Lumentum Holdings Inc. (NASDAQ:LITE) Q4 2023 Earnings Call Transcript

Lumentum Holdings Inc. (NASDAQ:LITE) Q4 2023 Earnings Call Transcript August 17, 2023

Operator: Good day, everyone, and welcome to the Lumentum Holdings Fiscal Fourth Quarter and Fiscal Year 2023 Earnings Call. [Operator Instructions] Please also, note today’s event is being recorded for replay purposes. [Operator Instructions] At this time, I would like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please go ahead.

Kathy Ta: Thank you, and welcome to Lumentum’s fiscal fourth 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 and beliefs regarding synergies of recent acquisitions, including NeoPhotonics; financial and operating results macroeconomic trends; trends and expectations for our products and technology, our end markets, market opportunities and customers; and our expected financial performance, including our guidance as well as statements regarding our future revenues, financial model and margin targets.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings. We encourage you to review our most recent filings with the SEC, particularly the risk factors described in the quarterly report on Form 10-Q for the quarter ended April 1, 2023, and those in the 10-K for the fiscal year ended July 1, 2023, to be filed by Lumentum with the SEC. 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 fourth quarter and full year 2023 results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. With that, I’ll turn the call over to Alan.

Alan Lowe: Thank you, Kathy, and good morning, everyone. We are extremely optimistic about the long-term secular demand drivers in the markets in which we participate and lead. Additionally, our efforts and investments to grow our share in our existing markets and adjacent markets are generating positive traction that will benefit us for years to come. Our focus on technology and product leadership will ensure our growth and differentiation in support of our customers’ needs now and into the future. In the near-term, we are facing significant headwinds as both our direct and end customers actively work to reduce their elevated inventory levels. We believe that the current customer inventory correction cycle will continue through the balance of the calendar year, and therefore, our shipments will be well below end-market demand.

Even at these depressed shipment levels, we believe we are continuing to grow our market share outside of the consumer market. We are seeing meaningful demand strengthening for our Datacom chips as hyperscale customers prepare to ramp AI capacity. We believe that our Telecom and Datacom revenue will be up in calendar ‘24 compared to calendar ‘23, as inventory levels should return to more appropriate levels at our customers and their customers. Despite the inventory headwind we experienced in the second half of fiscal ‘23, our full year revenue was up 3% from fiscal ‘22. Also, fourth quarter revenue and EPS were both above the midpoints of our guidance ranges we announced last quarter. Our acquisition integration is going very well. And in fact, we have completed our ERP consolidation and are now running on one company-wide ERP system.

We are tracking ahead of our previously announced synergy plans, while we continue to deliver on our new product and technology road maps. At the same time, we continue to focus on our customers to drive an even stronger partnership and a differentiated level of satisfaction. ROADM revenue was especially strong in Q4 with increased sequential shipments across all ROADM product categories. Also, our commercial lasers business grew sequentially and particularly in new applications of ultrafast lasers for the solar cell market. As I indicated earlier, long-term demand trends for photonics products continue to be extremely favorable. Generational upgrades to C+ L-band as well as extended C and extended L-band architectures are underway in the backbone of networks where our transmission and transport products are highly differentiated and enabling for our customers.

We are designing products for the next generation of our customers’ Photonics roadmaps, which will use 130 gigabaud and 200 gigabaud data rate coherent technologies. We are developing these high-speed products in both discrete and integrated form factors, paving the way for enhanced performance in metro and long-haul applications as well as new applications at the edge of the network. With the addition of the teams from our NeoPhotonics and IPG acquisitions and the capabilities to develop DSPs and RFICs, we believe that our vertically integrated approach to these high-speed transmission products will give us the lowest product cost in the industry. In addition, we demonstrated our coherent 800G ZR technology earlier this year, which we believe is the industry’s first which will provide high-speed connectivity with extended reach for data center interconnect within metropolitan areas.

Turning to cloud data centers. As I indicated earlier, we are seeing increased customer activity for AI in the data center and expect this to translate to increased shipments of our chip level products for 800-gig transceivers. We have broadened our Datacom product portfolio with continuous wave or CW lasers for silicon photonic applications that connect server racks and AI clusters, which require higher data rates while consuming less power. Starting in fiscal Q1, we expect a return to sequential growth in our Datacom revenue. The data center optical component market is projected to grow sharply over the next 4 to 5 years to accommodate the increased traffic associated with AI as customers employ ever higher bandwidth interconnects between racks within racks in between servers and storage.

We also believe that Datacom VCSEL growth will be meaningful in the next several years as copper is replaced by short-reach multimode optical links. As stated earlier, we expect Telecom and Datacom revenue to be up in calendar ‘24 from calendar ‘23 as customers reduce their inventory levels of our products and our shipment rate is more in sync within market demand. Before I provide additional detail on the fourth quarter results, I would like to address the topic of China’s export controls placed on gallium and germanium. We have determined that our existing supply is sufficient for the medium-term, and therefore, we expect that these controls will have little to no impact on our manufacturing output. We will continue to monitor the situation and work with our suppliers to source material outside of China to mitigate any long-term impacts of these controls.

Now let me turn to the fourth quarter and full year results. Telecom and Datacom revenue was down 2% sequentially but up 2% year-on-year. As expected, we saw sequentially lower shipments of tunable access modules in the quarter. As we expand our customer base and current customers complete near-term product transitions and reduce inventory levels, we expect this business to return to growth in fiscal ‘24. The lower revenue in tunable access modules was partially offset by sequential increases in narrow line with tunable lasers and ROADM shipments across several leading customers. In fiscal ‘23, our tunable access module product line achieved new record revenues, growing 57% year-over-year with strength in metro access and fiber-deep applications.

These products enabled cable MSOs and wireless network operators to improve network performance while avoiding the cost of replacing existing infrastructure. In fiscal ‘23, we doubled our manufacturing capacity for tunable access modules in our wafer fab and our back-end assembly and test factories to address the anticipated growth in our shipments to these customers. Our ultra-narrow line with tunable lasers and our advanced ROADMs are key enablers of our customers’ next-generation network architectures that are just starting to be deployed. We saw sequential growth in narrow line with tunable lasers and across all major categories of ROADMs, including low-port count, high-port count and contentionless MxN platforms. Also, fiscal ‘23 ROADM revenue grew 22% from fiscal ‘22, driven by the adoption of these advanced ROADM architectures.

Cloud data centers are being redesigned to support the high bandwidth requirements of AI workloads. These workloads require several times more bandwidth than traditional cloud computing. At this early stage of AI hardware deployment, 800G transceivers can provide the bandwidth while also reducing latency. The new 800-gig transceivers utilized eight different wavelengths at 100 gig per lane, triggering orders for our EML products and driving a return to growth for our EML product line. Additionally, we are seeing strong demand for our high-power CW lasers for customers utilizing silicon photonics to build 800G transceivers. In calendar ‘24, our 200-gig per lane EMLs will enable the next generation of transceivers with capacity of up to 1.6 terabits.

We expect to start ramping shipments of 200-gig EML products in calendar ‘24, and customer qualifications of 800G and 1.6-terabit transceiver designs are well underway. We expect our 200G per lane optics to be the workhorse of hyperscale data centers for years to come. To further address the connectivity requirements for AI and machine learning clusters, we have been developing high-speed VCSELs for short-reach connections between servers and switches in these systems, and we expect to begin to ramp these shipments meaningfully in calendar ‘24. In the longer-term, we also expect to supply even higher-power CW lasers for leading AI hardware architectures to provide the high bandwidth, low-latency optical interconnects essential for training and inference applications.

asharkyu/Shutterstock.com

Turning to Industrial and Consumer. Fiscal Q4 was down from Q3 and down year-over-year as expected due to smartphone seasonality and end-market demand. We continue to expect our fiscal ‘24 3D sensing revenue will be lower than that of fiscal ‘23 due to our assumption around 3D sensing end-market demand, pricing and an additional competitor on a certain pocket, as discussed previously. In the fourth quarter, Commercial lasers revenue was up 4% sequentially, but down 2% from the same quarter last year. Overall, fiscal ‘23 Commercial lasers revenue was up 8% from fiscal ‘22. We achieved a 35% sequential growth in ultrafast laser revenue and over 25% sequential growth in fiber lasers, which was partially offset by sequentially lower solid-state laser shipments primarily for semiconductor applications.

Our growth in ultrafast lasers is being driven by new applications, particularly in solar cell processing. We expect that as demand for these new types of applications grows, we will continue to gain share in ultrafast lasers. Based on our latest customer forecast, we expect overall Commercial lasers demand to be softer over the next several quarters due to customer inventory digestion and macro factors impacting end markets. We expect continued rapid growth in new applications for our ultrafast lasers to partially offset these near-term headwinds. Although we expect our shipments in the near-term to be soft, I’m very confident about Lumentum’s mid to long-term prospects given the current softness is primarily driven by high inventory levels, the fundamental end market and technology trends driving our growth expectations are strong and unchanged, and Lumentum is investing in R&D to capitalize upon the long-term growth drivers and is uniquely positioned to serve our customers at scale with 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 as we partner with our customers. Before turning it over to Wajid, I would like to thank our employees and our customers around the world for their focus and dedication as they continue to collaborate and partner with Lumentum as we execute upon our strategy. With that, Wajid?

Wajid Ali: Thank you, Alan. Net revenue for the fourth quarter was $370.8 million, which was down 3% sequentially and down 12% year-on-year. As Alan mentioned, this revenue level was not unexpected and was driven primarily by the customer inventory digestion we have seen and expect to persist through the end of the calendar year. During the quarter, we had three greater-than-10% customers, all in the telecom market with no 10% customers in the Consumer market. GAAP gross margin for the fourth quarter was 24.2%, GAAP operating loss was 15.1% and GAAP diluted net loss per share was $0.88. Fourth quarter non-GAAP gross margin was 36.7%, which was down sequentially and year-on-year, primarily driven by product mix, factory underutilization and lower revenue.

Fourth quarter non-GAAP operating margin was 9.1%, which decreased sequentially and year-on-year. Fourth quarter non-GAAP operating income was $33.7 million, and adjusted EBITDA was $59.4 million. Fourth quarter non-GAAP operating expenses totaled $102.4 million or 27.6% of revenue. Non-GAAP operating expenses were down $2.5 million from Q3 due to tight expense controls. Q4 non-GAAP SG&A expense was $40.7 million. Non-GAAP R&D expense was $61.7 million. Interest and other income was $13.3 million on a non-GAAP basis due to higher interest rates on our cash and investments. Fourth quarter non-GAAP net income was $40.2 million, and non-GAAP diluted net income per share was $0.59. Our fully diluted share count for the fourth quarter was 68.6 million shares on a non-GAAP basis.

Our non-GAAP tax rate remains at 14.5%. Turning to the full year results. Fiscal ‘23 net revenue was $1.77 billion, which was up 3.2% from fiscal ‘22. GAAP gross margin for fiscal ‘23 was 32.2%, GAAP operating loss was 6.5% and GAAP diluted net loss per share was $1.93. Full year fiscal ‘23 non-GAAP gross margin was 43.2%, which was down relative to fiscal ‘22. Fiscal year ‘23 non-GAAP operating margin was at 19.2%, down from fiscal ‘22. Fiscal ‘23 non-GAAP operating income was $339.2 million, and adjusted EBITDA was $431.7 million. For fiscal ‘23, our fully diluted share count on a non-GAAP basis was 69.1 million shares. And non-GAAP net income was $315.3 million and non-GAAP diluted net income per share was $4.56. On to the balance sheet.

Cash and short-term investments increased $346 million sequentially to $2 billion, primarily driven by our convertible note offering. During fiscal ‘23, we generated $179.8 million in cash from operations, of which $49.2 million was generated in fiscal Q4. During the quarter, we purchased 2.67 million shares for $139.8 million, which includes 2.34 million shares repurchased concurrent with the issuance of our 2029 convertible notes. As we make progress on the integration of NeoPhotonics products into our global manufacturing footprint and attain synergies without impacting customer deliveries, we plan to carry elevated inventories over the short-term. However, we expect inventories to decline by approximately $30 million exiting calendar year ‘23 as we continue to focus on cash generation.

Turning to segment details. Fourth quarter Optical Communications segment revenue at $320.5 million decreased 4.4% sequentially and down 13.6% year-on-year. Optical Communications segment non-GAAP gross margin at 36.1% decreased sequentially and year-on-year. Our fourth quarter lasers segment revenue at $50.3 million was up 4.1% sequentially and down 1.8% year-on-year. Fourth quarter lasers non-GAAP gross margin of 40.6% was up sequentially, but down year-on-year. Now let me move to our guidance for the first quarter of fiscal ‘24, which is on a non-GAAP basis and is based on our assumptions as of today. We expect net revenue for the first quarter of fiscal ‘24 to be in the range of $300 million to $325 million. Within this Q1 revenue forecast, we anticipate Telecom and Datacom and Commercial lasers to be down sequentially, driven primarily by customer inventory dynamics we have discussed.

We expect Industrial and Consumer to be approximately flat sequentially. Based on this, we project first quarter non-GAAP operating margin to be in the range of 1% to 4% and diluted net income per share to be in the range of $0.20 to $0.35. Our non-GAAP EPS guidance for the first quarter is based on a non-GAAP annual effective tax rate of 14.5%. These projections also assume an approximate share count of 67 million shares. In terms of expectations beyond Q1, as Alan mentioned, we do expect a return to growth in Telecom and Datacom shipments in calendar ‘24 compared to calendar ‘23, as customer inventory levels are reduced and our shipment rate is more in sync with end-market demand. Our synergy plan that we communicated at our March investor event at OFC is proceeding ahead of schedule in terms of operating expense reductions.

We will exit certain manufacturing facilities at the end of this calendar year, which will deliver significant cost of goods sold synergies over the subsequent quarters. Overall, we remain on track to the total synergy plan of $80 million in annualized savings that we articulated previously, and we have achieved over half of the savings in fiscal year ‘23. With that, I’ll turn the call back to Kathy to start the Q&A session. Kathy?

Kathy Ta: Thank you, Wajid. [Operator Instructions] Now let’s begin the Q&A session.

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Q&A Session

Operator: Thank you, madam. [Operator Instructions] Your first question comes from the line of Meta Marshall from Morgan Stanley. Please go ahead. Again, Meta Marshall from Morgan Stanley. Your line is now live. Please go ahead.

Meta Marshall: Sorry. Thank you so much. Just having the buttons day. Just in terms of how you guys are evaluating how much of this is inventory correction versus potential for share loss or just not being involved in certain platforms, just how are you kind of evaluating that given kind of repeated kind of step downs and maybe more particularly on the Telecom business, maybe as the first question.

Alan Lowe: Yes. Thanks, Meta. As we said in the remarks earlier, we believe we’re not losing any share other than in the consumer space, where we’ve been talking about that share normalization and the third competitor. I’d say in Telecom, we’re very confident in our ability to continue to hold share, if not gain share, especially as we introduce new products. So I firmly believe that the slowdown in revenue is really mostly inventory correction and has really nothing to do with share.

Meta Marshall: Great. I mean just as a follow-up, just how do you examine kind of what – or get a sense of what the inventory positions are? And is kind of the belief that revenue would resume kind of in the revenue growth would resume in the calendar ‘24 period based on when people are telling you that they want to start to get the equipment again? Or is it a matter of that’s when you think that budgets will open up from your customers and they’re expecting. I guess just is that an expectation? Or is that backed by kind of conversations you’re having with customers?

Alan Lowe: Yes, I wouldn’t say it has to do with releasing the budgets. I think it’s primarily due to the inventory levels on their balance sheets and their desire to lower those, given the availability of components and the availability of us to supply. So I would say that as we look at the next few quarters, Telecom is going to be tough through the balance of the calendar year. And I’d say that we’re seeing some signs of inventory absorption faster than expected at some of the hyperscalers where we expected that to take longer. So I think AI is helping with that, both inside the data center as well as in the data center interconnect space. So I think from that perspective, that’s why we’re confident about calendar ‘24 being higher than calendar ‘23.

And those are really in-depth conversations with customer executives and really viewing our inventory in their locations and at their contract manufacturers. And that’s why we believe that the next couple of quarters are going to take to get rid of that inventory.

Meta Marshall: Great. Thank you. I will pass it on.

Kathy Ta: Thanks, Meta.

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

David Vogt: Great. Thank you very much for taking my question. And just two for me. One, Alan, going back to the inventory question, I guess, can you kind of help us understand, you made a comment that you think you’re undershipping to industry demand, where that demand might be today? And how you see that demand sort of progressing as we move through this sort of more challenging period of time in ‘23 into ‘24? That kind of colors your view about recovering back to growth in calendar ‘24. And then maybe a longer-term question, I’ll just give you both at the same time. When you think about mix of the business today, obviously, Consumer and Industrial is a lot smaller than it was last year. And presumably, that’s a relatively strong gross margin business.