All right, I think we'll get started here in about 10 seconds, if everyone wants to take their seats. All right, welcome to the tech conference. I'm Tom O'Malley, semiconductor and semiconductor capital equipment analyst. Lucky enough here to have Lumentum CFO, Wajid Ali. Thank you for joining us.
Thanks so much, Tom.
So a lot going on. First off, it's a pleasure to have you here. There's been a lot of changes since we were here a year ago, and I think the most recent one is you. We just want to start maybe taking a step back, 30,000-foot view. Can you talk about the strategic rationale for the acquisition, and then financially, what do you expect the contribution to be from that asset?
Yeah, sure. So, I mean, I think if you take a look at many of the investments that we've made as a company, we really want to strengthen our position both inside the data center and outside the data center. And, you know, the acquisitions that we've had in the past have been more focused outside of the data center within our connect solutions. But with Cloud Light, you know, we're really kind of strengthening our position with data center and high-end transceivers to be able to take advantage of growth that's there. And so our thinking around Cloud Light was really the fact that we're going to be able to get into a market that's growing quite quickly.
I mean, if you take a look at some of the data, you know, demand for greater than 400 transceivers is growing, you know, 4x over the next 4 or 5 years. So there's a lot of business to go around in that space. You add to that, you know, some of the vertical integration opportunities that we've got from some of the prior acquisitions that we've done, and it really gives us an opportunity to improve the operating profile of the business as it... So that was really the thinking around the CloudLight acquisition, to take advantage of developing our strength within the data center, and also to improve the operating margin profile of that business through some of the vertical integration opportunities that we've got.
Even without that, the acquisition itself from a financial standpoint is accretive to us from an operating margin standpoint in the quarter that it closed, and it's accretive to us on an EPS standpoint as well. So, you know, kind of all the financial check marks are there for us as it relates to CloudLight.
What can you do to scale a business that has such a small OpEx footprint? How do you integrate it? Like, when you're looking at it, you have my CFO hat on for a second, you know, what levers can you pull when you go to lean business already that's maybe levered to a particular customer? What buttons do you push to help scale that and keep the cost profile on what it is while you're scaling it to other?
Yeah, no, that's a great question. So, you know, from a manufacturing capacity standpoint, one of the things that we're looking at is how can we really take a look at the footprint that we've got, especially from a, from the back-end standpoint, to be able to leverage the, the revenue growth that we're expecting to see, in that part of the business. And so the operating leverage, even with its, its existing capacity, is quite good. But as the business is expected to expand, some of the, back-end availability that we've got at our Thailand facility or at our, our Futian facility, allows us the opportunity to expand, that part of the business without actually increasing our, our overhead expenses. The second part of it is really the vertical integration.
I think what we're taking a look at from that standpoint is really the opportunity for us to integrate our CW lasers into the transceivers that CloudLight provides. It's the opportunity to bring in our own VCSEL technology into the AOCs that CloudLight sells. And then eventually also have the ability to have our own EML technology to not only improve the operating margin profile of that business, but really to enable the transition to 1.6T, which we expect we're going to be at the forefront of. So I think kind of those things combined really allow us to bring up the operating margins of CloudLight, probably better than they could on their own or anybody else owning that asset.
I guess another aspect that we hear a lot, particularly over the last year and a half, is just the importance of domestic supply chains, particularly in areas that are sensitive to the U.S. government. Is there an angle here where owning this asset gets you into a position with certain customers that you weren't in before? Maybe talk to customers. You know, conversations with customers and, or, you know, what you've seen already since you've-
Yeah, I mean, it's been less than a month. It'll be a month tomorrow, of us closing the deal, and the activity on the customer front has probably been better than we expected. And you know, whether it's domestic reasons or it's because Lumentum has been a secure supplier for many of the hyperscale customers already or we're engaged with them already. Certainly, I think that there is a confidence that having Lumentum as part of the success of CloudLight ensures that the technology roadmaps moving forward will be invested in at the appropriate levels. And so I think that the hyperscale customers know that about us in terms of some of the success we've had in the past, and then them allowing us to be part of their long-term roadmaps....
Also, gives them a lot of confidence as well. So I think that's probably the main reason why we've seen a lot of customer interest in the last 30 days and a lot of the time where our business unit leaders are spending in order to accelerate that part of the business. Because that was also part of the thesis of purchasing CloudLight, is that under the umbrella of Lumentum, we would be able to expand the customer base and really take advantage of that market growth opportunity that we want.
I wanna rewind the clock just a little bit. I think it was several years ago, you guys decided to move on from your data transceiver business, and the decision at the time was, "Hey, you know, we can be competitive here on the chip side," but the transceiver business was a lower gross margin profile. You said, "Hey, we're, as a business, we wanna move gross margins up." I understand from the CloudLight angle that operating margins can improve very drastically, but can you talk to me about why you decided to get back into that business and what can you do from a gross margin perspective?
Yeah, I mean, a few years ago, the transceiver business was a lot different than it is today. I mean, it was really enterprise customers that were leading the demand for transceivers. And now the world's completely changed. It's really hyperscale customers that are leading transceiver demand, and the secular nature of that demand is much stronger than it was at the time when we had brought in Oclaro. Now, I think us having the amount of experience that we've had with the EML part of that actually enables us to broaden the transceiver business that much better. For example, we've already launched and are qualifying our 200G EMLs that are part of the EMLs that came with the Oclaro transaction.
That is gonna enable transceiver demand, not only for 1.6 T, but also for designs that have 4 by 200 for 800Gs as well. So, you know, I think from a timing standpoint, us having an asset with CloudLight and being able to really change the way the transceiver designs are completed because of some of the vertical integration opportunities that we have is much better than we could do on its own. Now, you're right. From an operating margin standpoint, that's really how we're looking at it, because the gross margins can only improve to an extent, given the amount of BOM cost there is.
But really, it's us going out and making sure that we execute integration opportunities to ensure that we can get the gross margins up from where they are right now as well.
So you talked about 18-24 months synergies. You're highlighting some revenue synergies here now. Can you talk about what those, the size of that, may be? Obviously, it's not an enormous acquisition, but just helpful from a relative size perspective, what could you get out of it?
Yeah, I mean, so what we've talked about is the fact that, CloudLight is operating on its own, in the low teens operating margins, and we expect to be able to get it up to the high teens operating margins. So let's call that 500-600 basis points, kind of just the delta between the two. So if you multiply that out by its current revenue level, that gives you about $10 million-$12 million worth of synergies. If you multiply it out by a future revenue level, let's call it an annualized number of $300 million, then that would give us $15 million-$18 million of synergies that CloudLight wouldn't have been able to achieve on its own. And so that's really probably the opportunity set for us.
Then in terms of spend, when you look out into next year, does it require more CapEx investment on that side? I think that there's a view, if you have a concentrated customer and you're looking to broaden that, often there's a lot of design activity that is in place that often ends up on the OpEx side. From a CapEx perspective, what does that take?
I think the team at CloudLight did a great job of investing in the capital that was needed, not only to enable the 800G demand, but also to eventually move to 1.6T. So I think kind of at a very high level, probably the CapEx requirements will be very similar to what Lumentum has as a standalone, 5%-6% of revenue. And so at least in the next 24 months, it shouldn't exceed that.
I think a good case study, not exactly the same, but something similar, is when you did the NeoPhotonics deal. You saw a good technology asset that was well-positioned, that was at a gross margin profile that maybe at the time was below where the corporate average was.
Right.
But can you talk about what has happened with that deal so far, and have you been able to do what you expected out of it? And talk about maybe where that gross margin profile is trending. I know you can't give specifics, but just generally, how has that deal gone and maybe what lessons did you learn you can apply here to Cloud Light?
Yeah. So I mean, the acquisition of NeoPhotonics has gone very well. I mean, obviously, I don't think any of us expected the telco downturn that happened, and certainly NeoPhotonics transmission products were also affected by similar to what our transport products were. But you know, our narrow linewidth lasers, products that go into 400G ZR and ZR plus modules are very well. We're quite excited about the transition to 800G ZR as well. As part of NeoPhotonics, we recently demoed 800G ZRs and we got very, very positive reception around that product line as well.
So I think from a product roadmap standpoint, Photonics has done very well for us, and we've been able to invest in it, and we expect to grow that part of the business. Especially because we believe that, and this was part of our thesis for NeoPhotonics, that we felt that the market was moving to pluggables. You know, pluggables, especially from NeoPhotonics, have lower latency and things of that nature. That certainly is playing through, and so we see a lot of market demand there. From a synergy standpoint, specifically, you know, we had put a stake in the ground when we had completed the acquisition, that we would see $60 million synergies annualized. I'd say probably nine months after that, we came out that we thought it would be closer to $80 million.
So we're very much on track for that. I think, you know, we're probably at the two-thirds mark in terms of realization of those synergies, but we still have some to go as we move through some of the back-end consolidations that are happening right now. As well as some of the product in-feed opportunities that we're still working through, that are going through the normal design times from our R&D team. So I think those are the two pieces that are still left. But we were able to up that, and we've realized about two-thirds of it so far.
Very helpful. So as part of the closing of the Cloud Light deal, you rebucketed into two new segments: Cloud Networking and Industrial Tech. For those who don't know in the room, could you just remind us what... Which of your previous businesses are going into those two businesses? Where does the new business come? Then maybe a helpful way to talk about it, I know that, you have some of the growth rates that you've given historically, but what do you expect in terms of growth rates for those two businesses, just so people can level set where you, you know, the next couple of years can go?
Yeah, sure. So, our historical telecom and datacom businesses, as well as our 3D sensing business that was in our OpCom segment, basically got pulled out. And our 3D sensing business and our lasers business got moved into the industrial segment. And our telecom and datacom, as well as our most recently acquired CloudLight acquisition, will go into the Cloud and Networking platform. So that's really how we've broken the two out. And the real reason for that is because that's how we see the markets in terms of the customers growing as well. So we do think that there is a clear delineation of kind of growth rates in each one of those markets and what each one of those platforms require.
So on the, on the Cloud and Networking side, you know, the, the historical Datacom business, the chip business, is probably a, a low double-digit grower, from, from our perspective. And the, the Telecom part of the business, obviously, a mid single digit over a long term. And, the Cloud Light part of that business, we communicated, we think it's, it's expected to grow at about 30% over the next few years. On the industrial side, we, we almost think of lasers as a, as a GDP plus type business, and so it's very much related to the, to the macroeconomy and how the overall GDP of, of, of the global economy is going.
Then on the 3D sensing side, it really depends on what type of innovation is happening at our large mobile customer. If there's a lot of innovation happening then we're certainly a leader there, and we get tapped a lot, and so there's opportunity for growth. But if there isn't, then there's generally kind of the classical ASP reduction that happens every year, and so it can be a flat to slightly down business, depending on what's happening-
Mm-hmm.
with the large customer and the designs that they're working on. So that's, that's how to think about the different growth.
Very helpful. I wanna dive into a little bit more of the demand trends in some of the subsegments that you just talked about. So I think one that you highlighted already is clearly we're going through a cyclical downturn in the telecom business. Now, there's two parts to that, right? There's the inventory build, which clearly happened at some of your... And then there's also the demand profile. Can you try to distinguish between the two? Where do inventory levels sit today? Is demand okay now, but the inventory problem is bad, or is demand also poor with the inventory?
Yeah, I mean, so all the feedback we've been receiving from our customers is that demand seems reasonable, and inventory levels of our products within their supply chain is working its way down. And you know, based on that, we get this question a lot. Our thinking, at least for a base case, is that the demand recovery really kind of happens in the middle of calendar 2024. And you know, by that point in time, it'll be 4 or 5 quarters of inventory digestion, and so by that time, we expect to see some type of normalization in our shipments into customers being more equal to the shipments that they have out. And right now, there's been a mismatch for the last 3 quarters or so.
So that's really the timing that we expect for that. We haven't really seen much from a demand standpoint in terms of it going down or it staying flat, and we think that is fairly normal.
If you look at your largest customers, which you guys break out, you had a couple quarters of very elevated bill. You actually saw that percentage kick up in the last quarter. Is this just different programs that they're running, that they need different types of your product? Because I know you sell multiple products to that customer. Or are there different customers that maybe have inventory positions that are different from one another? Across the board, your largest-
... Yeah, no, I mean, it is, it is very much across the board, especially as you take a look at it between transport and transmission. We haven't seen a lot of differences in terms of, you know, maybe ROADMs being higher than, you know, products in our transmission group. They've basically come down at very similar levels.
Okay. Across the board. So I just want to pivot to the Datacom side. You guys have previously been pursuing a chip-only strategy. I think there's been a long road where originally there was market declines, then there's been capacity constraints on the upswing. Where does that business sit today? I know you're selling primarily, you know, to the large hyperscalers. Is that trending as you expected? I know that there was a period of digestion for what you thought through the rest of the fiscal year. Where are things there?
Yeah. So, you know, primarily we've been selling 100G EMLs in that space, and probably last June we saw a bottoming of that business. And what we saw coming back to us was a lot of demand for 100G EMLs primarily because of the demand for 800G transceivers, you know, going up quite quickly at our customers. And that business, every single quarter, has been increasing sequentially. And those increases have really been driven by the capacity that we've had to back into that business. And I'd say probably exiting this fiscal year, we'll be at a more normalized run rate, where the supply that we have equals demand.
What we're really excited about in the Data com side of the business is the transition to 200G EMLs. We believe that we are going to be a market leader in that space, and what that'll do for us financially is that will effectively increase the revenue capacity of the fab that we've got.
Yeah.
Because we'll be able to get a higher ASP in a market where we are leaders, and we're going to be enabling, you know, 4 by 200, 800G transceiver designs, as well as being the only ones to enable 1.6T designs, because they require 200G EMLs to really operate. And so, you know, we've seen that story before when we were the leader in 100G EML, competition had caught up to us. That benefit flowed through how well we were doing in the Data com business, and we're quite excited about how well we can do with 200G EMLs as well, because we're going to be first to market.
Do you have a view on how far ahead of the competition you are in that 200G EML?
It's tough to say. I would say on the 100G EML, we had probably a 12- to 18-month advantage.
Yeah.
On 200 Gs, it's tough to say how much advantage we have, but I would say that probably there is some clarity between the two now.
We look at the universe of companies that are here at the conference. I think a consistent theme that we, that we saw over the past year as well, is supply constraints, very abnormal lead times, input costs were skyrocketing, often affected, the gross margin profile of business. So can you talk about what you're seeing today? Are you still having trouble with any supply? Is there any abnormalities that you think will correct themselves by next year? Just walk through all the moving pieces you have to deal with.
Yeah, I mean, overall, at a company level, we've been trying to bring our inventory levels down. And we've been able to do that partly because demand has come down, but also because our requirement for safety stocks have come down as well. And that's happened because there has been a loosening in the supply chain overall, just industry-wide. And so I think that I don't really see any bottlenecks in terms of our ability to provide product if there is a ramp-up in demand that's quick. And also we just don't see the same type of pricing action happening from an input standpoint that we were seeing before as well.
I think that that was a COVID-driven era that was driving abnormality in pricing from a raw material standpoint and a supply standpoint, which caused us to balloon our safety stocks as well. But that has completely reversed, and we're just working that through the system, and hopefully it should be more normal moving forward.
You'll grant me one more on the broader tech side. I discuss so frequently that it's probably ingrained in your brain, but the 3D sensing side. So you've basically de-risked the entire model, talked about it being pretty insignificant in terms of the out year. You just mentioned that how that business trends is highly correlated with how, like, your lead customers are being there. There's talk about potentially somewhere down the road there being additional technology opportunities with the front-facing sensor under glass, and today you see increased competition on the back side of the phone. Share has moved around on the... Can you talk about, to your knowledge, what you guys can do in a world in which that technology transition occurs?
Financially, just given the fact that that gross margin profile has always been the best of your business, what does that mean for you? Is there any expectation or early days of development with that customer?
Yeah, so I mean, obviously, we can't talk about some of the R&D projects we're working on with, with not just that customer, but also with other customers, that we've got. But, you know, in our most recent quarters, we've generally seen that customer hover around 10% of our sales. And, you know, we're continuing to stay engaged with that customer, in their, R&D roadmaps, as well as their new product development, whether it has to do with their mobile phone or whether it has to do with, the other, their iPads or of that nature.
So, you know, as their technology changes, I can say that they like to tap on us because they know that they can work with our R&D teams to come up with innovative products that will have good time to market and be able to ramp as their demand ramps. But beyond that, there's not really much I can say about that. But you're right, we have de-risked the model in terms of what our expectations are, at least at a steady state level.
Just want to use this opportunity. We have a couple minutes left here. If anyone in the audience had a question, if they would want to raise their hand, we can get them a microphone. I had a couple more, so Bill is being today. All right. Capital allocation. Not a, not a crazy question right now, just because you just did the deal.
Right.
But you still have a lot of cash. When you look at where your cash priorities are over the next 1-2 years, can you talk about how you'd do additional deals, you buy back some shares, kind of there?
Yeah. So I mean, even after the Cloud Light acquisition, we've got quite a bit of cash on our balance sheet, and we've got a convertible debt that's due in the middle of March. And so our plan for that is to use the cash on the balance sheet and pay that off. We do still have some authorization left for share buybacks, and that's something that we're always considering. And I think that a lot of the CapEx investments we needed to make in the core part of the business has been made, and I think we're investing appropriately from an R&D standpoint as well.
So there is still sufficient cash on our balance sheet to go back and take a look at where there are—there are other opportunities that enable a strengthened product portfolio across either one of our product segments. So, so I certainly think that there's an opportunity to continue to do some acquisitions that continue to strengthen the company.
Yeah. I just wanted to offer one final question, and this is one we ask of most companies here, is when you look in 2024, clearly, we spent a lot of time in this fireside talking about the new acquisition. But what are you most excited about as a company? And what would you point to investors as why they should be looking at the Lumentum stock today?
Yeah, I mean, we're clearly from the conversation we've just had, we're quite excited about the opportunities presented to us in the Cloud Light acquisition. But we're also very excited about the fact that, you know, our classic Datacom EML business could be a nice collection with what we believe we will have a competitive advantage on with our 200G products. And we could see a very good cycle again with that product set. And, you know, the amount of activity that's going on with hyperscale customers and the opportunity to vertically integrate into hyperscale transceivers, it just really provides us with a great opportunity to continue to grow our business.
Very helpful. Thank you so much for being here.
Thank you.
Have a couple of days, and thank you all for joining.
Thanks, Tom.