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Edited Transcript of LITE earnings conference call or presentation 8-Aug-18 12:30pm GMT

Q4 2018 Lumentum Holdings Inc Earnings Call

Milpitas Aug 31, 2018 (Thomson StreetEvents) -- Edited Transcript of Lumentum Holdings Inc earnings conference call or presentation Wednesday, August 8, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan S. Lowe

Lumentum Holdings Inc. - President, CEO & Director

* Christopher W. Coldren

Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO

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Conference Call Participants

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* Alexander Henderson

Needham & Company, LLC, Research Division - Senior Analyst

* James Martin Kisner

Loop Capital Markets LLC, Research Division - SVP

* Joseph Eric Wolf

Barclays Bank PLC, Research Division - MD & Head of Equity Research

* Jun Zhang

Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst

* Meta A. Marshall

Morgan Stanley, Research Division - VP

* Michael Edward Genovese

MKM Partners LLC, Research Division - MD and Senior Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

* Samik Chatterjee

JP Morgan Chase & Co, Research Division - Analyst

* Simon Matthew Leopold

Raymond James & Associates, Inc., Research Division - Research Analyst

* Thejeswi Banavathi Venkatesh

UBS Investment Bank, Research Division - Associate Director and Analyst

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Marcella, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Q4 and Full Fiscal Year 2018 Lumentum Earnings Conference Call. (Operator Instructions) Chris Coldren, Interim Chief Financial Officer, you may begin your conference.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [2]

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Thank you, Marcella. Welcome to Lumentum's Fourth Quarter 2018 Earnings Call. This is Chris Coldren, Interim Chief Financial Officer and Senior Vice President of Strategy and Corporate Development. Joining me on today's call is, Alan Lowe, President and Chief Executive Officer.

This call will include forward-looking statements, including statements regarding the markets in which we operate, including potential market sizes, trends and expectations for products and technology, purchasing trends and demand for our products, Lumentum's expected financial performance, expenses and position in the market as well as statements regarding our pending acquisition of Oclaro. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations. We encourage you to review our most recent filings with the SEC, particularly, the risk factors described in our 10-Q filings for our third quarter, which ended March 31, 2018, the registration statement on Form S-4 and the risk factors that will be included in the Form 10-K to be filed for fiscal 2018. The forward-looking statements we provide during this call, including the projections for future performance, are based on our 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 results and projections are non-GAAP. Non-GAAP financials should not be considered as a substitute for or superior to financials prepared in accordance with GAAP. Our press release with our fourth quarter and full year fiscal 2018 results is available on our website, www.lumentum.com, under the Investors section and includes additional details about our non-GAAP financial measures and a reconciliation between our GAAP and non-GAAP results. Our website also has our latest SEC filings, which we encourage you to review, and supplementary slides relating to today's earnings release.

A recording of today's call will be available by 11:30 a.m. Pacific Time this morning on our website.

Before turning the call over to Alan, we have some additional comments relating to the pending acquisition of Oclaro. First, today's call is not an offering of securities. The information discussed today is qualified, in its entirety, by the S-4 proxy statement prospectus on file with the SEC in connection with the proposed transaction. We encourage security holders to read the joint proxy statement prospectus and other documents filed with the SEC carefully, as they contain important information about the pending transaction. Further on the pending Oclaro transaction, we previously mentioned that we have received HSR approval. The merger is subject to certain other closing conditions including antitrust regulatory approval in China. We entered Phase I of this approval process in mid-July. Additionally, Oclaro's stockholders approved the transaction at their meeting in July. We continue to work with Oclaro on completing this pending transaction.

During the Q&A session, please keep in mind that the focus of this call is our earnings report and guidance, and we will not be sharing incremental information related to the status of our pending acquisition of Oclaro beyond our prepared remarks.

Now, I would like to turn the call over to Alan for his comments and fourth quarter and full year business highlights.

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [3]

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Thank you, Chris; good morning, everyone. Last week was Lumentum's third anniversary of being a stand-alone public company. Today, I'm very excited to be here for a third year in a row discussing new record revenues and profitability. Record revenues in TrueFlex ROADMs, commercial lasers and industrial diode lasers drove strong fourth quarter results. These capped off the fiscal 2018 that saw net revenue grow 25% to $1.25 billion and non-GAAP earnings more than double over fiscal 2017. Our fiscal 2018 results underscore that our strategy of investing in differentiated products, addressing multiple growing end markets, critically dependent on our photonics, is succeeding.

The global markets in which Lumentum participates have fundamentally robust, long-term trends that increase the need for our photonics products and technologies. The world is becoming more reliant on ever-increasing amounts of data flowing through optical networks and data centers.

New networks and data centers need to be built to satisfy this insatiable demand for data. Globally, regardless of who is supplying the optical networking equipment or who is deploying the network, the products and technology Lumentum supplies are essential. Higher level of precision, new materials, and factory and energy efficiency are all increasingly important to manufacturers around the world. To address these trends, suppliers of manufacturing tools globally are turning more and more to laser-based approaches and the types of lasers Lumentum supplies.

Laser-based 3D sensing is a rapidly developing market. The technology enables computer vision applications that enhance security, safety and new functionality in the electronic devices that people rely on every day.

Now I'd like to turn to fourth quarter highlights.

Our lasers segment grew 7% over the prior quarter and achieved new record revenues. Growth was driven by strong demand from customers in both the micro and macro material-processing markets. We achieved new record revenues from our Kilowatt-Class Fiber Lasers. We continue to ramp our newest fiber laser products to meet strong customer demand and are benefiting from investments in capacity expansion made earlier in the year. Later this calendar year, we will be introducing a full turnkey fiber laser system to broaden our customer base. We expect this, along with other new laser products to be introduced in the future, will even further accelerate growth.

Our industrial diode laser product lines, which is primarily driven by customers building their own fiber lasers, also delivered record revenue. Growth was enabled by newly expanded capacity and efficiency improvement. However, even with these, the combination of external customer demand and internal demand for use in our own fiber lasers outstripped our ability to supply in the fourth quarter. As noted on our last call, part of these capacity additions are in our own factory in Thailand, which started shipping qualified industrial diode products in the fourth quarter.

Even though in the fourth quarter, 3D sensing revenue declined due to customer seasonality, early in the fourth quarter, we started shipping VCSEL products we believe will be used in next-generation product cycles. We expect this volume ramp to continue through the first quarter and into this fiscal second quarter of 2019. This earlier ramp will result in 3D sensing volumes being spread across more quarters compared to last year's peak profile. In the fourth quarter, we had modest revenue contributions from multiple Android customers who have or will be announcing new high-end devices. We have numerous additional products in design with our lead customer. We are also engaged with new customers on multiple new products and have received production purchase orders from several of these customers. We expect to broaden our customer base and product mix over time as 3D sensing proliferates from high-end mobile devices to a broader range of products and price points. We also expect -- we also continue to work on 3D sensing and LIDAR for automobile applications expect this to be a growth driver in 2021 and beyond. With our proven manufacturing scalability, proven field reliability and new product pipeline, we believe we are well positioned to be the partner of choice for 3D sensing customers around the world in fiscal 2019 and over the long run.

Turning to our communications product lines.

Fourth quarter Telecom demand was strong and drove 9% quarter-on-quarter revenue growth. We had notable strength in TrueFlex ROADMs, which achieved new record sales. ROADM modules and line card systems continue to be limited by production capacity in the quarter. We are adding more new capacity to meet the increasing customer demand. Our strong ROADM demand is from customers around the world, including from multiple customers in China.

Telecom pump laser sales continued to be strong, but remained limited by capacity. With increasingly strong ROADM sales, our internal need for pumps further exacerbates pump capacity limitations. Therefore, we are also expanding pump laser capacity to meet customer demand, which we expect to remain strong.

Datacom revenues were down 5% quarter-on-quarter and margins remain challenged. As I've highlighted on prior calls, later this calendar year, we are planning to introduce a significantly cost-reduced 100G transceiver, targeting the hyperscale data center market to increase our competitiveness and margins in this rapidly growing end market. We also continue to make good progress on our 400G datacom transceiver programs, which are receiving a lot of interest from a broad range of customers. In moving from 100G to 400G, significant technology leaps are required, and Lumentum's core technologies positions us well.

Since our last call, we've made progress towards the closing of the Oclaro acquisition. In July, the stockholders of Oclaro approved the transaction. We are still subject to antitrust regulatory approval in China, but as Chris mentioned earlier, we are in Phase I of the Chinese process and cannot predict when we will receive clearance.

Earlier in my remarks, I highlighted significant long-term trends that make the markets in which we participate increasingly dependent upon our photonics solutions.

During fiscal 2018, we made good progress on our key strategic objectives that accelerated growth, margin expansion and customer and end market diversification. This positions us very well for the future. We ramped new major product lines in 3D sensing for mobile devices and engage numerous customers globally, planting the seed for future product and customer expansion. We developed key new ROADM products that we expect to be the basis for future network deployments, while at the same time ramped next-generation ROADM sales globally, including in China, and achieved record sales levels. We launched a new fiber laser platform and ramped sales to record levels. This new fiber laser platform will enable laser customer expansion globally in the future.

We have a lot going on at Lumentum and it is a very exciting time here. I would like to thank our customers for their partnership and our dedicated employees for their hard work, which has put us in an excellent position for long-term growth.

I will now hand the call over to Chris for more details on our financial results and guidance for the first quarter of fiscal 2019.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [4]

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Thank you, Alan. Before jumping into our fourth quarter results, I'd like to run down our full year fiscal 2018 results.

Net revenue for fiscal 2018 was $1.25 billion, up 25% compared with fiscal 2017. Growth in both our Optical Communications and laser segments contributed to this revenue increase. Fiscal 2018 Optical Communications segment revenues were up 23% and our laser segment revenues were up 31% compared to the prior year. Within our Optical Communications segment, Telecom and datacom revenues were each down relative to the prior year, while our industrial and consumer revenues were up substantially in fiscal 2018. For the full year, GAAP gross margin was 34.6%. GAAP operating margin was 11.2% and GAAP diluted net income per share was $3.82. Full year fiscal 2018 non-GAAP gross margin expanded 420 basis points to 38.9%, driven by higher levels of higher margin industrial and consumer and laser products in our revenue mix, as well as overall increased leverage over our fixed manufacturing costs. Non-GAAP operating margin expanded 730 basis points to 19.7% for the full year. Operating margin expansion was larger than gross margin expansion due to strong leverage over operating expenses. Our full year non-GAAP operating expenses only grew 7%, while our top line grew 25%, relative to the prior year. Fiscal 2018 non-GAAP net income, at $247.8 million, also increased more than 100% relative to the prior year, resulting in non-GAAP diluted net income per share of $3.82.

We ended the year with cash and short-term investments of $711.5 million, an increase of $156.2 million, relative to the prior year, driven by strong free cash flow, despite elevated capital investment levels throughout the year related to manufacturing capacity expansion and new products and expenses relating to the bring-up of our new factory in Thailand.

Now turning to the fourth quarter. Net revenue for the fourth quarter was $301.1 million, which increased 1% sequentially and increased 35% compared with the same period last year. GAAP gross margin for the fourth quarter was 31.7%, GAAP operating margin was 6.9%, and GAAP diluted net income per share was $0.40. Fourth quarter non-GAAP gross margin was 37.2%, which increased 90 basis points sequentially and increased 430 basis points compared with the same period last year. Gross margin increased due to improved Optical Communications gross margin as well as overall higher lasers volumes. Non-GAAP operating margin for the fourth quarter was 17.8%, and increased by 130 basis points sequentially and 860 basis points compared to the same period in the prior year. Operating margin expansion was driven by gross margin expansion, combined with leverage over operating expenses.

Non-GAAP net income was $61.6 million for the fourth quarter and includes $3.3 million of other income and expense, and a tax benefit of $4.7 million recognized in the quarter. Non-GAAP diluted net income per share was $0.95, based on a fully diluted share count of 65 million. Operating expenses totaled $58.5 million or 19.4% of revenue compared with $59.1 million or 19.8% of revenue for the prior quarter. R&D expense was $34.2 million and SG&A expense was $24.3 million.

Turning to segment and product line details, our Optical Communications segment revenue at $244.9 million declined by less than 1% sequentially and was up 31% relative to the same period in the prior year. Within our Optical Communications segment, Telecom revenue at $133.1 million, was up 9% sequentially and up 11% relative to the same period in the prior year. As Alan highlighted, Telecom transport products including ROADMs were significant contributors to the Telecom growth.

Datacom revenue at $34.5 million, was down 5% sequentially and down 31% relative to the same period in the prior year.

Industrial and consumer revenue, at $77.3 million, was down 12% sequentially due to 3D sensing seasonality, but up 368% relative to the same period in the prior year due to large growth associated with the introduction of 3D sensing into consumer mobile applications. Optical Communications segment gross margin, at 34.8%, increased 110 basis points sequentially, despite the degradation in revenue mix, with more Telecom and less industrial and consumer revenue. The drivers of expanded gross margin were both improvements in Telecom margins, associated with the higher mix of higher-margin transport products and lower average manufacturing costs due to higher volumes.

Our laser segment revenue at $56.2 million, grew 7% sequentially and was up 57% relative to the same period in the prior year, driven by strong demand for both fiber lasers and other lasers used in the consumer electronics and manufacturing space. Fourth quarter lasers gross margin was 47.9% and declined 50 basis points relative -- 50 basis points due to the relative increase in fiber lasers in the revenue mix. Fiber lasers have, on average, lower gross margins than our other lasers products.

Now on to our guidance for the first quarter of fiscal 2019. Noting again, that all projections are on a non-GAAP basis, do not take into account any effects from the acquisition of Oclaro, as we currently cannot predict the timing of the closing.

We project net revenue for the first quarter to be in the range of $340 million to $360 million, with operating margin in the range of 19% to 21% and diluted net income or earnings per share to be in the range of $0.90 to $1.10. Notable quarter-on-quarter changes in product line revenues in our projections include, Telecom being up, driven by continued transport product growth, industrial and consumer being up, due to the ongoing 3D sensing ramp and lasers being down, due to customer seasonality and product cycles, though we expect fiber lasers to continue to grow in the first quarter.

Before turning the call over to Marcella to start the question-and-answer session, I would like to ask everyone to limit discussion to one question and one follow-up. Marcella, let's please begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Samik Chatterjee from JPMorgan.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [2]

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I just wanted to start off on 3D sensing and see what changes you've seen in the competitive landscape in 3D sensing with your primary customer over the last generation -- compared to the last generation and how should we think about market share for Lumentum going on a go-forward basis, given sort of how much more time your competitors have had to prepare for kind of ramp-up?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [3]

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Yes, thanks for the question. It's a little bit hard to know down to the level of share, we have contractual share commitments, but we believe we're getting significantly higher share than the contractual obligations that we have with our customers. I think at this point in time, what we're focused on is making sure we don't give our customer any excuse to want to buy from anyone else, and that's really exacerbated by the fact that we've shipped tens of millions, if not over hundreds of millions of units, with no failures. And so those kind of statistics and field reliability data that we can point to really gives us a seat at the leadership position of shares. So we expect to continue to have a very strong share position, not only on the existing products, but on next-generation products, where we're working hand-in-hand with our lead customer as well as other customers for products that will be introduced in 2019 as well as 2020. So we're feeling very comfortable with where we are today.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [4]

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Got it. And just a clarification, you said the 3D sensing revenues in FY '19 would be more spread out in terms of the quarterly cadence relative to what kind of the peak we saw in the second quarter in FY '18, but do you still expect the second quarter in FY '19 to be sort of still the highest revenue quarter? Or is -- do you expect more of a sequential ramp-up through the year in 3D sensing revenues?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [5]

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Yes, we continue to expect the second quarter or the December quarter to be the larger quarter associated with this product ramp. But reminding everybody that last year it was quite peaked with more than $200 million of revenue in the December quarter, while only $40 million in the September quarter and nothing effectively in the June quarter, or very low levels in the June quarter, whereas now, as we said, our June quarter, our fourth quarter, we believe we were shipping product that would be ending up in customer products in the fall. And we've guided for September, and we expect the 3D sensing to be larger in December than September, but not nearly that dramatic of a peak that we saw last year.

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Operator [6]

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Your next question comes from the line of James Kisner from Loop Capital Markets.

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James Martin Kisner, Loop Capital Markets LLC, Research Division - SVP [7]

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Just a follow-up on the last question, for 3D, obviously -- I'm glad to hear that Q4 count will be up, but there's a pretty wide distribution of estimates out there for Q4. I'm wondering if you could help us out even just very qualitatively, could volumes be up 20% in Q4 sequentially, 10%, 50%, 100%, obviously not a 100%, but just any kind of texture at all. And then just separately, I just want to understand the operating margin guidance a bit better, in June, you'd guide 14% to 16%, you just delivered almost 18%, and you're guiding 20%. It just seems like that, that might be a bit conservative just given how much the mix is improving and the revenues are improving in September, just wondering, if there's a reason why you're not getting more leverage.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [8]

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Maybe I'll start with the latter question first, that certainly -- first, guidance we try to be conservative, but I would also say that during the quarter, we did quite well with improvements in yield and cost that brought manufacturing cost down and with a favorable mix with strong ROADM sales, continued strength in lasers, that resulted in an increase in margin beyond our guidance. With regards to talking about December volumes, we only provide guidance 1 quarter at a time. I think when we look at the range of Street estimates out there, I think most analysts are kind of looking at that there's a generally a fixed sort of amount, if you will, of market demands between multiple quarters, and so what we're hoping is, folks will take our view on how things are spread out this year, and use that to be able to estimate the December quarter off of the entire size of the pie and the fact that we've shipped stuff in June and have a stronger September than the Street expected, but we don't provide guidance for December at this point.

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [9]

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And maybe if could add on the operating margin for the September quarter, as we said in the script, our lasers revenue will be down despite growth in fiber lasers, which Chris highlighted, have lower gross margin than our overall lasers margins. So the high-margin lasers business is going to decline and that comes into play when we gave our guidance.

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Operator [10]

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Your next question comes from the line of Joseph Wolf from Barclays.

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Joseph Eric Wolf, Barclays Bank PLC, Research Division - MD & Head of Equity Research [11]

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I guess, another 3D sensing question. Just in terms of the commentary on -- and the other applications, I guess, for the Android ecosystem, if you think about that and timing, can you talk a little bit about a range of applications, a range of ASPs and perhaps some sort of mix we could be thinking about 12 to 18 months from now in terms of the overall business?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [12]

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Yes, the customers, as you probably are aware, are very secretive with respect to what the application they are using the 3D sensing for, so it's hard to tell. I will say that we are working on Android customers for what we believe to be front-facing as well as world-facing applications. So we're expecting to see new applications in calendar '19 that use the other side of a mobile device, which is pretty exciting. As far as mix, it's hard to say. I mean, as we said in the script, we have seen announcements as well as expect announcements to be on very high-end phones, on the Android market, initially. And your guess is as good as mine as, with respect to how fast that proliferates to the mid-range products as well as the lower-end price ranges for those mobile devices. So I think our focus is making sure we're there for all of the customers and on the high-end and prove our track record on reliability and cost and delivery. And your last question on ASPs, I don't expect them to be any different than what we had on a ASP or margin standpoint in the past, as we look forward in the Android market.

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Joseph Eric Wolf, Barclays Bank PLC, Research Division - MD & Head of Equity Research [13]

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All right. And then just as a follow-up, on the datacom side, where there's been some declines in the sales, at least, sequentially. Pricing versus volume in this segment and does the new product launch later in the year recover some of that? Just kind of the trends you're seeing. Is the business not worth going after? Or is the competitiveness of that sector changing at all from your perspective?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [14]

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I think it's been a very competitive part of the market for the past couple of years, and we haven't had a product that had the right cost to be able to go after the hyperscale side of the market. On the client side of the Telecom networks, where datacom transceivers play, we have a very good product line, very high reliability and meet the needs of those customers. But in the hyperscale, we haven't had anything that has really been able to compete effectively, except when we first initially introduced 100 gig transceivers when we were first to market. I'd say that, later this year, we will have product that will be able to address the hyperscale in a meaningful way, even with continued compression on ASPs. So we're pretty pleased with where we are. I wouldn't count on a whole lot of that volume in the December quarter, but really initial ramp in that quarter with further growing volume in the first half of calendar '19.

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Operator [15]

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Your next question comes from the line of Simon Leopold from Raymond James.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [16]

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I wanted to delve into 2 topics, the first one is reflecting on your second -- sorry, your June, fourth fiscal quarter, 3D sensing strength. I want to get a better understanding of the sources of what appear to be upside versus at least our expectations. In other words, is it the smoothing of the orders from the historical customer? Is it that better share than you had anticipated? Or is the delta this incremental demand from Android? So what was the upside driver to that June quarter? And then I've got a follow-up.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [17]

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Yes. So I would say that the upside, well, kind of tear it apart a bit. The Android revenues are in the few million dollar range, sub-$10 million certainly. So revenues primarily consist still of our lead customer. I would say that, this year, it's the smoothing that the ramp is starting earlier than last year, not because it's early, last year was quite a late ramp. And I think that that's the upside that you're seeing in the June and September guidance.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [18]

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Great. And I wanted to follow up with a question regarding the operating margin outlook for the September quarter. I know you did give us some directional comments on Telecom, commercial lasers, 3D sensing. I guess, what I'm struggling with is, I look at the comparison to the December 2017 quarter where the operating margin was 28%, I look at where you landed this quarter around 18% operating margin and then your guidance puts you in sort of this 20-ish kind of level. And I'm left with the impression that it should be higher, and I just want a little bit of help to see if I'm missing something intuitively, is this conservatism or some onetime-ish or mix aspect that we should get a better appreciation for in September's operating margin forecast?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [19]

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Yes, I think, Simon, I guess, a couple of things going on. First, obviously, as Alan highlighted, that our -- commercial lasers business is a nicely profitable business and with that turning down a bit, particularly the micro materials processing lasers, which are above lasers average gross margins, that is impactful to the overall operating margin. And there is a level of conservatism in our numbers.

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [20]

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Yes, I'd say the other thing is, as we bring up our Thailand facility, there is some added costs that are somewhat of a drag that weren't there last year. And we hope that to go away over the next few quarters.

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Operator [21]

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Your next question comes from the line of Alex Henderson from Needham.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [22]

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I'll ask just one real mundane one. Could you give us some sense of what your think your tax rate is going to look like in FY '19?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [23]

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I think for modeling purposes, I would assume something in the 10% range.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [24]

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Great. So no change there. My primary question, really is around the leveling between 2Q and 3Q calendar on the 3D sensing. So, relative to where you had expected this -- the June quarter to come in and relative to what you actually showed up at, are we talking about a $10 million or $15 million pull-in from the September quarter? Is that kind of the level of variance relative to the surprise that you experienced in that quarter?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [25]

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Well, yes. I mean certainly we had more strength with an earlier ramp that -- as I said, there's probably a fixed amount between the June, September and December amount, so pulling it in -- came from September and potentially from December.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [26]

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Is that leveling the right vicinity though?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [27]

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Let me just add to that. If you recall, in the September 2017 quarter, we shipped $40 million at the end of '17 -- at the end of September, and we were on a huge ramp that I think was gating our customers' ability to launch the product. Just given that newness of the technology and the challenges that we had and the learning curve we were going through. So I think that was an abnormal type of ramp, and this is more of a normal type of ramp. We're getting prepared for new products and so I'd say, this is more of the new normal than last year by a long shot.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [28]

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Yes just to be clear, I get the point of the normality, I'm just trying to figure out what the variance relative to what you expected was? And going back to the baseline question, is the number that I threw out, the $10 million to $15 million delta between what you'd expected and what came in, a reasonable proxy for how much was pulled out of the -- which came in earlier than expected and therefore smooth. So is that the upside -- magnitude of the upside to 3D that you had in the June quarter?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [29]

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I guess, I think we had more orders and more demand from Android than we had originally 3 months ago expected and slightly more on our lead customer. But it's hard to tell, their consumption rate versus their -- our shipment rate. So it would be speculation if I were to guess it was $15 million of stuff that there -- building for next year's model or next release model versus existing product, so it's hard to tell.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [30]

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But that is the variance from your internal prior expectations for the June quarter, regardless of where it came from? Is that correct?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [31]

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I'd say that lasers came in with stronger demand than we had expected and we made improvements on fiber laser productivity and production to do a little bit better in lasers than we had in the plan. ROADMs were stronger than we expect -- not expected, we had demand that we were not going to be able to satisfy. And we worked with our CM partners to get more ROADMs outsides, so it's pretty broad based that helped us get up over $300 million for the quarter.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [32]

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Yes. I just not to be a dog with a bone here, but I was really only asking about 3D sensing. The upside in 3D sensing in the quarter, was -- is my guess of $10 million to $15 million of the variance relative to what you'd expected a reasonable proxy for what occurred, regardless of what the reason is?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [33]

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Alex, I think the challenge in us answering the question is, we've never shared what our expectations for 3D sensing for the quarter were. So I -- what you're trying to drive at is, is it 10% or 15% of this is going into future devices? Or is it 100%, or is it 0%? And we just don't know, other than to state that we believe a healthy fraction, hence why we called out that we started ramping products that we think are going to be used in next product cycles in this quarter or in the June quarter, that is.

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Operator [34]

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Your next question comes from the line of Rod Hall from Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [35]

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I wanted to actually -- I got two, but I wanted to focus on the lasers business a little bit. You said, Chris, I think in your prepared remarks, that the diode demand was above your ability to supply. But then, you guys are saying, lasers are down, which would be normal seasonally. I just wonder, are you expecting some of that demand that you left on the table to flow into the next quarter. Or is it -- did you just lose the demand? I'm just curious what's going on with that supply meeting demand and whether you're able to meet demand in the forward quarter, in the September quarter? And I've got a follow-up question.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [36]

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Yes, Rod. I think we apologize, maybe some confusion. So we've got 2 different set of product lines, both lasers. One is, our industrial diode laser, semiconductor laser products that share the same manufacturing capacity, for example, with pump lasers for Telecom, in the case of wafer fab and chip capacity, but also those same industrial diode laser lasers, are the lasers that go into our fiber lasers as pumps. We expect continued fiber laser strength going into the September quarter. And therefore, continue to have that capacity constraint situation on both industrial diodes and fiber lasers. The part of the lasers business that is declining, is that which is sold into the -- essentially, the microelectronics space or what we call, the micro materials processing side. There, that is impacted by the typical consumer electronics cycle, where manufacturers add capacity in late springs and in through the summer and then aren't adding new equipment in the late summer and into the fall, because they need to have already had that capacity to produce consumer electronics products. So we do expect that, that micro materials processing portion of our lasers business to -- into the new calendar year, to resume back on a growth trajectory.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [37]

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And could you just comment, Chris, on when you think those industrial laser diodes -- when that capacity meets demand? Or does it in the next few quarters?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [38]

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So I think there's a couple of things that are coming into play. We're still constrained today and will be constrained through the September quarter. As we're adding new capacity in our Thailand facility, so we expect that to help alleviate but not totally satisfy the demand. I will say that, as we introduce our own turnkey fiber laser and broaden our customer base for our fiber laser customers and products that will consume more of those diodes and more of those pumps. And so I think, we've been planning for adding additional capacity in Thailand, we have more capacity coming online. And we're doing best we can to try to estimate what the demand is going to be in the future. But we expect both fiber lasers as well as those pumps to external fiber laser manufacturers to continue to grow in the future quarters.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [39]

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Okay. And then I wanted to just see if you guys would give us any color on 3D module yields. Whether -- I guess, the broad question I have is, whether you believe we get back to sort of normal yields for components like this? Or do you think we're living in a world where yields just remain abnormally well? So just curious, what you think about that?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [40]

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Yes, we don't have a ton of visibility to the module integrators and what their yields are. I can tell you that, that our yields are very stable and very high and we're very happy with our cost structure with respect to our continued increase in yields and productivity for our part of the process. As far as what's going on at the module integrators -- and we're shipping now to additional module integrators to address the Android market. It's hard to tell, they don't give us a lot of detail on that. And so from our perspective, that's a good sign that our component is not the problem, if there is a problem, but that, I think there's been progress certainly and we really can't comment more on that.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [41]

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Do you guys make module yield assumptions in your own calculations, Alan? Or you just kind of take the orders as they come and...?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [42]

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We try to cross our estimates with the order rates to try to figure out our share and so we do, but not knowing what they actually are, it's only speculation.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [43]

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Yes, it's certainly (inaudible) keep our customers happy. So we're not turning away orders, so...

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Operator [44]

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Your next question comes from the line of Michael Genovese from MKM Partners.

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Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [45]

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I have a bigger-picture question about the optical market, because in ROADMs, pumps and other optical products, things sound very good across regions. But when we think about China, the U.S., Europe and the rest of Asia, looking forward for the next 12 months, which have the best drivers for growth behind them? Which regions do you think might just be flat? And are there any that are at a risk to decline over the next year?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [46]

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Yes, so I would say that in the products where we have strength, we're seeing strength across all regions with respect to ROADMs, pumps, amplifiers and things like that. So I think we're seeing broad-based strength in China with respect to those products, especially, as a year ago, they didn't deploy ROADMs and now they're deploying ROADMs. So we're expecting China growth in ROADMs to be -- to continue to be robust and we're adding capacity to address that. Broader, higher level, it's hard to say, I'd say that non-China APAC is strong, India is strong, North America continues to be strong. Europe is, anecdotally it's just okay, but hard to really speculate where our product actually ends up going other than where we ship to.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [47]

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Yes, and I think, Mike, just to add to that. Certainly, our customers are global in nature. So when we sell to a Chinese customer, that Chinese customer may be selling into Europe or India and vice versa, if we sell to a North American customer, they may be selling into India or for Europe as well as North America. And as we highlighted in our prepared remarks, we've got broad-based pull from virtually our entire customer base for next-generation ROADMs. So I believe, it's overall global in nature and, as Alan highlighted, the anecdotally, certainly between India and China are -- lots of discussion around them because those are new geographies relative to the North America from a ROADM standpoint.

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Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [48]

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Great. And then just quickly, on Oclaro, not asking about the deal so much as asking about the -- or not asking about the milestones for the closure, I'm asking about the strategy behind the deal. I think, given that the pluggable market, CFP2-ACO product cycle probably is not lasting forever and there is certain products moving beyond that. But could you talk strategically just about the integration of their transmit and their receiver technology and how that's going to help your product portfolio going forward? And any updated thoughts since you held the conference call announcing the deal.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [49]

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Yes. Well I think we'll reiterate what we talked about when we announced the deal that, Oclaro is a leader in the transmission technologies and we're a leader in the transport technologies. And combining the 2, gives us better relevance to our customers as well as better scale to make longer-term larger investments in R&D. Kind of to your opening statement about ACO product life cycle, I would look at things in the light of, ACOs are just one implementation of a very differentiated photonic integrated circuit technology that Oclaro has. And that's what put them into a leadership position on those modules. And as the world evolves to what's next, it's not going to be something radically different, it's going to be an evolution or a refinement of that same technology, and whether that's next-generation DCO module or whether that's customers that choose to buy said components directly that would be going into those modules. I think, leadership in the first generation of these integrated 100 gig and above modules will naturally translate into leadership -- into subsequent generation.

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Operator [50]

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Your next question comes from the line of Meta Marshall from Morgan Stanley.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [51]

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Maybe following up on Mike's question. Just kind of looking at overall ROADM demand. What percentage of that is China now? Kind of assuming that China is maybe 30% of the optical market in general. Are they to that point of your ROADM demand yet? And then maybe second question, just quickly an update on the CFO search and if you would kind of potentially hope to have anybody identified prior to the Oclaro acquisition closing?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [52]

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Okay. So I'll handle the first, leave Alan on the second. So on the first question, trying to think how to answer the question. So ROADMs in China, we don't know, we presume generally that, our customers in China would be the ones who are selling into Chinese deployments. We don't know the exact split between what we sell to them, what ends up in China or what ends up being exported from China elsewhere. But just to put a ballpark of roughly 20% of our ROADM sales are going to Chinese customers. I think your point of being 30% of the market is probably an underestimate as to what the major Chinese customers have in market share, it could be a little higher. So I think that, that highlights or underscores that there's a lot of opportunity to grow with those Chinese customers.

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [53]

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And to your questions on CFO search, we've have had no problem bringing in very capable and experienced CFO candidates. It's hard to say when we're going to have somebody on board relative to the closure of Oclaro, because I don't know when that's going to happen. I'd say that, we're going to take our time and make sure we get the right person on board and not to compliment Chris publicly, but he's not doing a bad job himself. So I'd rather make sure we take the time and find the right person as opposed to rush to find somebody that may not be the right person. But I'd say that I've met with many excellent candidates that are very well qualified, so I don't have any doubt that we'll find a very, very capable CFO, the timing is just uncertain relative to Oclaro.

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Operator [54]

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Your next question comes from the line of Thejeswi Venkatesh.

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Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [55]

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When do you expect Tier 1 Android handset makers to adopt 3D sensing? I assume most of what you're seeing already is sort of the Tier 2, Tier 3.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [56]

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I would say that, well, I'm not sure how we would define Tier 1, 2, 3, to us, they're all Tier 1, but I think what you're really alluding to is, the guys that we're designed into now and/or the ones that have at least publicly launched, tend to be a little smaller than some of the larger Android handset vendors, or at least, they are smaller when you consider high-end devices. We are engaged with every large Android manufacturer and have design-in processes. We can't comment on the timing of their launches, that would be disclosing their confidential information. But I would say that, over the next 12 months, virtually every one of them has plans at this point to launch product, but just can't comment on exactly when.

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Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [57]

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Understood. And with respect to your lead 3D sensing customer now, what does pricing per device look like for the fiscal '19 cycle relative to the $4 in the previous cycle?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [58]

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Yes, we're not going to comment on pricing other than to say that prices have come down a little bit year-over-year. And this is semiconductor product, the volumes go up, prices come down, and year-over-year price downs are nothing unusual, if you will, and maybe consistent with other analogous high-performance semiconductor devices in the similar kind of supply chain.

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Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [59]

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Understood. And just one last question, there were concerns about excess VCSEL inventory in the supply chain, but it doesn't sound like you're quite seeing that? So I was hoping you could comment on that.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [60]

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I think the key question is, where in the supply chain? Certainly, we do have some inventory of VCSEL chips, given we were, last year or -- into early this calendar year, running our manufacturing quite hot to meet larger demand than ultimately materialized in this calendar year. And therefore, those wafers were started, with a lengthy manufacturing cycle, you can't just hit the brakes immediately. And so we have some level of inventory that enables us to generate more revenue than, say, some of our suppliers' projections would suggest.

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Operator [61]

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Your next question comes from the line of Jun Zhang from Rosenblatt Securities.

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Jun Zhang, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [62]

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So staying on 3D sensing topics. So one of your VCSEL wafer suppliers in Taiwan provided a softer guidance for Q3. I'm just wondering if you could give us some colors on the gap between the wafer consumption and in your VCSEL shippings. And could you also talk about inventory level on the VCSEL product level? And are you able to continue using the some of the existing wafer inventory or existing wafer chipset for the second half shipment, because I think that there might be some newer requirement for the VCSEL or a newer generation of VCSEL coming in the second half. That's my question.

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [63]

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Sure, Jun. Yes, just to echo what Chris said, I think the supply chain for VCSELs is a multiple-month supply chain that you can't just shut off. So I'd say, I can't really comment on our supply chain and the production levels that they're at. I will say that we're very comfortable with the inventory that we have being able to be used in the market and so we're not expecting any obsolescence of any chips that we have in finished goods or that we have flowing through the line today.

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Jun Zhang, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [64]

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Okay, great. And also, do you think that the improving yield rate at your side could potentially consume less wafer and also potentially help them on the gross margin side?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [65]

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Yes, certainly, we continue to strive to increase yields as well as shorten cycle times or at least increase equipment utilization. So that leaves us upside in gross margin. We expect that we're in the very early stages of a very large market. So I don't think on a sort of an annual run rate basis that we expect to be consuming fewer wafers moving forward by any stretch.

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Jun Zhang, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [66]

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Okay. And also, any further potential cost reduction on the VCSEL laser production side?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [67]

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Well, we continue to work throughout our supply chain to work together with them to drive their cost down, so that we can continue to drive our cost down. So I'd say that it's an ongoing process that we have to work with our partners to make sure that we're being competitive in the market as we continue to ramp up volume. So as Chris said, it's a semiconductor process that is expected to come down in cost over time, and with higher volume, and that's what we're working with our partners to achieve.

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Jun Zhang, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [68]

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Okay. So my last question is that, you mentioned there's some opportunity from the 3D sensing module in the back camera from Android market. And I just want to get some color from you guys about, what's the difference between the 3D sensing module in the back camera and the front-facing camera? And also what's the ASP difference between those 2 chipsets?

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [69]

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So I can't necessarily comment on the module details and that's what our customers deal with. But on our side, in the chips we produce, presumably -- and how we infer often, it's a back side or world-facing, it's just that the chip either has higher power or it has a different beam profile to be able to image over longer distances. In order to accomplish that, the chips tend to be larger and potentially more complex, meaning multiple addressable sections, able to be modulated or turned on and off rapidly, all of that next to generally a higher ASP, every customer is asking for something a little different. So I don't think there is a great rule of thumb of how much higher ASP, but it can be significantly higher than the other chip used for the same functionality on the front side. Really it's, again, a semiconductor process, so it's really just that the chip is twice as big, it's probably going to be priced twice as much.

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Operator [70]

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Your next question comes from the line of Tim Savageaux from Northland Capital.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [71]

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Question on Telecom to start with and then a follow-up on 3D sensing. You saw 9% sequential growth on the Telecom side in the June quarter. This based on how I'm looking on a number -- well looking at peer reports and what we're seeing across the space, I think there's a pretty solid case to be made for acceleration in that rate of sequential growth, maybe up into the low and maybe even mid-teens depending on what we're assuming on the 3D side. I wonder what sort of assumptions, in terms of sequential growth rates in Telecom, are informing your September quarter guide?

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [72]

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Yes, as I said, the products where we have strong leadership position are capacity-constrained. So our guidance reflects how fast we're bringing on capacity in our factories and how fast we can ramp that capacity as well as get higher productivity of the existing capacity. So we don't guide the specific percentages of increase, but I'd say that, certainly demand for those products is higher than a double-digit sequential growth rate. The question in my mind is, how fast can we bring that capacity on to satisfy the customers' demand and that's really what we're working on.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [73]

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Right. And as a quick aside, you seem to have seen a pretty decent uptick on the gross margin side in the Optical Communications front this quarter as well. But my real follow-up is on 3D, which I want to try look at from a broader perspective, in looking at really the entire supply chain, there is -- and here this is a calendar year '18 over calendar year '17 perspective. In doing that analysis, there is a number that keeps popping up, it's sort of like Pi or the golden ratio in nature, and that's really kind of a doubling or really more precising 90% year-over-year increase in revenue across the 3D ecosystem. Just as a reminder, your calendar '17 revenue was $243 million. From a trajectory standpoint, does that make sense to you kind of that overall doubling in calendar year revenue? And that way, we're looking at it over a period of multiple quarters versus various fiscal years or long cycles or what have you.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [74]

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I guess, calendar year, I get your logic, although calendar year is a little screwy just because of last calendar year only having 3D sensing in half of the calendar year, if you will, so...

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [75]

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Ergo the doubling, Chris.

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Christopher W. Coldren, Lumentum Holdings Inc. - Senior VP of Strategy & Corporate Development and Interim CFO [76]

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Yes, yes. So that's my point is, doubling, that's not much of a change, right.

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Operator [77]

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There are no further questions. I will now turn the call over to Alan Lowe.

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Alan S. Lowe, Lumentum Holdings Inc. - President, CEO & Director [78]

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Thank you, operator. We regularly discuss our business at Investor Relations events. These events are listed on our website in the Investor Relations section and are regularly updated. This concludes our call for today. We would like to thank everyone for attending, and we look forward to talking with you again in another few months. Thank you.

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Operator [79]

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This concludes today's conference call. You may now disconnect.