Earnings Call: Q2 2019

Feb 5, 2019

Good morning. My name is Matthew, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Second Quarter Fiscal Year 2019 Lumentum Earnings Conference After the speakers' remarks, there will be a question and answer Thank you. Brent. Thank you, Matthew. Welcome to Lumentum's second quarter fiscal 2019 earnings call. As Matthew highlighted, this is Chris Coldrin, Interim Chief Financial Officer. Joining me on today's call are Alan Lowe, President and Chief Executive Officer and Jim Fanucchi from Darrow Associates, who is helping us with Investor Relations. This call will include forward looking statements, including statements regarding the markets in which we participate, including potential market sizes, trends and expectations for products and technology, including product development and projected new product releases, purchasing trends and demand for our products, our expected financial performance, expenses and positions in the market as well as statements regarding our recent acquisition of Oclaro. These statements are subject to We encourage you to review our most recent filings with the SEC, particularly the risk factors described in our 10 K filing, which was filed with the 4 relating to our acquisition of Oclaro, which was declared effective on May 31, 2018, and in our 10 Q for the second quarter of fiscal 2019, which we expect to file with the SEC later this week. The forward looking statements we provide during this call including projections for future performance are based on our reasonable beliefs and expectations as of today. Momentum undertakes no obligation to update these statements except as required by applicable law. Please also note unless otherwise stated, all results and projections discussed on this call 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 second quarter fiscal 2019 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 today's earnings release. A recording of today's call will be available by 11:30 am Pacific Time this morning on our website. Now, I would like to turn the call over to Alan for his comments and second quarter market and product highlights. Thank you, Chris. Good morning, everyone. I'm very pleased to be here to discuss our 2nd quarter results. First, I would like to make some comments regarding our recent acquisition of Oclaro. On December 10th, after receiving antitrust approval from China and nearly 9 months after announcing it, we closed the acquisition. I believe joining forces with the talented employees of the former Oclaro has created the industry's strongest team and the industry industry's leading portfolio of telecom transmission and transport products. Further, the combined team's capability in the design and manufacturing of high performance indium phosphide lasers and photonic integrated circuits is unparalleled. The chemistry, cultural fit, and shared purpose of the combined team is excellent. I could not be more excited about our bright future together. I would like to take this opportunity to review key elements of our acquisition strategic rationale. The first is leadership at the indium phosphide photonic chip level. Photonic chips are of increasing importance to the full range of the world's rapidly expanding communication infrastructure spanning access, wireless, data center, Metro and long haul networks. Indium phosphide lasers and photonic integrated circuits are the only practical devices for generating the optimum web links of light for transmission over optical fiber. Customer requirements are unrelenting in their drive toward higher speed, lower power consumption, or transmission market and sustainably differentiate ourselves from our competition, its innovation and economies of scale at the fundamental indium phosphide photonic chip level. We have employed this same strategy in the industrial and consumer markets without gallium arsenide materials and we believe our success in these markets validates this strategy. We further believe indium phosphide could meaningfully penetrate consumer and automotive sensing market. The second element of our acquisition rationale is to establish a clear leadership position and to improve the industry structure in the growing optical communications market. The world continues to become more reliant on ever increasing amounts of data flowing through optical networks and data centers. Next generation wireless and access technology including 5G will further accelerate network bandwidth requirements. The economics of 100g and higher speed technologies along with ROADMs are becoming more favorable everyday for network operators. This is accelerating the pace of global long haul regional, DCI, and metro network deployments utilizing these products and technologies. The Optical Communications Components Industry has long needed industry consolidation. We believe our acquisition of Oclaro given us a 1st mover advantage in consolidation. Further, we believe it is catalyzed and will accelerate further consolidation. The acquisition establishes leadership and high speed transmission that complements our existing transport leadership. With market leading products and technology and strong long term customer relationships in a growing and consolidating industry, we are well positioned for long term profitable growth. Options to profitably participate in the datacom market. It is anticipated that growth in hyperscale data center build outs and 5G wireless deployments will drive new levels of growth in the high speed datacom market. Profitability in these markets at the transceiver level is challenging. Hypercompetition and limited product differentiation are driving rapid price declines. Though some competitors have left the market, we continue to see new competitors emerge at the transceiver module level, so none with indium phosphide chip capabilities. Combining with Oclaro gives us a differentiated leadership position across a range of photonic chips on which the datacom, wireless and access markets critically rely. This creates new avenues to profitable growth through meaningful chip sales and more cost competitive transceivers In Chris's remarks, he will provide more details on the acquisition. Now turning to our 2nd quarter results. Revenue at $373,700,000 contained $29,600,000 of contribution from the acquisition. Our prior guidance did not include any acquisition contribution, excluding the acquisition revenue came in at roughly the midpoint of our prior guidance. Strength in demand and manufacturing capacity expansions drove ROADM and fiber lasers to new record levels. Revenue from our telecom product lines grew 21% sequentially driven primarily by the strong growth in ROADMs, ROADMs sales and the 20 days of contribution from Oclaro's telecom product lines. ROADM revenue grew 29% quarter on quarter 110% relative to the prior year. Man from our customers for our telecom products is very strong and is spread across a broad customer and geographical base. We continue to add ROADM capacity but demand will outstrip our ability to supply throughout the third quarter. Datacom revenue was down slightly sequentially. The previously anticipated decline was partially offset by the acquired datacom revenues in the quarter. In the third quarter, we expect datacom revenue to decline relative to combined company historic levels. We continue to be selective in our sales of transceivers in this margin challenged product area, and this is impacting revenue. With the closing of the acquisition, we now have chip sales in the datacom and 5G markets which we expect we will continue to grow. Turning to our industrial and consumer product lines, which includes 3 d sensing. As expected, 2nd quarter revenues from industrial and consumer diode laser product lines were down 10% quarter on quarter driven by softer demand for 3 d sensing lasers. Android customer revenue came in as expected and we continue to make excellent progress with additional Android customers and additional new design wins. The market for laser based sensing is still in its infancy. We believe the market opportunity over the long run is safety and new functionality in the billions of electronic devices that people rely on every day. The seeds for this long term market opportunity continue to be planted. During the second half of calendar twenty eighteen, additional customers announced or started shipping, high end 3d sensing enabled devices. During calendar 2019, based on customer engagements we have today, we expect new and existing customers will announce and release additional new threesensing enabled products. Several of these opportunities are expected to bring new functionality that could expand We believe these new customer products are the first step higher volume devices in the years to come. The customer learnings software APIs and supplier ecosystems developed in these initial products will enable and allow more rapid adoption of 3 d sensing and subsequent product cycles. We believe our leadership position in the market We have a proven capability that customers around the world know they can rely upon. We have shipped 100 of millions of devices with unmatched performance quality and reliability. The advantage this experience gives us is a valuable attribute and is difficult to replicate and overcome. Customer requirements for the next several product generations to come require us to further push the edge of laser device technology and manufacturing capability. We believe the same technology differentiation and unique depth of experience that enabled our success to date and the current generation devices will be even more critical to future generations of 3 d sensing lasers. Our Commercial Lasers segment revenue was up 10% quarter on quarter and 9% relative to the prior year. During the second quarter, we benefited from capacity expansion and further ramped volumes of our newest fiber laser products to meet strong customer demand. We again achieved record revenue from our kilowatt class fiber lasers, which grew 12% sequentially and 133% relative to the prior year. Targeting higher growth material processing applications. In calendar 2019 and over the long run, we have good opportunities for growth driven by new product I've highlighted significant long term trends that create terrific market opportunities for Lumentum and even more so with the closing of the Oclaro acquisition. Further, I've highlighted our strategy to accelerate growth and drive sustainable margin expansion and customer and end market diversification. Is a very exciting time at Lumentum for all of our stakeholders. I will now hand it over to Chris for more details. Thank you, Alan. I will first run through the second quarter financial results, add some additional details around the Oclaro acquisition, and then provide our guidance for the 3rd quarter. Net revenue for the second quarter was $373,700,000 and included $29,600,000 of revenue contribution from the Aclaro acquisition. GAAP gross margin for the second quarter was 33.4%. GAAP operating margin was 3.1% and GAAP diluted net income per share was 0 point 0 $8. 2nd quarter non GAAP gross margin was 40.1%, which was approximately flat with the last quarter. Non GAAP operating margin for or 18.1 percent of revenue. R and D expense was $39,300,000 and includes increased investments and new product development in addition to the added R and D expense from the acquisition. SG and A expense was $28,200,000. Non GAAP net income was $78,300,000 for the 2nd quarter and includes $2,000,000 of other income and a tax expense of $5,900,000. Included in the tax expense is a one time tax adjustment of approximately $2,700,000 due to the Oclaro acquisition impacting our full year estimated tax expense. Non GAAP diluted net income per an approximate 0 point 0 $4 negative impact due to the aforementioned tax adjustment related to the acquisition and is based upon a fully diluted share count of $67,800,000. The share count includes approximately 2,400,000 new shares due to the Oclaro acquisition being in the quarter for only 20 days. Turning to the segment and product line details, Our Optical Communications segment revenue at $325,400,000 increased 5% sequentially. Within our Optical Communications segment, telecom revenue at $172,500,000 was up 21% sequentially. Datacom revenue at $33,400,000 was down 2% sequentially. Industrial and consumer revenue at $119,500,000 was down 10% sequentially due to lower 3d sensing revenues. Optical Communications segment gross margin at 39.7 percent decreased sixty basis points sequentially due to lower industrial and consumer in the revenue mix. Our Laser segment revenue at $48,300,000 increased 10% sequentially, driven by growth in fiber laser sales. 2nd quarter lasers gross margin was 42.7 percent and increased 240 basis points due to higher volumes and product cost reductions. Now turning to more details on the acquisitions. The stock portion of the acquisition consideration Excluding unvested stock grants for continuing employees consisted of 11,000,000 new lumentum shares. The cash portion of the by the combined company's balance sheets, which at the end of the first quarter pre acquisition, had a total of approximately $1,100,000,000 in cash and short term investments. The cash consideration was also funded after the between the two companies during the second quarter. Our 2nd quarter ending cash and short term investments was $684,100,000. This is only $50,200,000 lower than Lumentum's first quarter levels due to strong cash generation by the business during the quarter. The ongoing annual interest expense associated with the new term loan is LIBOR plus 250 basis points. Today, this results in an approximate interest rate of 5 percent or $25,000,000 per year and additional interest expense. Since we are focused on similar customers, geographies and manufacturing capabilities and purchased the same types of raw materials, We have strong tangible expense synergy opportunities. As highlighted when we announced the acquisition, we believe these synergies will be in excess of $60,000,000 per year within 12 to 24 months from the close of the transaction. To date we estimate that we have achieved more than $10,000,000 in annual expense synergies We expect modest levels of new synergies to be attained in the third quarter, and then we expect synergy attainment will accelerate in the fourth quarter and into fiscal year 2020. Work done since the closing of the transaction gives us confidence in our ability to meet or exceed I think it is important to highlight these expense synergies did not include any increased revenue or profit due to new product differentiation our product roadmap acceleration resulting from the combined company's innovation engine. However, We believe over the long run, it is these types of synergies that will create the most long term value and underpins our strategic rationale for the transaction. Now onto our guidance for the third quarter of fiscal 2019, noting again that all projections are on a non GAAP basis, and now include Oclaro for the full quarter. We project net revenue for the 3rd quarter to be in the range of 420,000,000 to $440,000,000 with operating margin in the range of 16% and diluted net income These projections incorporate an approximate share count of $77,000,000 and tax expense of approximately $4,000,000 at the midpoint of the range. Note, our third quarter projections have several $1,000,000 of additional expense related to a reset of labor fringe rates in the new calendar year. Notable quarter on quarter changes in product line revenue and our projections include commercial lasers increasing primarily due to new product growth, industrial and consumer declining due to consumer electronics customer seasonality, Telecom increasing, driven by continued market growth and having a full quarter of the acquisition and datacom increasing to $50,000,000 to $55,000,000 due to having a full change there has been in these product lines over the past few quarters. We don't expect to provide this level of detail on an ongoing basis. Now before turning the call Our first question comes from the line of Samik Chatterjee with JP Morgan. Your line is open. Hi, thanks for taking the question. If I can start off with some one just relating to the quarter itself, you kind of on the revenue front, you came in in line with expectation or kind of in line with the guidance that you had issued, but on the operating margins and the gross margins, were lower? Is that kind of driven by the Oclaro integration? And can you kind of help us with what's the starting point for Oclaro in terms of gross margins and operating margins that you're building off? I'll make a couple of remarks and see if Alan has any additional I would say first, first is the product mix. So obviously, with the decline in, 3d sensing, that as an impact to margin. And then further, we're not going to break out any Oclaro gross margin. There's no Oclaro going forward. Those product lines have been merged with ours but certainly if you go back and look at prior quarters, Oclaro had been running below where our 40% gross margin was in the prior quarter. So there is some level of dilution of margin associated acquisition. Okay. And so if I can just follow-up with the 3 you're obviously expecting a lot of product launches from the Android guys where you have positioned on those launches. How should we think about the ramp up on those volumes or your expectations in terms of when the volumes on Android smartphones for you guys become comparable to kind of volumes with your lead customer? Is it kind of a 1 year time horizon? Are you thinking about it as a multi year time horizon before? You kind of see more diversification on your 3 d sensing customer base? Yes, I'd say that we're expecting more diversification throughout this calendar year. It's hard for me to predict when the Android 3 d sensing business will you know, behalf of our 3 d sensing business, but there's certainly plenty of potential for that to happen. I think the key to that is moving from the high end devices that are in the market today to more than mid range, lower cost, higher volume products and that really is in our customer's hands, and we're providing them the technology and capability to announce those products. It's just not clear to us when exactly that will happen. But I think it will happen and it's just a matter of time. Okay. Thank you. Our next question comes from the line of Alex Henderson with Needham And Company. Your line is open. Great. Hey, like to talk a little bit about the Oclaro acquisition post the conclusion of it. Really focusing on what your expectations are in terms of pairing out redundant revenues and much lower margin type products that were in the Oclaro mix. Obviously, it's a pretty nice chunk of change coming in, in terms of revenues, but I assume that you're going to pair some of that stuff out. So be helpful to have some sense of what the impact is both in terms of reduction in revenues from, consolidation as well as the impact on margins from that? Yes, I mean, I think you've already seen part of that in our guide Datacom and that's why we were very specific about the absolute revenue in the $50,000,000 to $50,000,000 to $55,000,000 in Q3. We are going through the product rationalization as well as fab utilization optimization and we'll be talking to our customers later this quarter, and putting in putting in place the actions to drive to the lowest cost product or the highest margin product where appropriate, where there is overlap. But the overlap is pretty minimal. And we expect to drive those to conclusion throughout this calendar year. Is it reasonable to think of $50,000,000 to $100,000,000 kind of range for line pairing? Well, I think if you go back in history and look at the 2 companies datacom business, you'll see that there's a good chunk of that already out of our Q3 guide in datacom. There will be more product rationalization. So it's not unconceivable that we hit that number. The other side, we're focused on driving innovation to grow our healthy new products faster. So we're hoping that that will more than offset the product pairing. And the margins on those are sub-twenty on gross. Is that kind of the right range? On which? On the stuff you're pairing? There's some that are much more challenged than that that we're taking action with. And that's again, one of the reasons you saw, the guide on datacom in the short term. One last question, then I could see the floor. 3 d sensing, obviously, the Apple brought in numbers pretty sharply in the fourth quarter. There seems to be a wide delay of estimates for the upcoming quarter. I assume that what we're looking at here is a supply chain that had you know, 8 to 10 weeks worth of processing it that takes time for that to run through. Hence, I would assume that that would result in a very low number for the March quarter. Is that the right thought process? I'll give you my thoughts and Chris can add to it. If you remember, it was November 12th when we got the first heads up. And so there was action taken during the December quarter. That was very different than the end of calendar 2017 where the heads up came very, very late, if not even into early part of the the calendar year. So there was there's been adjustments both, from our supply chain as well as I think through our customer supply chain and the module integrators to address some of that so that the build up is not nearly like it was a year ago. That said, we don't have total visibility beyond what beyond our walls. But we are taking a conservative approach with respect to large quarter guide and then whatever is remaining for the June quarter, in the numbers we provided. Does she have anything? Nothing further. Okay. Thanks. Thanks Alex. Our next question comes from the line of Simon Leopold with Raymond James. Your line is open. Thank you very much. Thanks for taking the question. I wanted to ask about the ROADM business in particular. Like to get some updates. Just my rough math suggests that the the quarter you reported was 90,95,000,000 in sales. And I understand you've added capacity. So just sort of trying to get an idea of how you see that particular line of business trending. And I'd like to include in your answer some thoughts on the competitive landscape. And how that's evolving? Thanks. Sure. I don't think your math is too far off, Simon. And I'd say that, you know, growing by 30% or 29% quarter on quarter was no simple task Had we've been able to grow another 30%, we would have sold all of that product as well. So there is still tremendous amount of pent up demand for our leading edge technology from twin 1 by 20s to even higher port count and now on the end by end product line where I'd say we have, if not year year's leadership in those kinds of products. So we're expecting and we're seeing continued demand strength across all of the regions, from Europe to China to North America on all of those products. At the same time, we're starting to see, you know, continued strength at the low end edge ROADM where, historically, we had not had such a competitive offering. We announced a very competitive offering in calendar 2018 and that product line is sold out. So it's a broad range of product demand that our cuts are asking us for. And, I think we, from a competitive landscape standpoint, we're out in front and continue to invest to maintain that leadership to to continue to have a large share of that market. Thank you. And just as a follow-up, I wonder if you could give us your perspective on the 3 d sensing market in terms two opportunities, as I see them, 1, world facing and 2, 5G, how either of those could play into the opportunities as we look out beyond calendar 2019 perhaps? Thanks. Well, I'd say from a world facing, we have multiple designs with multiple customers, pretty much across the board and the who's who and mobile devices working on time of flight, world facing sensors. And so we're very confident on our leadership ability to meet the market demands of these products where the technology continues to evolve and and get pushed. So I think, you know, that that'll come into fruition. You know, it's already starting to ship We'll see more and more devices throughout calendar 2019 as well as into calendar 2020. And I think, you know, the interesting thing there is that the whole new set of application use cases that should drive our customers to wanna introduce those things sooner. So that's again, out of our hands, we're just enabling the technology and the capability. As far as 5G is concerned, I mean, that's really more of a question for our customers and when they come out with 5 g capable handsets and, you know, what they put on those devices. So hard for me to say. But I'll tell you that the carriers are getting ready and investing. So it's coming. Thanks for taking the questions. Our next person is Michael Genovese with MKM Partners. Your line is open. Thanks so much. First question, on the ROADM demand, specifically in China, can you discuss from your perspective the evidence that these are real tenders turning into real deployments by multiple carriers versus, when it is inventory build going on. So what's your view on that? Yes, I mean, we have direct interaction with the carriers China and, you know, they have, this is beyond those pilot type of deployment. This is real deployments that are happening today. And so based on the constant, pressure from our customers executives across the globe, including in China, I have to believe that, there's not a tremendous amount of inventory build up But again, we don't have full visibility to that. I will say that we know that product that we ship into our equipment manufacturers in China are ending up being deployed in the field. And so that gives us confidence that these are real demands that that our customers need and are deploying. It's verified by the carriers in China. Yes, I'd add that our engagement with our lead customers as well as the carriers in China date back several years And, but we don't, as Alan said, have great visibility per se into inventory levels at our customer, at least the rate of deployment that was advertised when we kicked off these programs between our network equipment manufacturer customers and the carriers seem to be what's coming to fruition. So they're not it's not a recent surge, if you will. We've seen in ROADM sales out of the blue, it's very consistent with the several year roadmap that we've had between the equipment manufacturers and the carriers. Okay. Thanks for that. I think the other thing, Michael, is that with these higher port count rodems and more complex ROADMs. The average selling price is substantially higher than a 1 by 9 edge ROADM that we sell, you know, and have been selling for many, many years. So part of the uptake in ROADM revenue is average selling price, in these win 1 by 32 type devices where it's multiple factors of higher price compared to a normal one any of our competitors. Okay, great. And then as a follow-up, this strength, I know we talked about 100% year over year growth. I mean, it does seem to be concentrated in the ROADM area. You're probably also seeing it in pumps and amps, some other type of, you know, very high double digit growth rate. But, what about the pull through to transmission and specifically the Oclaro portfolio? Are we going to see specifically for these metro builds, are the regions like China or other regions where the Oclaro demand is still in front of us that's going to catch up with this strong ROADM demand we're seeing, or I guess another way of asking is why is it so concentrated in ROADMs and will it broaden out at some point? Yes, I would say there's a couple of pieces that, Mike. First is, certainly, we expect rodems as a ROADMs and pumps and other transport products as a leading indicator, if you will, of future transmission. Deployments given you need to put the ROADM and the amplifier infrastructure in, generally ahead of the transmission infrastructure. I would say though that we are seeing disproportionate growth in the transport and particularly ROADM space simply because previously, there were not significant deployments in China that were ROADM based, but there were 100 gig, 200 gig ports deployed, whether that be in long haul and then switching to regional. So we expect to see great growth in the transmission as you said using the word pull through. But I think the ROADM piece is a bit more pronounced given, from a geographical standpoint, China not being a large consumer domestically at least that is erodems in the past. And now, now they are now with that said also, China's consumption, at least our Chinese customers there, If we summed up all of their ROADM consumption, it's still below their share of the world's networking market. And therefore, we continue to believe there's continued growth above market growth in bringing our Chinese customers up to the levels that they should be purchasing ROADMs at. Great. Thanks so much for the very thoughtful answers. Our next question comes from the line of Meta Marshall with Morgan Stanley. Your line is open. Great. I wanted to dive into couple of things. First on the industrial laser business. I know that you guys have tried to expand capacity to be able to meet more than the needs of just your kind of one major customer. I just wanted to get a sense of are you selling to multiple customers at this point? Would you expect to kind of by the end of the fiscal year? And just what if you're not kind of what level of revenue should we think of as being the threshold to meeting other customer needs? And then maybe just a second more logistical one on splitting the if we could get a split of the 29.6 for Oclaro between telecom and datacom for the quarter would be Yes, maybe I'll start with the latter first and then let Alan answer the former. The 29.6 was approximately equally split between datacom and telecom. And as far as our commercial lasers business, and record revenues in fiber lasers. That's still, our primary fiber laser customer, and we still have some catching up to do. So we still have not met their overall demand. We're getting closer to this quarter. And once we do that and satisfy their needs, you know, we'll we'll look at, penetrating outside of of that customer. So I wouldn't expect meaningful revenue this fiscal year. I think it'll be more into, fiscal 2020. Our next question comes from the line of Tejas Venkatesh with UBS. Your line is open. Thank you. With the acquisition of Oclaro, you will now obviously have a deep presence both at Huawei and ZTE. Both of those systems customers have been in the news quite a bit recently. So I was hoping you could characterize overall Chinese demand and to the extent you can on these 2 customers? Well, as we said earlier, the road on demand in China because of it being non existent a year ago for domestic deployments is quite strong today at all of the leading, network equipment manufacturers in China, including the 2 you mentioned, but there are others. I would say that that the relationship with both of them is very strong. I can't control what's going on between the two countries. I wish I could. But I'd say that at this point in time, we're working with them closely across the range of products from telecom transport next generation ROADMs through the next generation of transmission from ACOs to DCOs and 400 gigs. So I'd say that the relationship engagement is broad and very strong at this point. Yes, I would say our aggregate exposure between those two customers is still less than their exposure, if you will, to their markets, which I don't you could argue is a good or a bad thing. It's a bad thing and that we want to grow that ultimately over the long run. But vice versa, if there's concerns about any interruption of business with them, yes, we have exposure and that would be very painful to lose that business. But we're not over exposed to it, relative to to most other participants in the market. Got it. And with respect to your lead customer lead 3d sensing customer, any change in the competitive situation, as you look out into the phones launched into the in the second half of twenty nineteen. I assume by now you have a fair sense of what that could look like? Yeah. I mean, I think, we're still, very happy with our share of the production shipments that we have today. And I would say that we're very happy with where we are positioned for next generation. New designs, whether that be front facing or world facing across the product and customer portfolio. So As I said in the prepared remarks, the next generation of devices is pushing the technology for higher densification, higher, wall plug efficiency and things like that that don't allow people just to catch up because they have the capability today to make yesterday's product. So, you know, we're pretty excited about where we are and and how engaged we are with many, many customers are indeed development efforts as part of their extension of their development. So I couldn't be happier with where we are. Our next question comes from the line of Mike Kelleher with D. A. Davidson. Your line is open. Hi, thanks for taking the questions. I wanted to go back to the datacom side. Could you just kind of clarify what your strategy is to differentiate on the datacom side. Is that a market you're leaning to? Is that something that faster speeds will lean into your strength. What exactly are you thinking about on the datacom side? Yes. So from a datacom standpoint, very excited about the market opportunity because there's an awful lot of volume that ships in that market, both between datacom and wireless. The real challenging puzzle to figure out has been profitability, particularly at the transceiver level over the past several years. So what we think the Aclaro acquisition brings to us, there's a couple of things. First is, meaningful chip sales, which is a operating at a different level sort of ecosystem or food chain, if you will, where it may not have the same kind of, rapid price reductions, etcetera. That are occurring at the transceiver level because there's fewer competitors than there are at the transceiver level. There's also much more significant barriers to entry and a much more focus on leading edge technology. So as you said, as we look to higher and higher speeds, or lower and lower power consumption at a given speed or wider environmental operating range those are all things that play into now the combined company strength with world class chip capabilities. If there is a way to make money at the transceiver level, then we expect with that chip capability We would be in the running as best as anybody else could be at the transceiver level. That remains to be seen, obviously, because we also have to see what the competition is doing and where prices land in that space. Again, our strategy is to focus on where we have the best technology, lead with that and then choose where to play in the market, where there are an ability to make money. Okay. And then as a follow-up, what shifts exactly are you thinking about? Are those photonic integrated circuits? Are those PSPs? What just? So these are lasers, so either directly modulated or EML's electro absorption modulated lasers as well as some receiver products. So the transmit and receive indium phosphide chips. Great. Thanks. Our next question comes from the line of Rod Hall with Goldman Sachs. Your line is open. Yes, hi guys. Thanks for the question. I guess I wanted to start on lasers margins and just see, I know you've said that you think that eventually could to 50%. But could you just comment on kind of whether that's still reasonable to think it eventually gets there and what sort of trajectory it might have then I have a follow-up to that. Sure, Rod, this is Alan. Yeah, I think that there is a clear path to 50% growth margin on lasers. Part of it has to do with volume, obviously, but all part of it also has to do with the mix between fiber laser and our micro machining business where typically in the fiscal Q1 and Q2, the micro machining revenue is low. And so as that comes up and has higher than average lasers gross margin, that will pull up the gross margin of lasers overall. I'd say that as we continue to move more and more of our laser dial packages into our own factory in Thailand. We're seeing, cost reductions that you saw part of the benefit in in the gross margin improvement in fiscal Q2. We're going to continue to see that as we drive costs down that will also help our gross margin. So I think that the combination of driving costs down, fiber laser as well as a mix towards additional micro machining should get us there before the end of the Okay. Thanks, Alan. And then I wanted to come back to 3 d sensing in the guide and just check the pricing situation. I mean, we would anticipate like 10% year over year declines. Is that sort of in the ballpark of what you're seeing or is pricing particularly in the big VCSEL we're interested in what's happening with the pricing trajectory? And also it'd be interested in your thoughts on inventory like how much module inventory might be out there is that perturbing the guide? Thanks. Yes, I'm reluctant to be talking about our 3d sensing pricing given that given that I'm sure our competitors are listening to this call. So, you can imagine prices go down over time and whether that's low single digits or in the double digits, I'll let you be the judge of that. As far as module inventory, we really don't have much visibility that, both at the module integrators as well as at the next step in the process. So I will say that we're shipping units today. And so it gives me it gives me visibility that they're continuing to build new modules, but that it's hard to extrapolate anything else other than that. Okay, great. I appreciate it. Our next question comes from the line of John Marchetti with Stifel. Your line is open. Thanks very much. Maybe just a quick follow-up on that inventory side. Obviously, a big jump in your inventory levels at the end of the quarter. Curious as to how much of that maybe comes from the addition of the Oclaro business coming in? And then how much of that is is 3 d sensing or VCSEL inventory that didn't sell through given some of the cuts that you've seen at your big customer? Yes, so John, this is Chris. There's very little or immaterial change in 3d sensing in for you on our balance sheet. What you're seeing is a combination of both the Oclaro inventory as you would think about it coming over as well as the accounting associated with the acquisition or that inventory is stepped up in value. For a value as well. I'd say the only, inventory build that we're having is As we wind down our Chinese based contract manufacturer, we're building up some inventory to be able to move that equipment into Thailand and not disrupt the ability to supply our customers. So there was high single digits of inventory growth, but done on purpose to make sure that we make a orderly transition to our factory in Thailand. Got it. And then maybe just as a follow-up, real quick, Chris, how should we think about sort of the normalized OpEx levels here in as we look to the back half of the fiscal year. Just trying to get a sense for, obviously, we had a partial contribution in the December quarter, but just trying to think of sort of where we are from an expense perspective as we start to think about the second half of the fiscal year. Yes. So we really only guide 1 quarter at a time and obviously, as we look to attain synergies, which will bring down our operating expense. So I think you can, you can impute from, from, our guidance what the, operating expenses are And then you'll have to make some assumption around synergies for the next quarter. So we don't have a good answer on being able to provide guidance for operating expenses out in Q4 and beyond. Okay. Thanks very much. Our next question comes from the line of Jun Zhang with Rosenblatt Securities. Your line is open. Thanks. So could you talk a little bit about vector content, in your existing client and the potential, Android client. And also, could you share with us about the VCSEL completion landscape in the Android market? Thanks. The what market? Andrew? In Android? Yes. Well, it varies, dependent upon you know, what, what type of 3 d sensing, and whether it's world facing, front facing, or both So I could say that in the Android environment, it ranges from single chip content, to, what I would expect in calendar 2019 2 to 3 potential chips that could drive additional content per device or additional dollar content per device. From a competitive landscape standpoint, in the Android market, it's a little bit different as we see you know, the cast of, people that claim they have a volume 3d sensing, at the Android, Android customers. It's a little bit different than we have, with our our lead customer. But I mean, they're all, they're all, capable, I think, eventually, and we'll be I think the key to our differentiation is pushing technology, and allowing our customers to do something unique that they couldn't necessarily do with last year's technology. Sure. So, you mentioned that, some of your existing clients might, you might see a a content growth this year. So do we expect a meaningful, a change in the, in the content this year or calendar next year for your, existing client base? Well, I think based on our design work with our customers, there are many that are working on world facing time of flight, high powered, vials that when they announced them in the product, that will increase the content per device. I I can't tell. Know, when they're going to do it or what models they're gonna do it or if they're gonna do it on a single high end model or if they're gonna put it on a range of products. We're just focused on making sure that when they do announce a product, it's with our VCSEL and with our solution that that gives them something that's unique. Great. Thanks a lot. Our next question comes from the line of Tom O'Malley with Barclays. Hey guys, thanks for taking my question. I guess, to start with the organic life data center business, it was down 45% and then it's guided down again. You guys had talked about some strategic decisions with the business. Can you first update that? And then further, could you see some gross margin uplift from the product pairing with Oclaro and what does the profitability of that segment look like at these levels versus where it could go in the future? Hey, Tom, can clarify, are you referencing datacom business? The datacom business. Yes. And for clarity, our the just reported Q2 was Oclaro plus lumentumdatacombusiness, not just the organic business, But to your question, they're both going down quarter over quarter. And the second part of your question. Sorry, Tom, go ahead. Yes, go ahead. Just following up on the gross margin uplift of that business. Yes, these products are low, low gross margin. So certainly, any either improvements through having a better product and replacing the low margin products or pruning out low margin products going to result in gross margin uplift overall for the company. With that said, that's obviously got to be balanced with ensuring that if we were to prune products that we don't leave the overhead overhang of overhead, if you will. But I don't think that's going to be a challenge, but that's something we just have to keep an eye on. Yes, I think just to add to that, I think as we continue to grow our chip business, that will be a good bump to gross margin at datacom. And then we're continuing to work on driving lower cost, 100 gig transceivers and 400 gig next generation transceivers to the market. So, the combination of bringing in new products and driving higher levels of chip sales should drive gross margin on the datacom business in the right direction. That's helpful. And then just as a follow-up, your guide implies, I think a slightly higher tax rate than expected, I think, about 6%. I mean, you kind of walked us through the moving parts there. Can you talk about the expected run rate there for June And do you still expect that rate to move up slightly into 2019? Yes, I think the rate might be a little lower than, but but that's in the zip code. I would not expect, on a relative basis that to change, going into the fourth quarter. Thanks guys. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Your line is open. Great. Thanks. Good morning. You'd mentioned briefly with regard to China, I think, but obviously there's applications across the board. The ACL platform Form, which historically is a pretty important part of the Aclaro franchise. I wonder if you could talk about kind of trends in that product line, both focused on DCI And Metro Markets, And then maybe step back to address the overall cloud opportunity, maybe differentiating between data center interconnect trends that we're seeing basically inside versus outside the data center, both your exposure to those via the ACL platform and how that might evolve heading forward? Yes. So Tim, I would say the way I would think about it is the following that the the the ACO platform that you referenced, certainly as a lot of customers today, either buying mostly at the module level. In some cases, at the component level, the product roadmap though is is to aggressively ramp DCO products across the existing ACO customer base as well as many other customers that have not adopted ACOs, ACOs certainly are a little bit more complex for a customer to to adopt in that they have to have a DSP and integrate the DSP with the ACO. So we see the the industry in mass, shifting towards, DCO over the mid term to long term. And we're very well positioned both with the lower speed, 100 gig, 200 gig, as well as 4 100 gig looking forward over the next few years. In terms of, I said, across the customer base, thinking generally of the telecom NEMs. But as you've highlighted, there's certainly the cloud customer base, who very much look to DCO modules as a, a great way for them to get their coherent solutions without having to be experts in integrating DSPs and ACO modules or building modules themselves buying components And so there's definitely an emerging market here between the cloud guys primarily for DCI. Great. And if I could follow-up just to wrap up. We've covered kind of overall demand trends in China on the telecom side and they look I guess, perhaps surprisingly strong. I wonder if you could make sort of any similar comments about the more carrier or metro long haul focus markets outside of China and your North American and European OEM customers, whether you're seeing similar trends relative to some of the growth you're looking at in China or how you would characterize that relative to your overall telecom growth? Yeah, I'd say that we're seeing broad, demand growth, North America, Europe, and anecdotally, throughout Middle East and and and and Africa with respect to the products where we have clear leadership ROADMs, next generation transmission components and ACOs and DCOs So it is a broad range of demand that, I think is a combination of just pure market growth. But in addition to that, I believe we're gaining significant share with our leadership capability and the things that we talked about earlier. So I think the combination of the 2 are driving our top end, our top line telecom transmission and transport. Our next question comes from the line of Troy Jensen with Piper. Chris, could you give us a timeline for when you expect to have the DCOs generally available? We expect to be ramping those this summer. Is that shipping samples or generally available? I would say generally available. All right. Perfect. And just a follow-up on that. Do you expect to use multiple DSP partners or will you be standardized just one? We have multiple DSP partners. Certainly, we've got a lead partner that's a very public relationship. All right. Then my last question too. It's been a while since we've got an update from Oclaro in their 400G lasers. The same question line, when do you expect the lasers to be generally available? I don't think we want to talk about that's a competitive product for sure, but it's something that we expect to be a leader in. That it's had. There are no further questions at this time. I'll turn the call back over to Alan Lowe. Thank you, Matthew. I want to thank our customers for their business and partnership I also want to thank our employees for their hard work in putting us into an excellent position for long term growth. We regularly discuss our business and 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 thank everyone for attending. And we look forward to talking with you again in another few months. Thank you. This concludes today's conference call. You may now disconnect.