Lumentum Holdings Inc. (NASDAQ:LITE) Q2 2023 Earnings Call Transcript

Lumentum Holdings Inc. (NASDAQ:LITE) Q2 2023 Earnings Call Transcript February 9, 2023

Operator: Good day, everyone, and welcome to the Lumentum Holdings’ Second Quarter Fiscal Year 2023 Earnings Call. All participants will be in listen-only mode. Please also note, 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: Welcome to Lumentum’s fiscal second quarter 2023 earnings call. This is Kathy Ta, Lumentum’s Vice President of Investor Relations. Joining me today are Alan Lowe, President and Chief Executive Officer; Wajid Ali, Chief Financial Officer; and Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer. Today’s call will include forward-looking statements, including statements regarding our expectations, regarding our recent acquisitions, including NeoPhotonics, such as expected synergies, and financial and operating results, macroeconomic trends, trends and expectations for our products and technology, our markets, market opportunity and customers, and our expected financial performance, including our guidance, as well as statements regarding our future revenues, our financial model, and our margin targets.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings. We encourage you to review our most recent filings with the SEC, including the risk factors described in the quarterly report on Form 10-Q to be filed for the quarter ended December 31, 2022, and those in the 10-K for the fiscal year ended July 2, 2022. The forward-looking statements provided during this call are based on Lumentum’s reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements, except as required by applicable law. Please also note, unless otherwise stated, all financial results and projections discussed in this call are non-GAAP.

Non-GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with GAAP. Lumentum’s press release with the fiscal second quarter 2023 results and accompanying supplemental slides, are available on our Web site at www.lumentum.com under the Investors section. This includes additional details about our non-GAAP financial measures and a reconciliation between our historical GAAP and non-GAAP results. With that, I’ll turn the call over to Alan.

Alan Lowe: Thank you, Kathy, and good morning, everyone. Our second quarter financial and operational performance was very strong led by robust demand from our Telecom and Commercial Lasers customers. Operating margin and earnings per share were both above the high end of our guidance range, with revenue above the midpoint. Wajid will cover this more in detail in the next section. As expected, sequentially higher revenue from Telecom and Commercial Lasers customers in the quarter offset the anticipated reduction in revenue from certain cloud customers due to inventory digestion and at a major consumer customer due to reduced smartphone unit production. As discussed over the past several years, share normalization has occurred in our consumer business, lessening our exposure to this cyclical market.

Nearly 90% of our total revenue is now derived from infrastructure markets which are driven by durable, long-term secular trends in which we serve with highly differentiated products and technologies. Lumentum lights up the optical fiber of the most advanced cloud, carrier, submarine, and 5G mobile networks across the globe. The technology we provide enables compute, data, and communications infrastructure to scale from a performance, cost, and power consumption standpoint. We enable higher-precision new materials and cleaner and more energy-efficient processes to be used in the microelectronics industry. The type of lasers we supply are key to manufacturing of electric vehicles, energy storage solutions, and solar cells. Our technology leadership position is stronger than ever due to successful investments in developing new products and technologies, as well as the two acquisitions we closed this past August.

We are now six months into integrating these acquisitions and tracking ahead of plan in realizing overall cost synergies, which contributed to our profitability and earnings per share results being above our guidance ranges. Our technology capabilities and manufacturing scale makes Lumentum the innovation partner of choice for our customers. We have the communication industry’s broadest photonic capabilities, including high-bandwidth coherent and direct-to-tech optical components and modules, ultra-narrow-linewidth tunable lasers, advanced optical amplification and ROADM solutions, coherent DSPs and RF-integrated circuits, as well as silicon and indium phosphide photonic integrated circuits. In close partnerships with our customers, we enabled the deployment of the industry’s latest high-capacity 400, 600, and 800G cloud and cord network solutions.

In addition, due to the escalated data traffic at the edge of the network, customers are deploying our products originally developed for core network applications at the edge or access part of the network. Revenue from edge networking products was up 40% year-on-year in the second quarter, and is now a major component of our Telecom business. We are confident that our technology leadership position and solutions for advanced compute, data, and communication infrastructure will continue to provide a tailwind for Lumentum’s long-term growth. Now, let me provide some detail on our second quarter results. Telecom and datacom revenue was up 44% year-on-year driven by organic and inorganic growth in Telecom. Within this, growth from Telecom customers was substantially higher but partially offset by inventory digestion at certain cloud customers.

Revenue growth continues to be limited by supply shortages of ICs from third parties. We have made significant progress over the last year on closing supply gaps, which has enabled our growth to date. At the end of the second quarter, remaining IC supply shortages resulted in approximately $60 million of unsatisfied customer demand. This is a modest improvement from the $80 million gap articulated in our last call. Revenue was especially strong in products which play into the industry’s transition to 400G-and-above speeds in next-generation networks, including narrow-linewidth tunable lasers, tunable transceivers for network edge applications, high-speed coherent components and modules, as well as our latest ROADMs. We achieved a new quarterly revenue record in narrow-linewidth tunable lasers which are key enablers of all coherent transmission solutions, including 400 gig ZR and ZR+ modules, and our customers’ latest 600 gig and 800 gig transmission systems.

We also set a quarterly revenue record with our tunable transceivers for network edge applications where a growing set of cable, MSO, and wireless network operator customers use our modules to expand data bandwidth in metro access, fiber deep, and wireless 5G fronthaul applications. Coherent components serving 400G-and-above applications also achieved record revenue with approximately half of the quarterly revenue in coherent components coming from the highest data rate applications at 600 and 800 gig. Second quarter ROADM revenue grew 45% in the same quarter last year due to continued strong demand and improved access to critical ICs. Shipments of MxN ROADMs grew 78%, and high port count ROADMs grew over 70% from the same quarter last year, representing a broader adoption of these next-generation ROADMs with market-leading customers.

As anticipated, inventory digestion at certain cloud customers and their module manufacturers resulted in a sequential decline in Datacom’s laser chip revenue. As highlighted on our last call, we expected the hyperscale customers to reduce their inventories of our laser chips during the second quarter. And now, we expect that this will continue throughout most of calendar ’23. Looking ahead on the technology roadmap, cloud datacenters will be designed for artificial intelligence and machine learning applications which bodes very well for us as we extend our technology leadership to even higher speed laser chips. We are on track with our 200 gig per lane EMLs for 1.6 terabit per second applications, and expect to enter production as we exit fiscal ’23.

We are also broadening and diversifying our product portfolio for intra-data center applications with differentiated high-speed VCSELs, DMLs, and high-power CW lasers and receiver photodiodes for silicon photonic solutions. For example, we expect to ramp production of our new 100 gig per lane VCSELs during fiscal ’24. This is a major new opportunity for us, and addresses the accelerating transition from copper to optical fiber in shorter-reach datacenter applications, especially those for machine learning and artificial intelligence. Turning to industrial and consumer, Q2 was down from Q1 as expected. During the quarter, we saw incrementally weaker overall demand for consumer VCSELs. We continue to focus on ramping new automotive and industrial sensing applications for our technology.

In the second quarter, we recognized approximately $3 million in revenue from automotive and IoT applications, and we expect this revenue to grow significantly in the coming years as these opportunities ramp. At this year’s CES Show, we had strong customer engagement across all applications of 3D sensing and LiDAR including from numerous automotive customers. We have a broad multi-prong approach to solicit LiDAR in automotive with a wide range of design wins with market-leading customers who are pursuing a variety of in-cabin and LiDAR approaches. In the second quarter, commercial lasers revenue was up 7% sequentially and 16% from the same quarter last year. While fiber lasers for metal cutting and welding continue to be our largest commercial lasers product line, products for emerging high growth application in solar, display, and electric vehicle manufacturing are becoming more meaningful.

And we now expect them to increase in our mix in the coming quarters. Underscoring this, ultrafast laser revenue in the quarter more than doubled from the same period last year due to expanded use cases. Our FemtoBlade laser was recognized with the 2022 Innovator’s Award at Laser Focus World due to our innovated design which enables faster processing time in micro machine applications for all LED displays, semiconductor ICs, printed circuit boards, and solar cells. We are very excited about lasers product roadmap which will expand addressable market further in the coming years. I am very confident about Lumentum’s future given our differentiated portfolio of innovative product and technologies, our strong foundation of intellectual property, and our significant opportunities for long-term growth in the cloud, networking, and advanced manufacturing markets.

I am also very confident in our ability to grow into adjacent market, extend product leadership, and expand profitability over the long term. In addition, we have made tremendous progress towards achieving our corporate responsibility goals including our drive to a net zero carbon footprints by 2030. Lumentum has also been named by Newsweek as one of America’s most responsible companies for a second consecutive year, in recognition of our achievements in ESG. Finally, I would like to thank all of our employees around the world for all their hard work and resilience as they continue to execute upon our strategy. With that, I’ll turn it over to Wajid.

Wajid Ali: Thank you, Alan. Net revenue for the second quarter was $506 million which was above the midpoint of our guidance range. Net revenue was flat sequentially and up 13.3% year-on-year. GAAP gross margin for the second quarter was 32.8%. GAAP operating margin was negative 4.3% and GAAP diluted net income per share was a net loss of $0.46 primarily driven by onetime charges related to acquisitions and restructuring activities. Second quarter non-GAAP gross margin was 44.9%, which was down sequentially and year-on-year as expected primarily driven by product mix including NeoPhotonics revenue. During the quarter, we incurred $11.7 million in extraordinary charges to acquire IC components from various brokers to satisfy customer demand.

These incremental charges were excluded from non-GAAP gross margin as disclosed in our filings. Second quarter non-GAAP operating margin was 23.1% which decreased sequentially and year-on-year due to product mix including from our recent acquisitions, but was above the high end of our second quarter guidance range. Second quarter non-GAAP operating income was $116.7 million. And adjusted EBITDA was $133.4 million. Second quarter non-GAAP operating expenses totaled $110.3 million or 21.8% of revenue. SG&A expense was $45.9 million. R&D expense was $64.4 million. Interest and other income was $5.1 million on a non-GAAP basis due to higher interest rates on our cash and investments. Second quarter non-GAAP net income was $104.1 million. And non-GAAP diluted net income per share was $1.52.

Both of which were above the high end of our guidance range provided on our last call. Net income for share performance was in part driven by accelerated acquisition synergy attainment, a cost savings action taken late in Q2 and higher interest income on our cash and investments. I will provide more color on our structural cost improvements in the guidance section of my prepared remarks. Our fully diluted share count for the second quarter was 68.6 million on a non-GAAP basis. Our non-GAAP tax rate remains at 14.5%. Moving to the balance sheet, we ended the quarter with $1.68 billion in cash and short-term investments, which was up $55.5 million from Q1. During the quarter, we had some one-time restructuring costs as we accelerated the attainment of acquisition synergies and drove some structural cost reductions.

Turning to segment details, second quarter Optical Communication segment revenue at $448.8 million decreased 1% sequentially, primarily driven by a decline in industrial and consumer which is mostly offset by growth in Telecom and Datacom. Optical Communication segment non-GAAP gross margin at 43.9% decreased sequentially and year-on-year, primarily due to product mix and the impact of the NeoPhotonics acquisition. Our second quarter Laser segment revenue at $57.2 million was up 7.1% sequentially, and up 16% year-on-year. Second quarter Lasers gross margin of 52.4% was approximately flat sequentially. Now, let me move to our guidance for the third quarter of fiscal ’23, which is on a non-GAAP basis and is based on our assumptions as of today.

When we acquired NeoPhotonics, we highlighted $50 million in synergy opportunities with $20 million in annual operating expense opportunities within the first fiscal year and then another $30 million cost of sales synergies as we exit the second fiscal year, we have already exceeded our $20 million cost savings target in annual operating expense synergies over the last six months of integration activity, we have executed well on our operating expense reduction plans, and are confident we will exceed our initial synergy targets. In December, we took additional actions that will structurally improve the long-term operating costs of the company. The benefits of these actions are reflected in our diluted net income per share guidance for Q3. As we execute on our integration and synergy plans, I will provide more details in future quarters.

Our Q3 guidance reflects our expectation, our reduce cloud and consumer end market revenue. Supply constraints on Telecom products and a few million dollar sequential decline in lasers revenue. We expect net revenue for the third quarter of fiscal ’23 to be in the range of $430 million to $460 million. Our Q3 guidance incorporates approximately $60 million of impact revenue driven by continued shortages of third-party components. Based on this, we project third quarter operating margin to be in the range of 17% to 19% and diluted net income per share to be in the range of $1 to $1.15. Our non-GAAP EPS guidance for the third quarter is based on a non-GAAP annual effective tax rate of 14.5%. These projections also assume an approximate share count of 69.4 million shares.

Turning to our annual outlook, due to substantial structural improvements in our operating expenses and tight cost controls, we anticipate fiscal ’23 EPS will be above the midpoint of our previous fiscal ’23 outlook of $4.65 to $5.65 per share to a new range of $5.15 to $5.45 per share. We expect that our fiscal ’23 revenue will be at the low end of our previously articulated annual outlook of $1.9 billion to $2.05 billion. This implies Q4 revenue will be approximately flat from Q3, given our assumption of growth in our Telecom and Datacom business offset by seasonally lower consumer revenue. We expect that Q4 will still be constrained by IC supply. I’m extremely pleased with the progress our team has made in synergy attainment and we are now in an excellent position to exceed our $50 million synergy savings target.

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

Kathy Ta: 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.

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Q&A Session

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

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

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

Simon Leopold: Thanks. And just as a quick, easy follow-up —

Kathy Ta: And, Simon, did you have a follow-up?

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

Wajid Ali: Yes, hi there, Simon. So, probably for the fiscal quarter Q2, we were able to impact operating expenses by about $5 million to $7 million incrementally better in the quarter than we had thought coming in to the quarter. From a total synergy standpoint, basically what’s happening is that the first year synergy targets that we had set for ourselves have gotten pulled into the first six months. And so, we’re being able to see the benefit of that in — and not only in our fiscal Q2, but in the fiscal Q3 and fiscal Q4 outlook we’ve provided, given that we’ve got a lower revenue level or we’re at the low end of our previously announced outlook on revenue. So, that’s really what’s happening from a synergy standpoint.

Kathy Ta: Thanks, Simon.

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

Tom O’Malley: Good morning, guys. Thanks for letting me ask a question here. I just wanted to ask on the industrial consumer, and particularly the 3D sensing side, in December. When you look at that market, you have talked about a normalization of share for a while now. But I just wanted to get an update there, in terms of normalization or — do you view that market as split equally or do you see yourselves losing additional share there just because, if you look at the numbers between the two of you, it looks like share has moved away; just any comments on what is a normalization of share and where that stands today? Thank you.

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

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

Tom O’Malley: Got it. And then just as a follow-up, through the December quarter, you saw some of your end customers actually beat estimates quite robustly. And they called out supply chain work throughs. Could you just talk about — you’re guiding that Telecom business down into the March quarter. Can you talk about what the supply chain looks like with your end customers? Do you see inventory on their balance sheets? Obviously, they’re beating on the revenue side, but they’re talking about backlog coming down. Just any update on the health there of that ecosystem just given the fact that you’re seeing March down, and then you’re indicating June flattish from a total company perspective. So, any comments there would be helpful. Thank you.

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

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

Kathy Ta: Thanks, Tom.