A - Alan Lowe:.

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. [Operator Instructions] 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..

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 ad 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, 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..

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 easy.

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 application. 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 or 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 gives 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.

With that, Wajid?.

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 $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.

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

Kathy?.

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

Thanks. I appreciate that. I’m [Technical Difficulty] 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, mixture? Help us understand that. Thanks..

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..

And then just as my follow [Technical Difficulty] 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?.

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..

Our next question comes from Samik from JP Morgan..

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..

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 that -- those elevated inventory levels, so that as we exit the calendar year, we’re more shipping in to 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 -- towards the end of the calendar year..

Okay, got it. And just a follow-up on Industrial & Consumer. Based on your guidance for the fourth quarter, you’re implying most of the sequential decline in revenue at your midpoint comes from that segment. That would put you at one of the lowest revenues you’ve done in that segment sort of going back quite a few years.

Is that -- again, you’re thinking about sort of in -- sell-through for the primary customer you have being weaker, or is this more again a reflection of inventory digestion even at this customer that’s probably impacting you in that -- in the coming -- in this quarter and the fiscal fourth quarter? Thank you..

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 -- on particulars around or quantifying end market at this time..

Our next question comes from Alex Henderson from Needham..

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?.

Yes. Thanks, Alex. This is Chris. Let me tackle that. I would say you got to think of this in time frames that, in the nearer term, the next -- and quarters, it’s really driving volumes, if you will, of our existing products or new products to be launched. As you highlighted, VCSELs -- 100-gig per lane VCSELs that will be in mass production here soon.

That will be a copper replacement as well as the 200-gig per lane EMLs and helping to accelerate digestion of inventory that’s already built, so that’s -- of our products that are already out there. So that’s the next couple of quarters.

As we look to the next few years, what you’re referencing is there’s new architectures that customers or new customers, let’s say, are seeking to launch that are intensive with new optical architectures.

I think we went through some of this at our OFC presentation where we are co-developing solutions with, let’s say, players that are leading not traditionally in the networking side, but maybe more traditionally in AI and compute side of things for next-generation data centers. So, there’s kind of a couple of waves of product intersects for us..

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?.

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..

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?.

Hi Alex, it was approximately $4 million..

Our next question comes from Meta Marshall from Morgan Stanley..

Alan, maybe I just wanted to kind of get a sense from you, kind of coming back to Samik’s question just about we’re not only seeing kind of the over-ordering the system vendors may have done for you guys to build inventory, but their customers also kind of over-ordered for supply chain issues as well on their part.

And so just how are you judging how much kind of end demand there is, I guess, given that there could -- or just the duration of this inventory digestion period just given some of the over-ordering that the systems vendors might have seen as well?.

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..

Got it. And just as a follow-up question. I noted your commentary about fiscal ‘24 had been lower than fiscal ‘23 on 3D sensing.

Are there just -- is there a general estimate just of kind of what the cumulative effect of pricing and share normalization and just kind of end market demand would lead to in fiscal ‘24 over fiscal ‘23 in 3D sensing?.

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..

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

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..

Yes. It’s -- I think it’s premature to know exactly what’s going to happen on the next generation of phones. We wanted to highlight that there is potential that one socket could be bringing in a new supplier. And I don’t think there would be any difference on the impact on us or our competitor with respect to that third supplier.

If they come in and if they’re able to ramp, I think it will be equally share shift into that new supplier.

Did that answer your question, Tom?.

Got it. And then -- it did. And then on the gross margins, you don’t break out the gross margins on the guidance. But just looking at what’s implied, it seems like the core telecom and datacom gross margin continue to be under pressure.

I know you guys have synergies rolling in on the Neo side, but could you just break down where you’re seeing that weakness? Is it in the legacy Lumentum products, or are you seeing the gross margin pressure on the acquired Neo products that are still waiting for some of those synergies to come in?.

Yes. Hi Tom, I’ll take that one. Yes. So on the synergy side, I mean, most of the synergies that we’ve seen to date have been [Technical Difficulty] as you saw our operating expenses come down quite significantly quarter-to-quarter from Q2 and into Q3 as well as in prior quarters during the fiscal year as we’ve taken appropriate actions there.

On the cost of goods sold synergy, we’re hoping to see most of that in the first -- the back half of our fiscal ‘24. We’ll do a lot of the consolidation activities in the back half of this calendar year and start to see some of those synergies flow through in the first part of calendar ‘24.

Now, on the gross margin for this quarter in particular, we made a note that we’re planning on reducing our inventory levels over the remaining part of the calendar year.

And as we do that, we will see some under-absorption within our manufacturing facilities as we continue to keep the infrastructure in place so that we can absorb a rebound in early ‘24. So, you’ll see some of that, and that will be impacting our gross margins over the next few quarters..

So, you’re -- just to be clear, you’re further reducing utilization inside of your own facilities?.

Yes. Yes, that’s right. Yes. Yes. And it’s mostly things like depreciation that will continue to impact us for a couple of quarters..

Our next question comes from Christopher Rolland from SIG..

So I guess my first question is, how do you see -- is this a trough for 3DS? Do you see it kind of ramping from here? Like, how should we be thinking about a new run rate? And then, what portion of this for next quarter is actually industrial so we can get a sense of that versus consumer? Thanks..

Yes. Typically, the June quarter is the low quarter seasonality-wise, given that this is really the last quarter of the prior model and inventory does come down as they -- as our main customer starts production in the September quarter of the new devices. So, this is the typical trough in any 3D sensing cycle for our main customer.

So, I think end user demand will pick up in the September and the December quarter, as it does typically. And most of what we’re seeing that’s impacting our outlook for fiscal ‘24 is the share shifting that we talked about that has been coming for the last 4 or 5 years is now coming to fruition and now it’s more normalized.

And as Wajid indicated, we don’t have a 10% customer in consumer anymore. And as far as industrial, industrial is low single digits on a quarterly basis of low single digits million..

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?.

Yes. Thanks, Chris. Those products are now sampling to customers and working with customers to be ready for the ramp.

I would say timing is later this calendar year and heading into the next calendar year, both for -- I mean we are shipping today CW lasers of a couple of different flavors for folks that use them in silicon photonic applications, but more significantly again in calendar ‘24..

Our next question comes from Ruben Roy from Stifel..

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, et cetera. 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..

Yes. I mean I think the largest opportunity, at least on a very long-term basis, is the automotive space, really ADAS, LiDAR as well as in-cabin. So, those -- it’s just long -- very long development cycles in the automotive industry, measured in five-year increments in some ways.

And we’ve been engaged for quite a while, but we -- with numerous customers with the focus on really planting seeds with various LiDAR architecture types to ensure that as decisions are made by the end customers that we end up in the ultimate solutions that they pick.

I think you’re going to see the next two years being still in much more modest growth for these industrial and automotive applications. As we highlighted on the call, shipping $3 million a quarter, which at the chip level, is significant, if you will.

We do expect that LiDAR modules will grow to, let’s say, over the next three to five years, a multibillion-dollar market, and then the LiDAR chips being maybe 10% or 15% of that, if you will. And then, five years after that, so we’re talking about 10 years out, it’s tens of billions of dollars market, if you will, for LiDAR modules.

So, it’s a long game that we’re playing. But fortunately, it leverages chip technology, which is something that we can leverage across multiple end markets..

I appreciate that. And a quick follow-up for Wajid on that topic. Wajid, you talked to the gross margin, understood on sort of the dynamics around telecom. But as consumer -- it seems like we’re going to be running a different run rate as you think about the rest of this year and potentially next year with competitive dynamic changing a bit.

How is that impacting the way you’re thinking about gross margins maybe from a longer-term perspective?.

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..

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

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..

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..

Got it. And then just as a follow-up to kind of go back to the gross margin side of things. I know you discussed your current 3D sensing position as well as managing utilization.

So, I’m just kind of curious, as we kind of view a demand recovery, as we look out beyond the June quarter, maybe at a high level, can gross margins decline from the June levels, or could that -- just kind of any color there at a high level, how it progresses through the year in more detail would be great..

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. So, those two should help us. ..

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..

Our next question comes from George Notter from Jefferies..

I’m trying to get a sense for what the right revenue run rate for the Company is under a normalized scenario. If I look back, you guys shipped a couple $500 million quarters. Obviously, those were predicated on inventory build. Now we’re guiding for $350 million to $380 million here in the June quarter. Obviously, there’s a huge gap in there.

And I have to confess it just -- it’s really hard to, I think, try to get an understanding of what the normalized revenue run rate here is as the market normalizes in terms of inventory digest.

So, what comments do you guys have about where this business shakes out ultimately on top line?.

Yes. George, as we said, we think we’re under-shipping in market demand, and I think that’s going to -- the guidance for the June quarter reflects that. How much we’re under-shipping and what the end market demand is three quarters from now, very, very difficult to have a crystal ball around that. That said, again, 3D sensing, low quarter is June.

Lasers, I think is at a lower level than we would expect it in normal times as we are going through a product transition, and we expect calendar ‘24 to pick up in lasers. So, should we be where we had originally guided the March quarter, I think that’s probably more reflective of end market demand.

And then as the market grows in high single digits to low double digits on a CAGR basis for telecom and datacom, then I think there’s a lot of catalysts that are going to drive even more rapid growth rate than that, given what we’re seeing inside the data center and between data centers in support of AI and machine learning.

So, I don’t think there’s any reason we can’t get back to those levels. It’s a matter of when we’re going to get back to those $500 million levels given the inventory digestion and whatever happens in the macro environment as we look at calendar 2024..

Our next question comes from Ananda Baruah from Loop Capital..

Just two quick ones, if I could. One is really a question and clarification.

Chris, on your prior remarks about sort of where you guys will be contributing to sort of AI build-out, is it -- like I guess the way I interpreted your remarks were certainly NeoPhotonics, does your data center chip business also sort of contribute to that? I would think, yes.

And then, I also heard some other areas as well across the lasers and photonics portfolio. So could you just clarify that that’s accurate? And is there any -- it’s super early days, but is there any way to context for us kind of what portion of the overall portfolio has some exposure, in any way that’s useful. And then I have a quick follow-up..

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..

Maybe I can add to that as well, I think….

Yes. That’s helpful context, Chris..

Just one other thing to add to Chris’ commentary is we’ve seen very strong demand for our subsea cable deployment where we provide components that amplify the signal at the bottom of the ocean. So we’re seeing a lot of the demand for subsea coming from the hyperscalers as they connect those large data centers.

Whether that’s a precursor to expectations on AI or machine learning or not, it is an area that we’ve seen strong demand. And these are big investments that take a year or more to deploy. So, I think we’re seeing some leading indicators that this is an area of growth for us as well..

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..

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..

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

Our next question comes from Mike Genovese from Rosenblatt Securities..

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..

Yes, Mike. I’ll give you my perspective, and then maybe Chris can chime in.

Yes, it has been -- the past few quarters where we’ve been talking about a slowdown in datacom, an inventory build at the cloud providers, hyperscalers, as they were ordering several quarters in advance because of the shortages in calendar 2022, they were ordering or some of them were ordering at an expectation that they would grow at a certain rate in the 30% to 40% range.

And as they’ve announced their growth rates are significantly lower than that, it takes longer time to burn off that inventory than originally expected. So, we’re seeing their inventory burn off. It’s still -- some customers and some of our module manufacturers, still a quarter or more of inventory there.

And our expectations are that the demand for AI and machine learning will help the consumption of this inventory, so that by the end of the calendar year, we’ll start shipping into the datacom market more like the end market consumption. But in the interim, there’s still inventory in the channel there..

Okay great. And then, my follow-up or a separate kind of question on commercial industrial lasers. The first half of this year had some pretty tough compares, so going into next year at a lower run rate.

But -- so how do you -- how should we think about year-over-year in ‘24 in that business?.

Yes. Thanks, Mike. I would say, we’re going to see, as we highlighted in the prepared remarks that lasers will come down a little bit, given it’s tied to, as Alan highlighted, semiconductor end markets as well as macro manufacturing, if you will. So, we believe that it will come down in the next several quarters.

Obviously, it was kind of ramping up through the year. But in the net, we suspect that -- at least as we look to customer forecasts at this point, that FY24 will be lower than FY23 was for commercial lasers directionally..

Okay, great. Thanks. I don’t want to beat the dead horse on the 3DS. So, I appreciate the color on the other segments. Thank you..

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

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..

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