Earnings Call Transcript - LITE Q1 2024

Operator, Operator

Good day, everyone, and welcome to the Lumentum Holdings First Quarter Fiscal Year 2024 Earnings Call. All participants will be in a listen-only mode. Please note that today's event is being recorded for replay purposes. After the presentation, we will have a question-and-answer session. I would now like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please proceed.

Kathy Ta, Vice President of Investor Relations

Thank you, and welcome to Lumentum's fiscal first 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, 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; financial and operating results; macroeconomic trends; trends and expectations for our products and technology; our end markets; 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, particularly the risk factors described in the 10-K for the fiscal year ended July 1, 2023, and 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 first 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.

Alan Lowe, President and CEO

Thank you, Kathy, and good morning, everyone. We are thrilled to welcome the Cloud Light team to Lumentum. The addition of Cloud Light's products to our portfolio positions Lumentum as a leader in providing photonics to cloud operators at a time when artificial intelligence is rapidly accelerating growth in the data center market. We believe Lumentum's served opportunity within data centers has expanded more than five-fold as a result of the Cloud Light acquisition. For years, Cloud Light has been supplying differentiated high-speed products to leading hyperscale customers, both custom products to address unique customer needs, as well as standard products to address a broad range of hyperscale customer requirements. In the last 12 months, over 90% of Cloud Light's revenue was derived from 400G and higher-speed products. In the most recent quarter, over half of Cloud Light's optical transceiver revenue was derived from 800G transceivers. In calendar 2024, we anticipate strong growth in Cloud & Networking revenue, driven by accelerating AI, computer requirements, and a resumption of shipping more in-line with end market demand. Also, in calendar 2024, we expect cloud applications to drive over 30% of Lumentum's cloud and networking revenue. Our cloud customers are responding very positively to this transaction. This combination results in a broader portfolio of differentiated products and technology. It also enhances the security of supply for our customers, given our broader combined global manufacturing footprint and high levels of vertical integration. Lumentum is well-equipped to address future cloud technology roadmaps as AI models drive an exponential increase in compute and networking requirements. I would also like to highlight that starting with this fiscal year, we are updating our financial segment reporting to better reflect the rapidly changing market opportunities ahead. Our financial reporting is now focused on two large and growing end market segments: one, Cloud & Networking; and two, Industrial Tech. Within Cloud & Networking, the cloudification of the network is blurring the lines between our historical served markets of telecom and datacom. Cloud data center and traditional telecom operators are increasingly purchasing the same types of data transmission products. We anticipate the emergence of new applications for optical switching technology not only to serve the growing complexity of long-haul and metro networks, but also to support the high optical link density required for AI training models in the data center. Our customer mix is changing as well. The addition of Cloud Light brings much more direct sales to cloud operators and infrastructure providers. We are also increasingly serving cloud and networking operators directly for their data center interconnect and edge networking applications. To better align our reporting with these market trends, the telecom product lines and the datacom product lines are now included in the Cloud & Networking segment. Turning to the Industrial Tech segment. Our portfolio of imaging, sensing, and laser products aligns with Industry 4.0 and 5.0 trends. Industrial sensing applications require high accuracy in determining distance, speed, and displacement, and are increasingly turning to laser-based approaches. Leading-edge semiconductor, solar cell, and electronic component manufacturing require the beam precision and short-pulse duration of ultrafast lasers to produce precise cuts and features to better reflect the growing importance of precision photonics across this broad application space. The industrial and consumer and commercial lasers product lines are now included within the Industrial Tech segment. Now, I will summarize our fiscal first quarter results. As we reported last week, first quarter revenue and EPS were above the mid-points of our guidance ranges. Through cost controls and efficient operations, we are managing the factors that are in our control. While we continue to see very strong growth in the demand for our data center chips, as well as our newly acquired intra-data center transceivers, this strength is being offset by the telecom and industrial inventory drawdown activities. Due to this inventory correction, we believe we continue to ship below end market demand. As we navigate this transition period, we are delivering as planned on our product roadmaps and synergy attainment with respect to our NeoPhotonics acquisition. Of course, we are also excited about the new opportunities that Cloud Light brings starting in the current quarter as we leverage their leading transceiver technology to deliver the fastest speed products to cloud customers. Now let me provide more detail on our segment level results in Q1. Cloud & Networking revenue was down 20% sequentially and down 36% year-on-year, with broad-based softness across most of our networking product lines, partially offset by sequential growth in intra-data center lasers and tunable access module. This is as we have expected, given the inventory correction underway at our networking customers. Robust cloud data center demand is currently the strongest growth driver for our Cloud & Networking business. As data centers are designed to support the high bandwidth requirements of AI workloads, 800 gig transceivers can provide that bandwidth while also reducing latency. For our transceiver customers, their new 800 gig transceivers utilize eight different wavelengths at 100 gig per lane, triggering orders for our chip-level photonics and driving growth for our EML product line. We are also seeing an increase in deployments of 800G transceivers that are supplied by our Cloud Light business, and we are working with our new team to enable them to ramp even more rapidly. Over time, we also expect to supply custom-designed high-power CW laser arrays for leading AI hardware architectures to provide the high bandwidth, low latency optical interconnects essential for training and inference applications. In calendar '24, our 200 gig per lane EMLs will enable the next generation of transceivers with capacity of up to 1.6 terabits. We are shipping qualification samples of our 200 gig EMLs now and expect to ramp production in calendar '24 with customer qualifications of 800 gig and 1.6 terabit transceiver designs well underway. We expect that 200 gig per lane optics will be the workhorse of hyperscale data centers for years to come once these qualifications are completed. Through Cloud Light, Lumentum is now a leader in high-speed active optical cables, or AOCs, as well as VCSEL-based transceivers to cloud customers to fulfill their short-reach connectivity requirements for new AI and machine learning cluster architectures. In addition, we've been developing high-speed 100 gigabit per second VCSELs and VCSEL arrays for these short-reach optical links, and we expect to ramp these shipments meaningfully in calendar '24. Moving on to our high-speed transmission product developments, we are receiving positive customer feedback on our next generation of 130 gigabaud and 200 gigabaud data rate coherent technologies. These high-speed products will be available in both discrete and integrated form factors to enable enhanced performance in metro and long-haul applications. In addition, at the ECOC conference last month, we received positive customer feedback on our coherent 800 gig ZR product. We believe we are the first to market with this capability, which will provide high-speed connectivity with extended reach for data center interconnect within metropolitan areas. Turning to Industrial Tech. Fiscal Q1 was up 4% sequentially from Q4, driven by the expected uptick in our 3D sensing business with a new smartphone product ramp partially offset by softness in fiber lasers as our leading fiber laser customer works to bring down inventory. Industrial Tech is down 40% year-over-year as expected, primarily due to more intense competition for market share on a certain 3D sensing socket, end market demand and pricing, as discussed previously. Based on our latest customer forecasts, we continue to expect industrial lasers demand to be soft into calendar 2024 due to customer inventory digestion and macro factors impacting end markets. However, we expect the rapid growth in new applications for ultrafast lasers to partially offset these near-term headwinds given growth in new solar cell manufacturing applications. To summarize, our market outlook is currently a tale of two dynamics. On the one hand, outside of the data center customers, we are facing continued headwinds from networking and industrial customer inventory digestion. In all of our end markets, we are committed to our long-term R&D roadmaps, and we are positioning the company for the robust growth of photonics opportunities that we see ahead. Before turning it over to Wajid, I would like to again welcome our new employees from Cloud Light, and thank all of our employees and our customers around the world for their focus and dedication as they continue to collaborate and partner with Lumentum.

Wajid Ali, Chief Financial Officer

Thank you, Alan. Net revenue for the first quarter was $317.6 million, which was down 14% sequentially and down 37% year-on-year. During the quarter, we had three greater than 10% customers, two of which are in Networking and one 10% customer in the Industrial Tech market. GAAP gross margin for the first quarter was 24.1%, GAAP operating loss was 25.4%, and GAAP diluted net loss per share was $1.02. First quarter non-GAAP gross margin was 34.9%, which was down sequentially and down year-on-year, primarily driven by product mix, factory underutilization, and lower revenue. First quarter non-GAAP operating margin was 3.3%, which decreased sequentially and year-on-year. First quarter non-GAAP operating income was $10.6 million, and adjusted EBITDA was $34.6 million. First quarter non-GAAP operating expenses totaled $100.1 million, or 31.5% of revenue, down $2.3 million from Q4 and down $6.6 million from the year-ago quarter due to tight expense controls. Q1 non-GAAP SG&A expense was $39.1 million. Non-GAAP R&D expense was $61 million. Interest and other income was $16.8 million on a non-GAAP basis due to higher interest rates on our cash and investments. First quarter non-GAAP net income was $23.4 million, and non-GAAP diluted net income per share was $0.35. Our fully diluted share count for the first quarter was 67 million shares on a non-GAAP basis. Turning to the balance sheet. Our cash position decreased during the quarter due to a few key items. We used $30 million in cash to purchase our wafer fab and campus in the UK. This purchase reflects our confidence in the longevity of indium phosphide technology to address the ever-growing need for higher and higher performance telecom transmission components. In order to capture our COGS synergies from the NeoPhotonics acquisition, we are pre-building nearly $30 million of inventory to help facilitate the factory consolidation happening over the next few months. And we had an annual Japan tax payment of approximately $17 million, as well as expenses related to the Cloud Light acquisition. As a result, cash and short-term investments decreased $69 million sequentially to $1.94 billion. To streamline operations and achieve synergies, we will be consolidating NeoPhotonics back-end manufacturing facilities, and therefore, we expect an under-absorption of capacity relating to these moves during Q2 and Q3. By the end of Q4, as we ramp up production of NeoPhotonics' products within Lumentum's manufacturing footprint, we expect to shift buffer inventory, enabling these manufacturing costs to align with the rest of our production. In addition, as we continue to focus on cash generation, we expect our internal inventories to decline throughout the balance of the fiscal year. Turning to segment details. For the benefit of our investors, we have expanded our earnings press release to include tables of historical financial data that are reformatted into our new segment categories. First quarter Cloud & Networking segment revenue at $229.7 million decreased 19.8% sequentially and was down 36.2% year-on-year. Cloud & Networking segment non-GAAP reporting profit at 10.4% decreased sequentially and year-on-year. Our first quarter Industrial Tech segment revenue at $87.9 million was up 4.3% sequentially and down 40.1% year-on-year. First quarter Industrial Tech non-GAAP reporting profit of 17.4% was up sequentially, but down year-on-year. Now let me move to our guidance for the second 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 second quarter of fiscal '24 to be in the range of $350 million to $380 million. Within this Q2 revenue forecast, we anticipate Industrial Tech to be down sequentially with Cloud & Networking to be up sequentially with the addition of a partial quarter of Cloud Light revenue. Based on this, we project second quarter non-GAAP operating margin to be in the range of 2% to 4%, and diluted net income per share to be in the range of $0.25 to $0.35. Our non-GAAP EPS guidance for the second quarter is based on a non-GAAP annual effective tax rate of 14.5%. These projections also assume an approximate share count of 67.4 million shares. In terms of expectations beyond Q2, as Alan mentioned, we do expect a return to growth in Cloud & Networking shipments in calendar '24 compared to calendar '23 as customer inventory levels are reduced and our shipment rate is more in sync with end market demand.

Kathy Ta, Vice President of Investor Relations

Thank you, Wajid. Before we start the Q&A session, I would 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

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. We have our first question coming from Simon Leopold from Raymond James. Please go ahead.

Simon Leopold, Analyst

Great, thanks for taking the question. I'll start with a straightforward one. I want to understand your expectations for the contribution from Cloud Light in the guidance for the December quarter. Since this is simple, I'll also ask my second question. I'm curious about your insights into the ZR market right now. We've experienced a period of inventory absorption, and during the ECOC trade show, it seemed there was some potential for improvement in that market. Could you elaborate on what you're observing in that segment, particularly regarding lasers and your own ZR devices? Thank you.

Alan Lowe, President and CEO

Thanks, Simon. The Cloud Light revenue is the revenue that they're going to ship from when we announced it closing, which was yesterday. So, about seven-and-a-half weeks of revenue. And we talked about trailing over $200 million, so you can extrapolate what you think the two months will be. And we're not going to actually break that out in any further detail. As far as the ZR market visibility is concerned, I think with all of what's going on inside the data centers with AI and machine learning, we've seen a pickup in ZR demand, in fact, probably earlier than we would have expected otherwise. And so, I'd say that, that has some healthy tailwind to it for data center interconnect, and we've seen some of that come through some of our hyperscale customers in new demand for the ZR modules. Chris, do you have anything else to add on either of those?

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

No. I think that's great.

Kathy Ta, Vice President of Investor Relations

Thank you, Simon.

Operator, Operator

Thank you. Your next question comes from the line of Samik Chatterjee from JPMorgan. Please go ahead.

Joe Cardoso, Analyst

Hi. Good morning, guys. This is Joe Cardoso on for Samik Chatterjee. Yeah, first question for me. Can you just give us some granularity relative to the underlying trends you're seeing in telecom? I think one of your peers in the space suggested it's seeing a bottom in the September quarter itself and expects it to begin to recover in subsequent quarters, and while another suggested it's more of a mid-2024 phenomenon. Just curious where you are landing on that spectrum and what's driving your confidence there. And then I have a follow-up.

Alan Lowe, President and CEO

We're currently in a situation where we're not meeting the demand from the end market, and we've observed some softening in that demand as well. This is contributing to the subdued demand for our telecom products. However, I believe that we will see inventories decrease during this time, including December, though some inventory consumption is likely to continue into the early part of 2024.

Joe Cardoso, Analyst

No, I got it. Thanks. I appreciate the color, Alan. And then, just relative to the non-Cloud Light datacom business, you had been talking about ramping capacity there, including some rehiring of headcount. I believe you were moving to a larger wafer size, et cetera. So, a bunch of moving pieces. I guess, can you just give us an update on how that is tracking? And then just whether with Cloud Light on the books now, does that help you accelerate some of these initiatives relative to what you were doing in terms of ramping capacity for the legacy piece of the datacom business? Thanks for all the questions.

Alan Lowe, President and CEO

The datacom EML market is very strong, and while we are currently facing allocation issues again, our capacity is coming online as we had expected and discussed in previous calls. The demand is even greater, particularly as hyperscalers are aiming for 800 gig solutions. An EML solution typically requires eight chips instead of four to achieve 400 gig, leading to an increased need for datacom chips. We've experienced significant growth in this sector, and we are on track to expand our wafer size in calendar 2024. Our facility is busy with this work, and we are also increasing capacity from the capital investments we made earlier this year, which are now becoming operational. Additionally, we are bringing back employees and hiring more to meet demand, although we are still on allocation for EMLs since the recovery happened faster than anticipated. Our backlog remains strong for the rest of the fiscal year and we expect it to continue growing into fiscal '25, especially with the introduction of 200 gig per lane EMLs, positioning us strongly in the market. Regarding Cloud Light, their designs currently utilize both multi-modal VCSEL and silicon photonics technologies. We aim to integrate our VCSEL designs to enhance product feeds, reduce costs, and improve margins. We are collaborating with the Cloud Light team to increase the use of our CW laser in their designs moving forward. While this doesn't directly affect our EML capacity, it presents opportunities for margin enhancement over time.

Joe Cardoso, Analyst

Understood. Very clear. Thanks, Alan.

Alan Lowe, President and CEO

Great. Thanks.

Kathy Ta, Vice President of Investor Relations

Thank you.

Operator, Operator

Our next question comes from the line of Meta Marshall from Morgan Stanley. Please go ahead.

Meta Marshall, Analyst

Great, thanks. Maybe first question just on whether you have kind of ironed out more of what CapEx investment you think Cloud Light will take during the year? And then, maybe as a second question kind of building off of Simon's question, you mentioned kind of the 800 ZR getting positive reception at ECOC. Just when would you expect that to kind of ramp into production? Thanks.

Alan Lowe, President and CEO

So, as you can imagine, the Cloud Light ramp has been very steep. And one of the things that we work with them on is to make sure that they continue to invest pre-acquisition, and they have. So, they've been continuing to grow their capacity. As far as future CapEx requirements, I'd say it's a little early in that. We have been getting very positive feedback from hyperscalers customers, and we expect that the acceleration of growth will be even stronger than expected. So, I think it's a little bit early to really determine are we going to further accelerate or stay on the path that they were on. I would say, we're probably going to have to accelerate CapEx as we've gotten feedback again from not only existing customers but new customers that they don't have much footprint in as they view this really as an extreme positive of a diversification of a U.S.-headquartered company and manufacturing footprint that is more global than current existing Cloud Light. So, I think we'll have to wait on that and give you an update on our CapEx plans for Cloud Light on the next call or some future meeting. As far as the 800 gig ZR ramp, I think we're still at the demonstration stage today. And again, positive feedback at ECOC. We've got to get from where we are today to beta samples and qualification samples, and then it takes a couple thousand hours of testing to get to production. So, I'd say that's really more of an early fiscal '25 and late calendar '24 type of initial ramp. But again I think we're positioned quite well with what we think will be first to market on that product. So, very, very happy with progress there.

Meta Marshall, Analyst

Great, thanks.

Kathy Ta, Vice President of Investor Relations

Thank you, Meta.

Operator, Operator

Thank you. Our next question comes from the line of David Vogt from UBS. Please go ahead.

David Vogt, Analyst

Great. Thanks, guys, for all the color. I'm just going to try maybe triangulating again on this Cloud Light transaction. So I think, Alan, in your prepared remarks, you suggested that the business should accelerate to about 30% growth in calendar year '24. If I just do some really quick math, does that assume your legacy business returns to growth in '24 based on sort of the disclosure that Cloud Light has about $200 million of revenue growing, obviously relatively rapidly? And then in conjunction with that, from a margin perspective, I know you talked about it on the last call, as it being sort of a slightly accretive transaction with regards to the first 12 months post-closing. But can you maybe share with us sort of the margin profile of this business relative to the existing sort of Cloud & Networking part of the business pre the transaction? Thanks.

Alan Lowe, President and CEO

I’ll start with the first question, and then Wajid can explain more about Cloud Light margins. You're correct about the growth rate, and as I mentioned earlier regarding Meta's question, the feedback has been very encouraging. When we translate that feedback into orders, we could see faster growth. However, it may still be a bit early to make that determination. I don’t believe Cloud Light affects the legacy business, other than bringing us closer to cloud customers. We're not planning to provide guidance beyond one quarter at a time, and we won’t separate legacy from Cloud Light going forward. As we've discussed, we think we are not meeting the end market demand fully, and inventories are declining. Therefore, we expect an increase in the first half of '24, likely aligning our shipments with customer consumption, especially in Q4. I anticipate a boost in Q4 compared to current levels, but predicting Q3 is more challenging right now. Wajid?

Wajid Ali, Chief Financial Officer

Yeah, David, so on the margin profile, we certainly see a lot of opportunity with Cloud Light. With the rapid growth that we're expecting in the business, there's some natural leverage that we should see at Cloud Light. And there's also a lot of opportunity with our existing manufacturing footprint to help that part of the business grow while utilizing some of the manufacturing capacity that we've also got. And then, probably the most important thing, which our R&D teams are going to be working with their R&D teams over the next few weeks, is really our plans around vertical integration. And those plans around vertical integration can provide quite a bit of upside from an in-feed standpoint on their own raw materials. So having said that, what we've communicated previously is that the Cloud Light business is currently operating in the low-teens from an operating margin standpoint and in the high-teens from an EBITDA standpoint. Our expectation that we've communicated is that, through the opportunities that we see that we can certainly get that business into the high-teens from an operating margin standpoint over the next 24 months. As the teams dig in more with their R&D teams, we'll be able to update our thinking around that in future quarters, but that's currently where our thinking is in terms of the business.

David Vogt, Analyst

Great. Thank you, guys.

Kathy Ta, Vice President of Investor Relations

Thank you, David.

Operator, Operator

Thank you. Our next question comes from the line of Vivek Arya from Bank of America Securities. Please go ahead.

Vivek Arya, Analyst

Thank you for taking my question. First question, I know you gave a 30% growth potential for Cloud Light, but that's more like a three to five year. Is it fair to say that they're growing faster than that? When I look at a lot of the compute deployments, they are growing like a 40%, 50% type of CAGR. So, is it fair to assume that at least in the near- to medium-term, Cloud Light could be growing more at a 40%, 50% rather than a 30% rate?

Alan Lowe, President and CEO

Yeah, I think that's fair. Given the introduction and rapid growth at 800 gig, we expect that Cloud Light should be able to grow faster than that 30% CAGR. That is a multi-year number. As 800 gig has been introduced, we highlighted that Cloud Light's revenue in the most recent quarter was more than 50% 800 gigs. So, we'll be highly leveraged to the growth of that as customers at the leading edge of AI deployments continue to shift to the 800-gig speed.

Vivek Arya, Analyst

Thank you. And for my follow-up, I just wanted to kind of double check the accretion math or the potential accretion math. So first of all, when you say something is accretive, are you talking on an EBITDA level? Are you talking on an operating income level? At an EPS level? So, if you could define what accretion means? And let's say if you define accretion on an EPS level, then is it immediately accretive, or will it be accretive sometime in the fiscal year when we put in all the puts and takes of the financial income, right, that is being lost on other fab consolidation activities and so forth? So, when is it actually potentially accretive on an EPS perspective in your opinion?

Wajid Ali, Chief Financial Officer

So, Vivek, we've communicated this earlier. We believe it's immediately accretive to earnings per share. And the way we do the math on the earnings per share is the operating income we expect to generate from Cloud Light on a standalone basis without synergies and compare that to what we're earning in our short-term overnight money market rates. And so, we just take a look at those two to determine accretion. And based on that, the transaction is immediately accretive. And that accretion only improves as we go through some of the synergy actions I spoke about earlier.

Vivek Arya, Analyst

Understood. Thank you.

Kathy Ta, Vice President of Investor Relations

Thanks, Vivek.

Operator, Operator

Thank you. Our next question comes from the line of George Notter from Jefferies. Please go ahead.

George Notter, Analyst

Hi guys, thanks very much. I'm just curious if you guys have gotten any other feedback on the Cloud Light acquisition from your other datacom customers. I think obviously you're competing with some of those folks increasingly. I'm just wondering if in the last week or two you've had any more feedback. Is this something that becomes problematic for the rest of the datacom business or is it a non-issue? Thanks.

Alan Lowe, President and CEO

Yeah, thanks, George. As you can imagine, I've had many discussions with our very important transceiver customers to assure them that our partnership is still very solid and they're very, very important to us. And I think there's plenty of demand to go around. And we've acted like strong partners with them over time. So, I'd say that the alternative is that they buy from another competitor or they buy from someone that they've trusted for years. And so, I don't see any negative implication with respect to our transceiver customers and their demand on us for EMLs, VCSELs, and DMLs for that matter. So, I think so far, so good. The feedback has been positive. And we have not seen any demand shifts as a result of the announcement from a week or two ago.

George Notter, Analyst

Got it. Thank you very much.

Alan Lowe, President and CEO

Thanks, George.

Kathy Ta, Vice President of Investor Relations

Thank you, George.

Operator, Operator

Our next question comes from the line of Christopher Rowland from Susquehanna. Please go ahead.

Christopher Rowland, Analyst

Hey, guys. Thanks for the question. One of your competitors spoke of a strong ramp in 800G starting in March. I was wondering if you could kind of describe the shape of your 800G ramp here over the next 12 to 18 months. And they were going to see kind of as a result of this strong growth, sequential growth each quarter of next year. I was wondering if you would see something similar on your horizon.

Wajid Ali, Chief Financial Officer

Hey, Chris. Yes, I would say we would see very similar commentary that both from the chip standpoint that we are shipping a lot of EMLs and have very strong demand that we expect continues over the next four-plus quarters as 800 gig continues to ramp. And then from the Cloud Light acquisition, their revenue is, as we've highlighted on the call, increasingly focused on 800 gig. And that is in its very early days, that market is just emerging and will continue to ramp up into the future. So yes, we believe the 800 gig portion of our cloud business will continue to grow into the foreseeable future.

Christopher Rowland, Analyst

Okay. I am curious about the sequential growth for each quarter of the upcoming calendar year. For my second question, I wanted to discuss custom engagements for laser designs by various system vendors, including holistic system vendors and hyperscalers. Additionally, I am interested in understanding if it is feasible to differentiate between cloud networking demand, specifically comparing the 51 terabit switches to AI, and how you anticipate this will play out next year. Thank you.

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

Yeah. So, a couple pieces. So, on the last bit with regards to where our products are landing, if you will, AI versus non-AI, we don't have 100% visibility to that. But our belief is that for the next year, at least, most of the growth or the primary growth in the market is driven by AI-driven applications. And then going back to custom laser designs, or if you will, yes, we are engaged with both, as you said, system providers, if you will, as well as cloud operators directly, hyperscalers. On custom laser solutions as well as now with Cloud Light custom transceiver solutions as AI continues to push the performance envelope and stress from power consumption, latency, and other requirements that are really critical to AI workloads. And that's one of the benefits of this combination, that we're bringing together unique manufacturing capabilities from Cloud Light, bringing together our unique chip manufacturing so that when we partner with customers, we have the full tool chest, if you will, to address the challenges of next generation roadmaps that they're looking to implement sooner than later.

Christopher Rowland, Analyst

Thanks, Chris.

Kathy Ta, Vice President of Investor Relations

Thank you, Chris.

Operator, Operator

And we have our next question coming from the line of Ananda Barua from Loop Capital. Please go ahead.

Ananda Barua, Analyst

Good morning, everyone, and thank you for the question. I'll focus on transceivers as well. Do you see any latency issues or obstacles in getting Cloud Light volumes to the run rate now that the deal is closed? I have a brief follow-up after that.

Alan Lowe, President and CEO

Could you clarify what you mean, Ananda?

Ananda Barua, Analyst

Is everything in place to simply take the orders and ship them out? Considering they are newly integrated into the organization, and given your balance sheet and reputation, which may create new opportunities for them, along with their existing manufacturing capabilities, are there potential requirements that could delay order fulfillment in the near term? I am curious if the system is currently functioning smoothly for order processing and shipping, or if there are tasks that need to be addressed soon to ensure the orders meet run rate revenue.

Alan Lowe, President and CEO

The Cloud Light team is receiving plenty of orders. Our capacity and capital expenditure plans are positioned to accommodate the volumes we anticipated before the acquisition. I expect demand to accelerate further, which may require additional capacity and expansion of our factory space. Fortunately, we have the opportunity to increase our footprint right now. Since we just closed the acquisition 24 hours ago, we are in the process of assessing everything and aim to manage this carefully. The team has been performing exceptionally well, and we intend to support them without causing distractions as they navigate a significant ramp-up. Overall, I believe the combination of our efforts will be beneficial, based on my conversations with cloud customers.

Ananda Barua, Analyst

That's very helpful. Given that you've made two acquisitions in the pluggable space over the last year, can you remain active in this area? It's clearly an area of interest. Do you have everything you need, or do you think it makes sense to continue exploring from a technology standpoint?

Alan Lowe, President and CEO

Yeah. I mean we're always looking. I think our focus is making sure we finish the acquisition synergies of NeoPhotonics, and Wajid talked about that. The back-end factory consolidation is happening now, and we'll get the benefit of those synergies at the end of this fiscal year, and that's meaningful. So, we have to finish that and we have to make sure that the Cloud Light acquisition goes up the ramp effectively to meet the demand of what's going on in the hyperscalers and AI/ML stuff. So, I think we have our hands full today for the next several quarters. But that said, we're always looking and always interested in what we might be able to tuck-in to give us another competitive advantage over our competition. Chris, do you have anything else to add there?

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

I was just going to say that to reiterate that I think Ananda is hitting a key point that we have had a deliberate strategy to build out both technology, manufacturing on the component capabilities over the last N number of years, and then that's translated into now getting more pluggable transceiver capabilities. And as Alan highlighted, as that all has come together now, we've got time to put all those pieces together and fully realize the benefits of those acquisitions and the post-acquisition organic work we are performing to really unlock the value and the multiplier effect between all of these acquisitions. But we are continuing to look. We are not done, if you will, building out our technology and product portfolios. But for the time being, we've got a lot of work to do to realize the maximum potential of what we've already taken on.

Ananda Barua, Analyst

Thanks, guys.

Kathy Ta, Vice President of Investor Relations

Thanks, Ananda.

Operator, Operator

Your next question comes from the line of Mike Genovese from Rosenblatt Securities. Please go ahead.

Mike Genovese, Analyst

Great. Thanks. First, can you talk more about the optical switch opportunity for AI? Could you elaborate on that technology and how far we are from generating revenues? Also, is this a MEMS-based product? I'm curious.

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

Hey, Mike. So, in today's data centers, obviously, there's a lot of bandwidth going around and as we've seen in core telecom networks for years being able to reconfigure the network optically and electronically brings a lot of value in hyperscale network operators or cloud operators rather, are beginning to realize that being able to reconfigure bandwidth optically within data centers is a key capability. There's a range of technology that can be applied. In our case, it will certainly involve MEMS. I would say, in terms of time to market, a little premature to talk about an exact timeframe, but I think over the next year, you're going to hear a lot more about it as prototypes begin to ship.

Mike Genovese, Analyst

Okay, great. Thanks, Chris. And I guess something maybe more immediate then, your competitor yesterday spoke about some near-term opportunity where they expected sequential growth because of some transport opportunities in China, WSS, ROADMs and AMPs. Are you seeing anything similar to that?

Alan Lowe, President and CEO

We've noticed that the China mobile tender is taking place, and it's encouraging to have a customer accelerate the deployment of WSSs and related components. We are actively working to meet the demand for this tender, which is significant and presents an opportunity that should lead to more substantial volumes in calendar year '24. However, this is a specific case where the bidding is occurring now, and the actual deployments will commence early next year. So, this is indeed an opportunity, and we are seeing it develop. I've also been in contact with the executives there to ensure they receive what they need in a timely manner.

Mike Genovese, Analyst

Okay. Perfect. Thanks for the color. Thanks, Alan.

Alan Lowe, President and CEO

Thanks, Mike.

Kathy Ta, Vice President of Investor Relations

Thank you, Mike.

Operator, Operator

Question comes from the line of Ruben Roy from Stifel. Please go ahead.

Ruben Roy, Analyst

Thank you for the follow-up, Alan. You mentioned that over the past 90 days, you've noticed some softness in certain areas of telecommunications. Could you clarify whether this observation pertains to specific geographies, customers, or end markets? Any additional details would be appreciated.

Alan Lowe, President and CEO

I think it's just echoing what I think you've heard from some of our network equipment manufacturers around regional softness and an inventory at the North America carriers. So I don't think it's anything new and enlightening. It's kind of more of the same that we've seen that is making us be cautious about the outlook for the current quarter and into early calendar '24.

Ruben Roy, Analyst

Okay. Got it. Thank you. And then as a follow-up, probably for Chris. With even more focused on data center optics, I was wondering if you can give us an update on how you're thinking about the coherent DSP project? And whether or not longer term, you think there's spot for that team and what you're planning on with data center optics there?

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

We are making significant progress on developing our coherent DSP, which is an important part of our pluggable module strategy. We expect to begin evaluating our latest 400-gig components in early 2024. This capability is crucial for the data center interconnect opportunity, and over time, we anticipate this technology will be used more extensively within the data center as well.

Alan Lowe, President and CEO

And maybe if I could add to that, Ruben...

Ruben Roy, Analyst

Thank you.

Alan Lowe, President and CEO

We have been expanding not only our DSP team but also our RFIC team to develop essential components in-house to enhance the margins of the independent IC company. These teams have been growing, and we are beginning to see the advantages of having in-house technologies like TIAs and drivers, which is a significant benefit for us.

Kathy Ta, Vice President of Investor Relations

Thanks, Ruben.

Operator, Operator

And we have our next question coming from the line of Dave Kang from B. Riley. Please go ahead.

Dave Kang, Analyst

Thank you. Good morning. My first question is about your comments on telecom. What level of decline should we expect in the December quarter? Are we anticipating a slight decline, or could it be in the high-single digits or even double digits?

Alan Lowe, President and CEO

Yeah, I don't think we had indicated that there'd be a decline. I think what we're indicating is that we're still shipping below end customer consumption. And so, it's muted with respect to being back to parity with regard to us building and shipping what our customers are shipping and deploying. And so that's more the comments than it's going the wrong direction because we're already at a very low level.

Dave Kang, Analyst

Got it. And then regarding your comments about C&N being up in calendar '24 year-over-year, I assume that was organic, right?

Alan Lowe, President and CEO

I'm sorry, I missed the beginning of the question. What being up?

Dave Kang, Analyst

I believe you mentioned that Cloud & Networking is expected to be up in calendar '24. That's organic, correct?

Alan Lowe, President and CEO

I would say both organic and inorganic, we expect that to be up. Yes.

Dave Kang, Analyst

Okay. So just to be clear, I mean, even without Cloud Light, C&N will be up next year, next calendar year?

Alan Lowe, President and CEO

Yeah.

Dave Kang, Analyst

Yeah. Okay. Just wanted to clarify that. Thank you. Okay.

Alan Lowe, President and CEO

Sure.

Kathy Ta, Vice President of Investor Relations

Thank you, Dave.

Operator, Operator

Thank you. There are no further questions at this time. I'd now like to turn the call back over to Mr. Alan Lowe for final closing comments.

Alan Lowe, President and CEO

Great, and thank you. I'd like to leave you with a few thoughts as we wrap up this call. First, I would like to extend a very warm welcome to the Cloud Light team joining Lumentum. The talented Cloud Light team already excels at delivering the highest speed optical transceivers to cloud data center operators and infrastructure providers. I very much look forward to our R&D teams working together to see what else is possible to deliver even more leading-edge product innovations to our customers. In addition, our business fundamentals are solid for the mid- to long-term as we serve the exponential growth in data center bandwidth required by the artificial intelligence, machine learning, mobile, carrier and cloud computing markets. New industrial applications are driving demand for our advanced imaging and sensing products, and our commercial lasers are expanding into high-growth applications beyond our traditional markets. We are committed to investing in innovation to meet 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.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.