentially and year-on-year, primarily due to an inventory reserve due to a fiber laser product transition and lower volumes. We expect product margins in lasers to recover after shipments fully shifted to the new laser platform and manufacturing volumes return. Now let me move to our guidance for the fourth quarter of fiscal 2023, 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 2023 to be in the range of $350 million to $380 million. Within this Q4 revenue forecast, we anticipate modest growth in Telecom & Datacom to be offset by a decline in Industrial & Consumer. We expect fourth quarter lasers revenue to be approximately flat with the third quarter. Based on this, we project fourth quarter operating margin to be in the range of 8.5% to 11.5% and diluted net income per share to be in the range of $0.45 to $0.65. 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 69 million shares.

Kathy Ta, Vice President of Investor Relations

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.

Operator, Operator

And our first question comes from Simon Leopold from Raymond James.

Simon Leopold, Analyst

Thanks. I appreciate that. I’m interested in the Telecom & Datacom segment. And let me explain what I’m looking for here is you were supply chain constrained during much of 2022, particularly I recall ROADMs because we couldn’t get the FPGA. So I guess I’m trying to get a better sense of how much inventory your customers can be holding. And what’s the composition within the segment of that inventory? Is it all plugables, a mixture? Help us understand that. Thanks.

Alan Lowe, CEO

Yes. Simon, it’s broad with respect to the inventory at our customers from our perspective as indicated by what we forecast to ship in the June quarter and what we think we’re going to be shipping in the second half of the calendar year. So, I wouldn’t say it’s any one particular product line. Although I would say that, to your point, ROADMs and ROADM line cards were constrained heavily over the past year, and that’s where I think a lot of inventory was built up. And therefore, a reduction, as we indicated in the script in our ROADM revenue and ROADM line card revenue in the March quarter, we expect that to continue into the June quarter and beyond. As supply constraints have been relieved and customers know they can get the product, I think they’re very comfortable now lowering their inventory levels to reflect the actual sell-through to their customers. And so, as we said also, we believe we are dramatically under-shipping end market demand. And as that happens over the next couple of quarters or so, we’ll get to an equilibrium, where we’ll start shipping again to end market demand as our customers’ inventories normalize.

Simon Leopold, Analyst

And then just as my follow-up question, preannouncement, and that looked much lighter than we expected. I know you had guided some sequential decline, but nonetheless, this is a market that had been holding up. So, I’d like to see if you could talk about what’s changed there? And how long does this relative weakness in commercial lasers last in your view?

Alan Lowe, CEO

Yes. Simon, as we also highlighted, the ultrafast laser business is going very well, 70% year-on-year growth as we get into new markets. I’d say the slowness came from a couple of areas, one of which is the transition we talked about in the fiber laser but also headwinds in the overall semiconductor demand industry, so in the semiconductor industry as we supply solid-state lasers into processing the semiconductor. So, that’s some softening that we see as well.

Operator, Operator

Our next question comes from Samik from JP Morgan.

Samik Chatterjee, Analyst

I guess, Alan, you mentioned even in the last response and in your prepared remarks that you believe you’re under shipping to demand. And I wanted to get your thoughts around sort of how do you think about sort of the right run rate. What is the sort of right level of demand right now? How much do you believe you’re under-shipping related to that? And maybe just extending that, you’re saying second half will have a recovery. Is that essentially the math that you’re doing in terms of how much you’re under shipping and how much inventory you’re digesting gets you to that sort of second half recovery, or is that what your customers are telling you? Thank you. And I have a follow-up.

Alan Lowe, CEO

Sure. I think it’s hard to say how much we’re under-shipping. Although clearly, the reduction in revenue in the March quarter tells us we are under-shipping relative to end customer demand. And we expect that as our customers announce their earnings in the coming quarters, their inventory levels will come down over time. And so, that’s an indicator of under-shipping end market demand. Although visibility is not perfectly clear for us, I’d say that we believe that a couple of quarters of this under-shipping should then alleviate those elevated inventory levels, so that as we exit the calendar year, we’re more shipping into our customers what they’re shipping out, and that’s what gives us confidence of getting back to a more normalized level of shipments through the end of the calendar year.

Samik Chatterjee, Analyst

Okay, I understand. I have a follow-up on Industrial & Consumer. Based on your guidance for the fourth quarter, it seems that most of the sequential decline in revenue at your midpoint is coming from that segment. That would indicate you’re approaching one of the lowest revenue levels in that segment in several years. Are you suggesting that the weaker sell-through from your primary customer is a factor, or is it more about inventory digestion at this customer that’s likely impacting you this quarter and the fiscal fourth quarter? Thank you.

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Hi Samik, this is Chris. I would say what’s most important to keep in mind in 3D sensing when you’re looking at prior years is obviously the share normalization that we’ve highlighted previously. That’s a very significant driver of reduction year-over-year and relative to the past. On top of that, obviously, end market and pricing a bit. I don’t think there’s anything else that we can really comment on particulars around or quantifying end market at this time.

Operator, Operator

Our next question comes from Alex Henderson from Needham.

Alex Henderson, Analyst

So, I wanted to delve into the AI commentary you made. Obviously, that’s one of the bright spots in the commentary. And try to understand the scope of the products that you have that allow you to compete in that market. Are you able to compete into just the Ethernet side, or are you able to also compete into the InfiniBand side of it? Is the VCSEL copper replacement part of that? And how rapidly do you think that that business will grow to offset any pressures in traditional datacom?

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Yes. Thanks, Alex. This is Chris. Let me address that. You should consider this in terms of time frames. In the short term, over the next few quarters, our focus is on increasing the volumes of our existing products and the new products we plan to launch. As you mentioned, the 100-gig per lane VCSELs will enter mass production soon, serving as a replacement for copper, along with the 200-gig per lane EMLs. This will help accelerate the clearance of already built inventory of our existing products. Looking ahead to the next few years, we see new architectures that customers, especially those not typically involved in networking but more in AI and computing, are interested in. We discussed some of this during our OFC presentation, where we are collaborating on solutions with these leading players for next-generation data centers. There are multiple waves of product intersections that we are navigating.

Alex Henderson, Analyst

So, just going back to the original question. When do you think that that really kicks in as a primary driver? Is it tens of millions of dollars of revenue in the back half of the calendar year, or is this something that takes a lot longer to ramp?

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

I think the back half of the calendar year will really be still in a phase of inventory digestion on existing products. I think the new stuff we’re talking about is more one to two years out. But going back to the existing products, as we get into calendar ‘24, then I think we’ll really see a reacceleration in the existing products, given the inventory should be burned off at that point in time.

Alex Henderson, Analyst

If I could just insert one last question. The inventory reserve that you mentioned, that was in the non-GAAP numbers, what was the size of that?

Wajid Ali, CFO

Hi Alex, it was approximately $4 million.

Operator, Operator

Our next question comes from Meta Marshall from Morgan Stanley.

Meta Marshall, Analyst

Alan, I wanted to get your perspective on the situation regarding inventory. We're not just seeing the system vendors over-ordering to build up their inventory; their customers have also over-ordered due to supply chain issues. How are you assessing the actual end demand, considering this may affect the duration of the inventory digestion process due to the over-ordering by the system vendors?

Alan Lowe, CEO

Yes. Meta, it’s hard for me to comment on what our customers are seeing. I can comment on what we’re seeing from our customers, and that is products where there is strong demand and deployments, we’re continuing to ship where there wasn’t a build-up of inventory. But where there was, and I think where there was fear of inability to get enough product for when their customers needed it, we’re seeing now that since the supply chains have eased that those inventory levels are coming down through this under-shipping of what we believe end demand is. So beyond that, it’s hard to say. I would say though, however, that we’re very confident in our share position, in our new product design funnel and our new product wins with our customers. So, that gives us confidence that as this inventory gets burned off over the next few quarters that we’ll be in a position to ship at end market demand, and we believe that there are still fundamental drivers that will drive end market demand to use these new products and continue to drive revenue growth for us as we get into calendar ‘24 and beyond.

Meta Marshall, Analyst

Got it. As a follow-up question, I noticed your comments about fiscal ‘24 being lower than fiscal ‘23 in 3D sensing. Could you provide a general estimate of the cumulative effect of pricing, share normalization, and end market demand for fiscal ‘24 compared to fiscal ‘23 in 3D sensing?

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Hi Meta. Yes. I think it’s a little premature to guide the full year on 3D sensing at this point. I think the key point here is, as we highlighted in the prepared remarks that end market demand, prices go down year-over-year. And the likelihood or potential for a new competitor on one of the sockets that we’ve led on in the past, all suggest that it will be down year-over-year.

Operator, Operator

Our next question comes from Tom O’Malley from Barclays.

Tom O’Malley, Analyst

I’m going to get a little specific on the technology and share side, and hopefully, you can do your best to answer it, but you talked about losing share in 3D sensing. I know you’re tired of this story, but it still does matter to move the numbers a little bit into the end of this fiscal year. Can you just talk about when you look at losing share, I think it’s pretty widely reported that there’s a new entrant in the world-facing sensor, is there a reason why share would be coming out of your pocket and not your competitors that you split that with today, or do you see that entrant kind of taking share equally from the both of you? And just walk through to the best of your ability why that would be the case.

Alan Lowe, CEO

It's too early to determine precisely what will occur with the next generation of phones. We want to point out that there is a possibility that one socket may involve a new supplier. I don't believe this will change the impact on us or our competitor regarding that third supplier. If they do enter and successfully scale up, I expect it will result in an equal shift in market share to that new supplier. Did that answer your question, Tom?

Tom O’Malley, Analyst

Got it. It seems that the gross margins are not explicitly detailed in the guidance, but it appears that the core telecom and datacom gross margin continues to be under pressure. I'm aware that there are synergies developing on the Neo side, but could you explain where this weakness is coming from? Is it related to the legacy Lumentum products or is the gross margin pressure coming from the acquired Neo products that have yet to realize those synergies?

Wajid Ali, CFO

Yes, I'll address that. Regarding synergies, most of the synergies we have achieved so far are reflected in our significantly reduced operating expenses from Q2 to Q3, as well as in previous quarters this fiscal year due to our strategic actions. For the cost of goods sold synergy, we expect to realize most of it in the latter half of our fiscal '24. We will undertake several consolidation activities in the second half of this calendar year, and we anticipate seeing some benefits from those synergies in early calendar '24. Concerning gross margins for this quarter, we noted that we plan to lower our inventory levels throughout the remaining part of the calendar year. This will lead to some under-absorption in our manufacturing facilities as we maintain the necessary infrastructure for a potential rebound in early '24. Consequently, this will affect our gross margins over the next few quarters.

Tom O’Malley, Analyst

So, just to be clear, you are further decreasing utilization within your own facilities?

Wajid Ali, CFO

Yes. Yes, that’s right.

Operator, Operator

Our next question comes from Christopher Rolland from SIG.

Christopher Rolland, Analyst

My first question is, do you think this is the lowest point for 3D sensing? Do you expect it to increase from here? How should we consider a new run rate? Also, what part of next quarter's revenue is from industrial applications so we can differentiate that from consumer? Thank you.

Alan Lowe, CEO

Typically, the June quarter is the lowest point seasonally, as it marks the end of the previous model and inventory decreases when our main customer begins production of new devices in September. This is the usual low point in the 3D sensing cycle for our primary customer. I expect that end-user demand will increase in the September and December quarters, as is customary. The main factor affecting our outlook for fiscal '24 is the market share changes we have discussed, which have been developing over the past four to five years and have now reached a more stable state. As Wajid mentioned, we no longer have a 10% customer in the consumer sector, and in terms of industrial, it accounts for low single-digit millions on a quarterly basis.

Christopher Rolland, Analyst

Okay. That’s very helpful. And then secondly, if we could talk about your 200-gig per lane EML, 800, 1.6T, when do you expect this to ramp considerably for you guys? And then, any update on your CW lasers and when you think that could contribute?

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Yes. Thanks, Chris. Those products are currently being sampled to customers, and we are collaborating with them to prepare for the ramp-up. I would say the timing is later this calendar year and into the next calendar year. We are already shipping CW lasers in various forms for use in silicon photonic applications, but we expect more significant developments in calendar year 2024.

Operator, Operator

Our next question comes from Ruben Roy from Stifel.

Ruben Roy, Analyst

Either Alan or Chris, I wonder if you’d characterize how you’re looking at some of the opportunities around 3D sensing and industrial, auto, IoT, etc. Obviously, it’s still early days. But what needs to happen, would you say, to get into more meaningful ramp? Is this a question of pricing or more testing? If you can kind of walk us through how you’re thinking about the ramps over the next 18, 24 months, that would be helpful.

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Yes. I believe the biggest opportunity, especially in the long-term, lies in the automotive sector, particularly in ADAS, LiDAR, and in-cabin technologies. The development cycles in the automotive industry are quite lengthy, often spanning five years or more. We have been working with multiple customers for some time, focusing on establishing various types of LiDAR architectures to ensure that as end customers make their decisions, we are included in the solutions they choose. Over the next two years, I anticipate more modest growth in these industrial and automotive applications. As we mentioned, we are currently shipping $3 million per quarter, which is significant at the chip level. We expect that LiDAR modules will evolve into a multibillion-dollar market over the next three to five years, with LiDAR chips representing roughly 10% to 15% of that market. Looking ahead about ten years, we foresee a market worth tens of billions of dollars for LiDAR modules. This is a long-term strategy for us, but it effectively utilizes chip technology, which we can apply across various end markets.

Ruben Roy, Analyst

I appreciate that. I have a quick follow-up for Wajid on that topic. Wajid, you mentioned the gross margin and the dynamics around telecom. As for consumers, it appears we will have a different run rate when considering the rest of this year and possibly next year, given some changes in competitive dynamics. How does this affect your thinking about gross margins from a longer-term perspective?

Wajid Ali, CFO

Yes. Hi Ruben. Yes. So, I mean, our longer-term gross margin targets really haven’t changed. A lot of the reductions we saw in gross margins this quarter did come from a mix between chips and module business, obviously, as chips generally have higher margin levels. But a lot of the decline came from just overall utilization of factories and shipments. And so, as we see our telecom, datacom business rebound as well as lasers rebound into calendar year ‘24, we should start to see improvements in gross margins and our overall operating margins from the levels that we’re delivering right now. And so, we really haven’t come off what we talked about at OFC around our midterm target model. And sorry, I would be missing the whole comment around synergies as well where we’ll see a real uptick in synergy activity flowing through our P&L in the first part of the calendar year and the favorable impact that will have on our overall operating model.

Operator, Operator

Our next question comes from Vivek Arya from Bank of America.

Blake Friedman, Analyst

This is Blake Friedman on for Vivek. Thank you for taking my question. First, just touching on the telecom and datacom side, I was wondering if you can discuss how pricing is holding up in this environment. And if you’re seeing any competitors price more aggressively in the current environment and how you view that risk in general.

Alan Lowe, CEO

Yes. We’re not seeing any change in the dynamic of pricing. I think the dynamic has changed from five years ago to what it is today where we partner with our customers and provide long-term price agreements that are tied to share of their spend in that particular product, and that usually starts when we decided to develop a product together. And so, there’s a varying degree of those types of long-term agreements as well as annual type agreements that were done several months ago. So, I wouldn’t say there was any dynamic change in pricing as we look at telecom and datacom.

Blake Friedman, Analyst

Understood. As a follow-up regarding gross margins, I'm interested in your 3D sensing position and how you're managing utilization. As we anticipate a demand recovery going beyond the June quarter, could gross margins potentially decrease from June levels? Any insights on how this may evolve throughout the year would be helpful.

Wajid Ali, CFO

Yes. I mean, there’s a number of moving pieces that could really impact us, especially as it comes to mix and even within telecom as it comes to mix on our various product lines. What I will say is that we noted in our prepared remarks that we are planning on bringing down our inventory levels by approximately $40 million exiting the calendar year. That is going to have an impact on overall gross margins, at least in the back half of the calendar year. And then, as we get back to more normalized levels, in the first part of calendar ‘24, we’ll have the tailwind of cost of goods sold synergies as well as what Alan talked about, which is us shipping closer to what is end market demand. And so, both of those should have a favorable tailwind. So yes, in the first part of our fiscal year, we will have a headwind, especially around our desire to bring down inventory levels. But then we should see an uptick with synergies and shipments being more reminiscent of what end market demand is.

Alan Lowe, CEO

So that’s the right way, I think we’re thinking about it, and that’s how we think you may want to think about it.

Operator, Operator

Our next question comes from George Notter from Jefferies.

George Notter, Analyst

I'm trying to understand the appropriate revenue run rate for the Company in a normalized scenario. In the past, you achieved a couple of $500 million quarters, which were primarily due to inventory builds. Now, we're projecting $350 million to $380 million for the June quarter, indicating a significant gap. It's challenging to grasp what the normalized revenue run rate will be as the market adjusts to inventory levels. What insights do you have on where this business is likely to end up in terms of revenue?

Alan Lowe, CEO

Yes, George, we believe we are under-shipping compared to market demand, and this is reflected in our guidance for the June quarter. It is quite challenging to predict how much we are under-shipping and what the market demand will be three quarters from now. However, 3D sensing is expected to hit a low in June. Lasers are currently at a lower level than we typically expect during normal times due to a product transition, but we anticipate an increase in lasers in calendar 2024. If we reach the level we initially projected for the March quarter, that would likely align more closely with actual market demand. As the market is projected to grow in the high single digits to low double digits annually for telecom and datacom, there are several factors that could prompt even faster growth, particularly in data centers supporting AI and machine learning. Therefore, I don't see any reason we can't return to those $500 million levels. The question is when we will get back to those figures, especially considering inventory digestion and other macroeconomic factors as we approach calendar 2024.

Operator, Operator

Our next question comes from Ananda Baruah from Loop Capital.

Ananda Baruah, Analyst

I have two quick questions. First, Chris, I need clarity on your previous comments regarding your contributions to the AI build-out. My understanding is that NeoPhotonics is involved, but does your data center chip business also play a role? I would assume it does. I've also noted other areas within the lasers and photonics portfolio. Can you confirm if that's accurate? Additionally, while it's still early, could you provide context on what portion of the overall portfolio has some level of exposure that would be relevant? I have a brief follow-up as well.

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Yes, thanks. Yes, I would go back to that in the nearer term, it’s the data center chip business, as you alluded to, which both has what we’ve been known for, high-speed EMLs transitioning to higher speed, but also the addition of high-speed VCSELs and the growth of high-power CW lasers used for silicon photonic architectures. So those are what I referenced as more nearer term, as in the next 10 quarters. As we look to the next couple of years, we anticipate the data center architectures will evolve to more application-specific equipment, if you will, and that application-specific equipment will have, maybe in addition to the standard Ethernet-type connects, more proprietary interconnects, using, in a sense, a custom-designed transmission links. And that’s where our engagement with leaders in the space is really important, taking our broader photonics capabilities around lasers and transmission in general as well as in some cases, optical switching, all will be brought to bear. So, it does impact a more broad piece of our company than just the datacom or data center business that today is the primary driver.

Ananda Baruah, Analyst

And I guess, the quick clarification is just given the guidance for the June quarter, kind of telco/datacom slightly up, flat to slightly up Q-over-Q. Are you essentially calling kind of the bottom here, June quarter in your telco/datacom business combined? And should we think of flattish through the remainder of the year until demand picks up? Thanks. That’s it for me. Thanks.

Alan Lowe, CEO

Yes. We’re reluctant to guide more than one quarter at a time. We are seeing some strength in the June quarter on coherent components for high-speed coherent modules. And whether that continues into the September and December quarter, it’s hard to say. We are expecting kind of a continued level of revenue or I should say, inventory digestion and certainly in the September quarter and then partially into the December quarter. So it’s, I would say, flattish kind of outlook, but we’ll give you more input on that in August when we have our next call.

Kathy Ta, Vice President of Investor Relations

Thank you, Alan. I think we have time for one more question, and then we’ll turn it over to Alan for some final remarks.

Operator, Operator

Our next question comes from Mike Genovese from Rosenblatt Securities.

Mike Genovese, Analyst

Just can we get specific color on datacom? I think that inventory correction started a couple of quarters ago. So the question is, is the inventory correction over, but now there’s sort of some order pushouts in the cloud, or any color you can give us on specific to the datacom business would be helpful. Thank you.

Alan Lowe, CEO

Yes, Mike. I’ll share my thoughts, and then perhaps Chris can add his insights. We have discussed a slowdown in datacom over the past few quarters and the accumulation of inventory among cloud providers and hyperscalers. They had placed orders several quarters ahead due to shortages in 2022, expecting growth rates of around 30% to 40%. However, their announced growth rates have turned out to be much lower, leading to a longer time required to reduce that inventory. We are observing that inventory gradually being used up, although some customers and module manufacturers still have a quarter or more of inventory remaining. We anticipate that demand for AI and machine learning will accelerate the consumption of this inventory, allowing us to align our shipping in the datacom market with the actual end-market consumption by the end of the calendar year. Meanwhile, inventory continues to exist in the channel.

Mike Genovese, Analyst

Okay, great. For my follow-up question regarding commercial industrial lasers, the first half of this year faced significant comparisons, leading to a lower run rate as we move into next year. How should we consider the year-over-year performance in 2024 for that business?

Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer

Yes. Thanks, Mike. We expect that lasers will decrease a bit, as highlighted in our prepared remarks. This is linked to the semiconductor end markets and the broader manufacturing landscape. We anticipate a decline in the coming quarters. The demand had been increasing throughout the year, but based on current customer forecasts, we believe that FY24 will be lower than FY23 for commercial lasers in general.

Kathy Ta, Vice President of Investor Relations

Thank you, Mike. I think now we’ll turn the call back over to Alan for some closing remarks.

Alan Lowe, CEO

Thank you, Kathy. I would like to leave you with a few thoughts as we wrap up this call. Mid- to long-term fundamentals remain intact for our business as we serve the exponential growth in network bandwidth, in artificial intelligence, machine learning, mobile, carrier and cloud computing markets. New automotive and industrial applications are emerging for our imaging and sensing products and applications for commercial lasers are expanding into new applications beyond our traditional markets. We remain committed to investing deeply in innovation to deliver on customer needs today and in the future. With that, I would like to thank everyone for attending, and we look forward to talking with you again at investor conferences and upcoming meetings in the coming weeks. Thank you, and have a great day.

Operator, Operator

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