Good morning. My name is Rocco and I will be your conference operator today. At this time, I would like to welcome everyone to the Lumentum and Coherent Combination Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. The call is scheduled for one hour. As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to Jim Fanucchi of Darrow Associates. Sir, please go ahead.
Thank you, Operator. Welcome to our call to discuss this morning's announcement that Lumentum is acquiring Coherent. This is Jim Fanucchi from Darrow Associates assisting Lumentum with its investor relations. Joining the call today from Lumentum's management team, we have Alan Lowe, President and Chief Executive Officer, Wajid Ali, Chief Financial Officer, and Chris Coldren, Senior Vice President of Strategy and Corporate Development. Also joining this morning's call is Andy Mattes, Coherent's President and Chief Executive Officer. Please note that this call will include forward-looking statements, including statements regarding our expectations regarding the acquisition, including expected synergies, future financial and operating results of the combined company, expectations regarding accretion, benefits to customers, and time to closing, as well as strategies of the combined company and the markets in which we operate, including trends in those markets and growth opportunities.
These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations. We encourage you to review our most recent filing with the SEC, particularly the risk factors described in our quarterly report on Form 10-Q for the quarter ended September 26, 2020, and the risk factors described in Coherent's annual report on Form 10-K, both of which have been filed with the SEC, as well as those in the S-4 to be filed by Lumentum with the SEC at a future date, and in the documents which are incorporated by reference therein. 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. Neither Lumentum nor Coherent undertake any obligation to update these statements except as required by applicable law.
A recording of today's call will be available by 11:30 A.M. Eastern Time this morning on Lumentum's and Coherent's websites. Before handing it to Alan, some additional points. While Lumentum and Coherent announced preliminary financial results for their respective fiscal second and first quarter, I do want to remind everyone that the focus of today's call is the transaction the two companies jointly announced earlier this morning. Lumentum plans to release its second quarter financial results and host a call to discuss these results on February 2nd. A press release with these details will be issued later this week. Additional details about Lumentum's second quarter results will be provided and discussed then. Coherent expects to release its full first quarter financial results the second week of February. For those following along with the presentation posted on our website, please turn to slide five.
I will now turn the call over to Alan.
Thank you, Jim. Good morning, everyone, and thank you for joining us on such short notice. This is a very exciting day. Earlier this morning, Lumentum announced that it will acquire Coherent, uniting two complementary industry leaders to accelerate the future of photonics. The combination creates a leading, highly diversified photonics technology company with significant increased scale and market reach. The combination also accelerates Lumentum's penetration of the significant opportunity for lasers and photonics outside of optical communications and 3D sensing. Before we get into more detail about the many compelling benefits of the combination, we will provide a brief overview of each company and the key positions we have in our markets. Please turn to slide six. For those of you on the call who are new to Lumentum, we are a leader in multiple growing market segments that benefit from the capabilities of photonics.
The type of products and technology we supply help accelerate the speed and scale of the world's internet, cloud data centers, and 5G networks. The unfolding computer vision revolution is just now underway and is driving applications enabled by our photonics technology, including biometric facial recognition, computational photography, LiDAR, and augmented and virtual reality. In our five years as a public company, we have made great strides in executing our strategy to grow and win, which is grounded in leveraging our broad technology and manufacturing capabilities, investing in and creating the best performing and highest quality products, and developing and nurturing close relationships with market-leading customers by enabling them to win. As part of this strategy, we have also successfully executed on other transactions.
For example, we closed our acquisition of Oclaro two years ago, and since then, we have achieved the objectives we set out when we announced the transaction. We have positioned ourselves as leaders in telecom and data com transmission solutions, and we significantly exceeded our synergy targets. We've integrated our teams, operations, and systems. Today is another big step forward that advances our strategic objectives, and we expect to build upon our track record of successful integrating acquisitions. We are confident we can achieve the goals of this transaction. I'm now happy to turn the call over to Andy Mattes, Coherent's President and Chief Executive Officer, who's here to tell you more about Coherent and why he believes this combination is so compelling. Andy?
Thank you, Alan. Good morning, everyone. I'm pleased to be here with you today.
Alan, I share your enthusiasm for the future of our two great companies and their combination. For those of you who are unfamiliar with Coherent, we are one of the world's leading laser and optics suppliers for the microelectronics, precision manufacturing, instrumentation, and aerospace and defense end market. Coherent has a 50-year history in photonics and lasers, over which time we have developed a portfolio of industry-leading products, built one of the most recognizable and respected brands in the industry, and generated a strong customer base. We are most well-known for our strength in OLED display manufacturing. On our last earnings call, I outlined the core elements of Coherent's go-forward strategy. These include focusing on certain key end markets driven by positive long-term market trends, new opportunities to expand our addressable market, and operational efficiency.
I believe combining with Lumentum can significantly accelerate these strategies and further position us for success. The combination will accelerate photonic innovation and expand our addressable market and improve operational efficiency by leveraging the scale and experience of the combined organization. This combination is beneficial for all our stakeholders. The transaction delivers immediate and substantial value to our stockholders through a cash and stock consideration with a significant premium, as well as meaningful participation in the long-term success of the combined company. Our talented and committed employees will benefit from new and exciting career opportunities as a result of the enhanced scale and breadth of the combined growing company, and our customers will benefit from a stronger supplier with a much broader set of capabilities committed to advancing lasers and photonics over the long run.
We are confident that Lumentum is the right partner for Coherent's next phase of growth and are excited to get to work to pave the way forward for the photonics industry for the next 50 years and beyond. Lastly, I want to recognize the success that Alan and the Lumentum team have achieved over the past few years in the industry. I'm confident that they share many of the same priorities and passions that we have for our organization going forward and look forward to working closely with Alan and his team to capture this great opportunity.
Thank you, Andy, for the kind remarks and for your leadership in getting us to this day. I'd now like to walk everyone through the compelling strategic and financial benefits of this combination. Please turn to slide seven of the presentation.
The combination of Lumentum and Coherent will create a leading photonics technology company with an expansive global customer base and a well-diversified revenue mix. The combined company will have exposure to large and diverse photonics market segments and will have room for growth. Uniting Lumentum and Coherent brings together highly complementary products and technologies and expands on our intersection with the value chains of important secular trends that are increasingly utilizing photonics. The combined organization will be well-equipped to accelerate innovation, pursue catalysts for future growth, and drive new opportunities from conception to volume deployment. Together, we will benefit from a very capable and innovative combined R&D engine, track record of customer-centric innovation, and strong customer relationships. Combined, we'll be an even better partner for each of our customers.
Lumentum is strongly committed to investing in innovation and manufacturing capabilities to deliver on customers' photonics needs today and into the future, and finally, the combination will deliver substantial run-rate synergies and achieve best-in-class financial performance. Wajid will get into more detail on the financial aspects of the deal shortly. Turning to slide eight, Lumentum and Coherent have complementary positions in major photonic market segments. In combining with Coherent, we accelerate our exposure and penetration of the more than $10 billion market segment for lasers and photonics outside of telecom, datacom, 3D sensing, and LiDAR. The combined company's growing addressable market at an estimated $20 billion in calendar year 2020 provides ample room for accelerated top-line growth. Now turning to slide nine, the added market exposure and relevance I outlined materially diversifies our revenue mix in terms of end markets and customers.
This combination will establish us as one of the largest photonics technology companies with nearly $3 billion of combined photonics revenue over the last 12 months. As we have seen over the past several years, scale matters. Both of our businesses benefit from economies of scale and operating leverage. Combining allows us to increase these benefits. Large scale increases global market reach, R&D and manufacturing resources, and the ability to shift resources and funding to address new opportunities and to make investments in fundamental technology. Slide 10 and 11 highlight important strategic aspects of this transaction. This transaction expands our opportunities to intersect key mega trends at multiple points along their value chains where photonics can bring value. On slide 10, Lumentum's products today serving the telecom, datacom, 3D sensing, and LiDAR markets fall on the right side of the chart.
These types of products are embedded in the operation of consumer electronic devices, cloud data centers, communication systems, and over time, next-generation vehicles. In combining with Coherent, we get a broader exposure to the other end applications where photonics are embedded, such as in the life sciences and aerospace and defense, which you will see on the next slide. The combination with Coherent also brings significant exposure to other portions of the value chain for the applications I've mentioned and many more we don't participate in today. This includes significant exposure to the photonics used in scientific and research applications and in the manufacturing of a wide range of high-value microelectronics and materials used in consumer electronic devices, communication systems, and electric vehicles.
Turning to slide 11, combining with Coherent significantly increases our exposure and relevance to the key applications shown here and position us at the forefront of many long-term growth trends. The COVID-19 pandemic has underscored the importance of diagnostic tools, which are increasingly dependent upon lasers and photonics. In combining, we gain significant exposure to the instrumentation and life sciences and markets. Likewise, the aerospace and defense end markets are increasingly turning to lasers and photonics in new applications. All aspects of life, work, education, entertainment, social interaction, and health and well-being are driving staggering increases in the bandwidth traversing the world's communication and cloud data center networks. With 5G starting to roll out globally, demand for the world's cloud and communication networks will only further increase. Laser-based 3D sensing and LiDAR are increasingly being used in a wide range of applications to improve security, safety, and quality of life.
These trends will drive strong long-term demand for our telecom, datacom, and 3D sensing photonics products. These trends will also drive new generations of increasing volumes of microelectronic products, including semiconductor chips, OLED displays, and other microelectronics used in 5G communication systems and consumer electronic devices. As I mentioned on the prior slide, Coherent brings us significant new exposure to the manufacturing of these items and allows us to participate in microelectronics supply chains in addition to photonics supply chains. Additionally, addressing climate change is increasingly important and is driving the transition to new electric vehicles and energy storage solutions. Lasers and photonics are increasingly being utilized in the manufacturing supply chain for these important applications.
Summarizing, while remaining a photonic technology company, combining with Coherent significantly increases our exposure to the growth related to the transition to 5G and electric vehicles, consumer electronic trends, and the necessary hardware to support the staggering growth in communications and cloud bandwidth. With that, I will now hand it over to Wajid to provide more details on the financial terms and benefits of the transaction. Wajid?
Thank you, Alan. Good morning, everyone. Under the terms of the transaction, which has been unanimously approved by the board of directors of both companies, Coherent stockholders will receive $100 per share in cash and 1.1851 shares of Lumentum common stock for each Coherent share they own. This equates to a total transaction value of approximately $5.7 billion. At closing, Coherent stockholders are expected to own approximately 27% of the combined company. In addition, two Coherent board members will be appointed to the Lumentum board in connection with the closing, and the board will be expanded to nine directors. We currently expect the transaction to close in the second half of calendar year 2021, subject to the approval by Lumentum's and Coherent's stockholders, regulatory approvals, and other customary closing conditions. We expect this transaction to deliver significant financial benefits and drive enhanced value for our stockholders.
Given the complementary nature of our businesses, we expect to generate more than $150 million of annual run-rate synergies within 24 months of the close of the transaction, driven by increased efficiencies in manufacturing capabilities, supply chain cost reductions, and alignment of business processes and infrastructure. For modeling purposes, we believe these expense synergies will be approximately two-thirds in the area of cost of goods sold and one-third in operating expenses. The transaction is also expected to be accretive to the combined company's non-GAAP earnings per share during the first full year after close. While not included in our synergy estimates, over the longer run, we are targeting additional growth in revenue and earnings from new product differentiation that results from the combined company's innovation engine in both existing and new markets.
As you have heard this morning and in our prior earnings call, we expect to continue to invest strongly in R&D given the growth opportunities ahead for us. Turning to slide 13, the cash portion of the transaction is being financed through $1 billion of cash from the combined balance sheets and $2.1 billion from a fully committed Term Loan B credit facility that will be available at the time of close. The stock portion will be funded through the issuance of $29.9 million additional Lumentum shares. I note that part of the cash will be used to pay down some of Coherent's current debt.
At the time of this announcement, the incremental $2.1 billion of term debt is in addition to Lumentum's existing $1.5 billion in convertible debt and results in a net debt position of approximately $2.3 billion and a total gross leverage ratio of 3.9 and a net leverage ratio of 2.5. This includes approximately $150 million of synergies and is based on the last 12 months of combined company pro forma EBITDA. With the anticipated growth in both companies, especially relative to the last 12 months, which included the impact of COVID-19 to both businesses, the leverage ratio may be lower at the time of the closing. Similar to our last acquisition, we will be very focused on quickly attaining acquisition synergies and delevering our balance sheet.
Turning to slide 14 and 15, I would now like to provide you with an update on the strong preliminary fiscal second quarter results we also announced earlier this morning. We expect net revenue for the second quarter to be approximately $478.8 million. We expect GAAP operating margin will be in the range of 22.6%-24.1%, and GAAP diluted net income per share will be in the range of $0.98-$1.06. We expect non-GAAP operating margin will be in the range of 34%-35.5%, and non-GAAP diluted net income per share will be in the range of $1.91-$1.99. As highlighted in the press release with our preliminary financial results, we anticipate scheduling our Q2 fiscal year 2021 earnings call to be on February 2nd. We look forward to discussing our results and providing third quarter guidance then.
A press release with that call's details will come later this week. Now I'll hand it back to Alan for his closing remarks.
Thanks, Wajid. Before we conclude the call, I want to reiterate how excited we are about the benefits of this combination for our stakeholders. For customers, we are committed to the photonics market and to strongly invest in innovation and manufacturing capabilities to deliver on customers' needs today and into the future. The combined company will have a larger global footprint and a broader portfolio of products and technology relevant to customers who increasingly need a broader array of photonics solutions. Importantly, we expect the transaction will create new and exciting career opportunities for our employees as we become a larger and more broadly focused and growing company. Lastly, as we've discussed in detail, we believe this transaction will create significant value for our stockholders. We will be creating a company with even stronger and more diverse long-term growth opportunities and sustainable technology positions.
We are prepared to quickly execute plans to attain synergies and pay down debt incurred in connection with this transaction. I want to thank you all for joining us here today. We hope you share our excitement about this announcement, which will enable us to unite two global industry leaders to accelerate the future of photonics. As I often say on our earnings call, the future is truly bright at Lumentum, and with the addition of Coherent, it will be even brighter. With that, I'll turn the call back over to Jim to start the Q&A session. Jim?
Thank you, Alan. We recognize we had a lot to go over today, and we want to be mindful of the time. To help ensure we can get to as many people as possible, I would like to ask everyone to limit discussion to one question and one follow-up. Operator, please take our first question.
Thank you, sir. And as a reminder to everyone, if you'd like to ask a question, please press star then one to enter the queue. And if your question has been addressed and you'd like to remove yourself, please press star then two. Today's first question comes from Simon Leopold with Raymond James. Please go ahead.
Great. Thank you for taking the question. Two things I want to ask about. The first one, I have to imagine you're prepared to answer, has to do with obtaining regulatory approval in China. I assume that that's significant, and given what we've observed over the last couple of years of other deals, just want to make sure I understand what sets your expectations regarding obtaining timely approval from SAMR. And then I've got a follow-up.
Yeah. Hi, Simon. Good morning. Thanks for the question. We've looked at this transaction for quite some time and been really admiring Coherent and the team there. Through the process of getting to today, we certainly have had a lot of advisors advising us on SAMR and antitrust. And I think the complementary nature of our product lines and the advice we're getting says that we should have a timely approval from all the regulatory approvals that we need. And so from that perspective, I think we don't expect any delays.
Thank you. And then just as a follow-up, it does appear to be that Coherent's gross margins are lower than Lumentum, even lower than Lumentum's similar products, the industrial commercial lasers. And I want to see if you could help explain what that's about, whether it has to do with any differences in accounting treatment or what might explain that and how you would expect the gross margin might be following the synergies. Thank you.
Yeah. Hi Simon, it's Wajid. So yeah, you're absolutely right. So the gross margins for Coherent's business is lower than Lumentum's. It's not really due to differences in accounting treatment. The accounting treatment is pretty similar to how we run our business. We spoke about the $150 million of synergies we're expecting within the first 24 months of the close of the transaction. And two-thirds of that $150 million are expected to flow through cost of sales. And so clearly, we expect to see Coherent's gross margins improve as we exit the first year as well as the second year. If you've followed Coherent for some time, you know that historically, Coherent has also had much higher gross margins than they've achieved very recently. And so we see that cycle coming back for us. And so we'll see some tailwind there as well. So I think we're well-positioned.
We've got a lot of experience in executing on synergies. I think that doesn't need to be said enough with how well we did with Oclaro. And then on top of that, the cycle coming back with Coherent should just be a nice tailwind as well. So we expect very good gross margins out of the Coherent business and to have two strong segments within our company, both with just phenomenal gross margins.
Thank you.
Our next question today comes from Rod Hall with Goldman Sachs. Please go ahead.
Yeah. Hi, guys. Thanks for the question and doing the call so quickly here. So wanted to ask about the Coherent laser annealing business for OLED. We understand that's how they make most of their money. I'm curious what the synergy between that business and your own smartphone supply business might be, or if there is any. And then also curious whether if you could go into a little bit more on other applications you see for these technologies that would allow you to add more revenue beyond just that annealing process. And then I have another question.
Andy, why don't you take the question about the annealing, and then we can talk about kind of the customer synergies after that.
Yeah. Happy to. Annealing is one of the key markets that Coherent is in. It's a very important piece of our portfolio. It's a very margin accretive piece of our portfolio, and we see this as a very strong market as we go into this exciting combination. And if you extend the dots going forward, we think a lot of goodness is going to come for all of our customers once you start combining our businesses.
Chris, do you have anything to add there? I mean, I do think that the complementary nature of our product lines, not only in lasers, but across the product portfolio, really gives us the ability to have positive revenue synergies with relationships that this combination really brings to the combined company, so I think there's lots of opportunities to be able to really grow in the future, and it's really a matter of having two great teams come together and figure out how to work together to allow our customers to win, and when they win, we'll win.
Yeah. What I was getting at is they both, they're different buyers. I mean, one is a direct buyer for a smartphone, and the other is upstream from that. And I was curious whether that sounds like there's maybe revenue synergy, but I wasn't clear how that might come together. It sounded like Chris, you were going to maybe answer that.
Yeah. I was going to amplify on that, Rod. I think you're headed in the right direction, that certainly there's differences within the direct organization that the product might go to on the two sides of the combined company. But nonetheless, these very large customers that buy microelectronics, they buy or build displays, they may be incorporating 3D sensing. At the end of the day, having a broader portfolio of capabilities and technologies to engage those customers with increases our relevance, moves us up the list of suppliers that they want to have strategic relationships with. And so it pays dividends, as Alan said, from literally coming up and engineering great new products, but as well building those relationships with those key customers, their executive teams, their senior technology and supply chain teams.
So we do think that there's certainly a lot of benefit from just the narrow business we're talking about here in laser annealing. But the same thing is true as you start talking about more broadly other products that supply into the microelectronics supply chain. I mean, it's something that Alan hit on in the prepared remarks, and that is our exposure on the Lumentum side over time is really just in optical devices that go into the application, whether that's 3D sensing lasers that go into smartphones or the optical components that go into communication systems. By combining with Coherent, we then have exposure to essentially the electronics supply chain, microelectronics, semiconductors, displays, etc. So we think that's really an important factor.
Okay. Okay. Thank you. And then the follow-up was just on the $150 million of synergies. I wouldn't have expected two-thirds to be in COGS. So could you guys dive into that a little bit more in detail and explain, maybe Wajid, you could do that, and why that is the case? You're combining manufacturing facilities or some sort of manufacturing synergies. Help us understand that. And then the other third of it, I assume that's central cost, but maybe talk to us about whether there's potential upside to that. Thanks.
Yeah. I'm not going to talk about whether there's potential upside to that. We'll certainly keep you updated like we did with the Oclaro synergies and provide you updates on a quarterly basis on how we're doing. But for now, I think we should keep the $150 million in front of us. A lot of what we did with Oclaro, we're looking to mimic that with Coherent. We've taken a look at the manufacturing footprint of Coherent and taken a look at where we think we can provide better efficiencies and where we can potentially provide some level of consolidation, and whether that's with our own manufacturing operations or whether that's entirely eliminating some of the plants as well. So as we've gone through that, we've gotten a lot of comfort level around most of the synergies being in cost of goods sold.
In addition to that, one of the things that really worked well for us was raw material savings with the Oclaro acquisition. When we took a look at the details of Coherent's bill of materials and their MRP, we saw a lot of opportunity there and a lot of overlap with the suppliers that we work with as well as the materials we buy. And so that was the other area of opportunity for us. There's also some opportunity for consolidation within our fixed manufacturing overhead as well. As you can appreciate, that can give us a lot of leverage on the upside. And so that's how we're thinking about manufacturing. On the operating expense side, Alan mentioned earlier in the prepared remarks, when we purchased Oclaro, we actually increased our overall R&D spending as our company grew.
And so most of the operating expense synergies that we'll see will be in common infrastructure and things of that nature, as you can appreciate, as well as public company costs that we expect will just come off right away pretty quickly as soon as we close the transaction. So that's how we're thinking about it.
Great. All right. Thank you.
And our next question today comes from Tom O'Malley with Barclays. Please go ahead.
Good morning, guys. Thanks for taking my question. My first one's really about the crossover in commercial lasers and materials processing. I think when I look at the two businesses, obviously those are the closest in relation to one another between the two companies. And I've heard commentary from both of you guys about how that market's become inundated with more competition in China, and clearly it's struggled kind of over the last year. Can you talk about one, does the combination and scale change that outlook? And two, Andy, you walked away from some business there earlier in the year. Is there a new focus? Are you going to be doubling down there, or will there be additional paring in those areas?
Yeah. Thanks, Tom. We're not going to get into the details of the integration planning that we're about to start, but I'd say that we do believe with respect to the scale that, for instance, I think you're implying about the fiber laser business. We have a very successful fiber laser business. We have a successful partnership with a very large customer. We think we can continue to leverage that partnership and expand upon it, both within that leading customer, but also by combining the two companies together and being one, we think we're going to have a lot of opportunity to really grow that business both at the component level, at the subsystem level, and at the fiber laser level. So I think the opportunity is huge and really opens the door for us to really grow that macro machining business for the combined company.
Great. And then my second one was on the A&D side. Andy, you recently mentioned that it was a new focus of the business. Perhaps you can talk to how the integration will help grow that business, given it was going to be such a point of focus here over the next year. How does Lumentum kind of help expand upon the initial goals there from the Coherent side?
Happy to. And without going into too many details that we still all have to work out in our integration teams, but just if you think about the focus and the encouraging early successes that Coherent has in our A&D business, and then you take all the IP that Lumentum has in its sensing business, you also think about all the IP that Lumentum has in photonic-based circuits. So without going into an R&D planning roadmap here, you can envision that there will be many exciting opportunities to broaden the portfolio and to be more relevant to our customers, and it will be a growing segment for the combined company going forward.
Thanks, guys.
And our next question today comes from John Marchetti with Stifel. Please go ahead.
Thanks very much. Alan, I wonder if you could just address for a moment maybe what this deal suggests for the optical communications market for you. Obviously, with some of the consolidation that's happened there and your commanding position, particularly on the telecom side, the move to really just providing chips on the data com side, is this deal sort of suggesting that maybe growth rate there is somewhat limited to whatever the market is, and there's not really an opportunity for more share gains? Just how to think about maybe the underlying trends within that optical communications business given the deal today.
Yeah. Thanks, John, for the question. I'd say that this is right in the wheelhouse of our strategy, which is really to make sure that we capitalize on the core technology that we have between the two companies to grow and expand within all of our markets. And I'd say specific to your question on telecom and datacom, I mean, that business has been muted with respect to this calendar year 2020, and I think that the demand sure hasn't slowed down. So our outlook for telecom and datacom is as strong as it's ever been. And I think that as vaccines get rolled out, we're very optimistic about how deployments of our new leading-edge products, both on 400, 600, 800 gig transmission, as well as next-generation ROADMs, where we have a very compelling customer value statement with those products, will really roll out in a meaningful way.
So this has no reflection in our confidence in the outlook for telecom and datacom. And in fact, I'm as excited about that part of the market as I have been in quite some time.
And then maybe just as a follow-up to that, Alan, how do we think about the significant increase in overall company revenue that's now exposed to consumer electronics, and particularly within the handsets, right? With Coherent's OLED business and your 3D sensing business, there's an awful lot of focus now on the consumer electronics market, which we know is subject to a lot of different share shifts and some things of that nature. So I guess from that exposure or market exposure, how do you think about some of the puts and takes and the risks there?
Yeah. Let Chris.
Hey, John.
Address that one.
Yeah. Hey, John.
Good morning.
Good morning. Yeah. So I think you hit the nail on the head that we get increased exposure to the consumer electronics. We get increased exposure to the cloud data center market. We get increased exposure to the optical communications market. And I'm underscoring that because of the role that the combined company's products play, not even the components that go into those infrastructure, as well as the manufacturing of the semiconductors and many other things that go into it. With regards to the consumer electronics side, we think there's a lot of transitions underway, whether that's LCD going to OLED and other advanced flat panel technologies that will drive more and more use of Coherent's technology, the transition from 4G to 5G. And there's something that comes after OLED, and there's something that comes after 5G that, again, will require that strategic partnership between us and those leading-end customers.
I think it's something that we've said repeatedly about how we view our role in the world and how we believe, or at least our customers tell us our role as an extension of their advanced development teams, so that as we work together with a broader suite of capabilities with those big consumer electronics customers, we can essentially architect the future together. The fact that we get another way of getting exposure to consumer electronics or electronics in general is just the very nature of where technology dollars are being spent, and we're trying to optimize, as we said in the prepared remarks, the number of intersections we can have with the value chains of all of these long-term trends that are unfolding.
Thanks, Chris.
And our next question today comes from Meta Marshall with Morgan Stanley. Please go ahead.
Great. Thanks. Maybe just a couple of logistics ones. With the Oclaro deal, there were a number of businesses that you kind of exited or had revenue disintermediated from. Is there any expectations of businesses that you might exit or there might be some overlap that we should be mindful of? And then maybe just a second question on understanding you plan to pay down the leverage quickly, but is there just a target leverage level we should be thinking of that you'd like to operate at? Thanks.
Yeah. Hi, Meta. I'll take the first one and then let Wajid answer the leverage question. I'd say that we're really excited about today. The announcement of bringing the two great companies together is what we're focused on. I think the next stage of the combination is really to do the integration planning, and through that integration planning, we'll figure out how to really strengthen and accelerate the innovation of some of the great product lines that come with Coherent and then figure out how to get those $150 million in synergies or more. I'd say that there's nothing on the chopping block that we know of today that would be product exits, but I'm not ruling that out.
I think that, to your point, as we showed with Oclaro, this kind of transaction really gives us an opportunity to look at how do we make sure we're focused on the right and growing product and market, and how do we maybe lessen our focus on ones that are going in the other direction. I think over the coming weeks and months, we'll have that all vetted out, and we'll share that with you. Wajid.
Yeah. Hi, Meta. So if you take a look at our current combined leverage, we're sitting at currently under two and a half times, and so we're going to be moving up to 3.9x , at least at the beginning. Our comfort level is to get it back down to under two and a half times from a gross leverage standpoint. We feel quite comfortable with the combined companies' EBITDA, as well as the CapEx requirements that we'll be able to get there pretty quickly, and so I don't want to give a timeframe right now, but our expectation is we'll be able to get down to under two and a half times gross debt to EBITDA in a pretty short period of time.
Great. Thanks.
And our next question today comes from Christopher Rolland with Susquehanna International Group. Please go ahead.
Hey, guys. I guess my first question is kind of given premiums for stocks that are trading out there in the industry today, why did you guys think that now was the right time to do this deal? What was the thinking behind the timing here? And then secondly, any other details as to why you felt the premium that you paid for the stock here was necessary? Thank you.
Yeah. Hi, Christopher. I think we're not going to comment on the timing issue other than to say Coherent is the crown jewel of the lasers industry, and we're super excited about the combination. I think through the negotiations, we think we have come to an agreement on a fair and equitable price that's good for our shareholders, good for their shareholders, and the mix of cash and stock also gives their shareholders an ability to play on the upside as we really integrate and grow the business and take advantage of this huge market that we're really opening up. So I think from that perspective, it's a win-win all around.
Great. And then as we look at the synergies breakdown here, the COGS, your synergies are really impressive here. And you hinted on where we might be getting some of that, but any more detail there would be great. More specifically, I'm wondering, were there pricing issues? Were they pricing below market in certain areas? Do you plan to tweak pricing? Exactly where in the manufacturing process are you expected to unlock all of these synergies? And then kind of related to this as well, SG&A as a percentage of semiconductor deals is significantly higher for everyone else. And I'm wondering why it's so small for you guys as a percentage of total. For many of the deals we've looked at, we've been able to eliminate 40% of SG&A costs, and we're nowhere close to that for this.
I'm wondering where the delta between most deals and this deal are. Thank you.
Sure. Thanks, Christopher. I'll take the COGS question and then ask Wajid to cover the SG&A. I think if you paid attention to Andy's recent earnings call, he's been talking about Good to Great and the plans that they have in place to really drive gross margins and really optimize the efficiency of the manufacturing operation. I think as we combine, that just accelerates our ability to execute upon what Andy's been talking about, so it's really nothing different than what Andy has been outlining and highlighting in the calls, and I think together, we really accelerate that ability to capture the things that already are on the roadmap, and again, it's early days, and through the next several weeks and months, we'll get into the integration planning, so we'll work on that acceleration of the Good to Great plan that Andy and his team have really developed.
And I'm super impressed with their team and how they've looked at everything within the company. And so I think that that's really what we're focused on. Wajid, do you want to take the SG&A matter?
Yeah. Sure. So okay. So there were kind of a couple of different questions within that SG&A. So first of all, why is it that as Lumentum, we've been running SG&A so tightly? I think that really shows what happened after we combined with Oclaro. We were able to take our fixed SG&A base and really leverage it quite well with the additional revenues that we had once we combined with Oclaro. With Coherent, as it relates to Coherent, you mentioned that 40% number. I'd really take Coherent's SG&A and break it out into S and then G&A. And so as far as the S portion is concerned, Coherent's business is expected to grow. We expect it to grow. Coherent expects it to grow.
And so our expectation is that we will continue to find leverage in S, but we will probably continue to invest in S as that portion of the business grows. Now, on the G&A side, which is really where we were able to find benefit with Oclaro, we see a lot of opportunity with Coherent as well. And so we've given you our estimate for now in terms of the two-thirds, one-third. We'd like to keep with that. But yes, there's certainly a lot of opportunity on the G&A side and how we can leverage that with one combined company. But at this point in time, we're not going to make any commitments beyond what we've already said.
Super helpful. Thanks, Wajid.
Our next question today comes from Brian Lee of Goldman Sachs. Please go ahead.
Hi. Good morning. This is Grace on for Brian. I have two questions. So for Coherent industrial laser business, so that business has been very profitable over the years, particularly relative to the OLED side. Any thoughts on how to address that and what this combination could do specifically to improve gross margins for that segment? Thanks. And I have a follow-up.
Grace, just very simply, we've started our Good to Great transformation. Alan has just pointed out to it. This combination will put our Good to Great transformation on the HOV lane. We will be able to move even faster, and if you take a look at the preliminary earnings that Coherent announced this morning, you can see our gross margins are already starting to move in the right direction.
Okay. Also, you mentioned vertical integration as a topic for the deal in terms of Coherent. There's been a deliberate insourcing strategy in place for a while, but what else are you referring to on the vertical integration strategy that could result in more synergies and cost benefits?
Yeah. I think everything is on the table. And I think as we get together with the very impressive Coherent management team, we'll work on the integration plan and what that means for vertical integration. And I think we've already looked at some opportunities for more product synergies from one to the other. And I think we're going to continue to look at how we take advantage of that. And I think as we look at the integration planning, that stuff will be vetted out. I don't know. Andy, you want to comment as well on this?
Yeah. Just focus the lens going forward. There's some really exciting markets. If you listen to Alan's prepared remarks, Lumentum has a very strong position in the EV market. Coherent has a very strong position and a very unique application with its ARM laser in this market. So there's many things that we will be able to work on that our teams will be able to put on the drawing boards and that our customers will benefit from when it comes to new product offering. So super excited about enhancing the portfolio.
Okay. Great. Thanks for the color.
Our next question today comes from Tim Savageaux with Northland Capital Markets. Please go ahead.
Hi. Pardon me. Good morning. Kind of circled around this a bit, but as you look at synergy potential on the gross margin side, to what extent do you expect manufacturing outsourcing to play a significant role there?
Yeah. So I think that's a great question, Tim. So like Alan mentioned, we are going to be going through our integration planning. We have some initial thoughts around what type of outsourcing activities can take place. And we've looked at some of the cost and benefits of that. But at this point in time, kind of making any specific comments about how we're going to be outsourcing some of the manufacturing is a little bit early. But that's certainly on the table as a critical pillar in terms of how we pull out costs from the Coherent manufacturing footprint.
Great. And to follow up there, I mean, gross margins are a bit higher this morning, but in general, Coherent's margins are not dissimilar to Oclaro's kind of at the time of the acquisition. And you were able to put upwards of 1,000 basis points on those. This question was kind of asked before, but I'm going to try it in a different way, which is, are there any analogies to the kind of module device dynamic that was so critical in the Oclaro integration, which is to say maybe there's something farther upstream that's lower margin and some core device or laser value that's higher margin that would allow you to kind of do something similar to what you did there? Thanks.
Hey, Tim. This is Chris. I'll take that one. Let's backpedal slightly and then get to that. First is, I think that we need to highlight we're coming off of, in the laser space, a pretty rough time period coming from COVID-19 and some other things that have happened ahead of that. So first of all, I think when we talk about Coherent's gross margins, we really need to think about what they will be at more normalized run rates than the current run rates. So I think if you look at our lasers business, margins are higher, but that's also because of the common scale we have in the company that our lasers business leverages the strengths that we're having in the rest of our businesses in telecom, etc.
And so I think on a combined basis, we get that benefit of sort of shared infrastructure costs, if you will, the diversification benefit, if you will, and operating leverage benefit. At the end of the day, very different end markets. The products are different, but the underlying technologies, how you put them together, the fundamental materials are very much the same. Then we layer on vertical integration. There is lots of vertical integration capability or opportunities multiple ways within the company of technologies we have that can supply into Coherent's products today and vice versa. But then to your point about module systems, there's certainly opportunity both in two phases, I would say.
There was, with the Oclaro acquisition, there was a little more making decisions that may be more difficult to make as a standalone company, but as a larger combined company that you might be willing to make a little more quickly and swiftly. But then on top of that, and I think this is more unique in the laser space than there perhaps is in the communication space, is the opportunity to move up, not just down, if you will, the tech stack as we did with the Oclaro acquisition and the datacom business. So opportunities to actually bring more product and value together for our customers, in a sense, moving up the food chain. And I'm not saying competing with those customers. I'm saying offering more of their share of or getting more share of their wallet with the combined capabilities of the companies.
In a sense, selling subsystems, I think, is the way Andy and his team have characterized that. And on a combined basis, we have more opportunities to do that. So sorry for the long-winded answer, but I think there's a lot of pieces going into why we believe over the long run that the incremental gross margin coming from the Coherent business over the long run is not inconsistent with our gross margin goals for the company and something that we should continue to emphasize over and over. This is a very strategic transaction based on not the next six months, but the next, as Coherent talks about 50 years.
I'm not to suggest that we're, if you look at the synergy numbers and the accretion timeline, we think this is going to be a very good transaction financially in the short to medium term, but this is really about the long term and what can be done together.
Ladies and gentlemen, we have time for one more question. Our last question today comes from Samik Chatterjee with JPMorgan. Please go ahead.
Hey, guys. Thanks for squeezing me in. I just wanted to just start off with a more broader question about the $10.6 billion TAM that you outlined for Coherent. If you could give me a bit more granularity around it as to what are the bigger drivers? More importantly, when I think about growth opportunities, which are the end markets that are more important in terms of growth, or how would you really quantify the growth for that $10.6 billion addressable market? And I have a follow-up. Thank you.
Yeah. So certainly, for that full 10.6, that's a comprehensive market, if you will. So I think if you were to look at market research reports, it's in the 5% plus kind of CAGR. But if you look at it from the standpoint of where we're choosing to play and optimizing our businesses, where we're even on a combined basis, only a portion, a smaller portion of that entire market, and so as we focus on where the growth opportunities are in new materials for new materials, advanced semiconductor chips, Andy alluded to opportunities as the transition to electric vehicles, transition to 5G, transition to OLED. These are all driving substantial volumes, if you will, in the laser space, as well as the two areas that we've just touched on slightly.
But life sciences and the world's experience with COVID-19 is certainly going to place a lot of focus on more affordable instrumentation that shifts in volumes, certainly not the volumes we're talking about in datacom and 3D sensing, but volumes that are much more substantial than, let's say, in the recent past for Coherent and its peers. And then as well, the aerospace and defense area where Lumentum's revenue exposure there is quite limited in Coherent space, larger than ours, but more limited than what it really could be. And then as we look at on a combined basis, the new opportunities for growth there. So I think there's a lot of major growth drivers that will enable us to grow substantially faster than the overall market that's in that $10 billion market estimate.
Let me just add two or three more examples, Chris. Just think about the growth that's going to come. OLED, microLED, all screens are going to have annealing going forward. Think about what's happening in the semi industry. It's booming. Look at what's happening in via drilling in the HDI space. This is a classic case where lasers are doing a monster transition of the production records that the customers have because it's a land grab where you replace traditional mechanical drills with lasers. And let me just sum up with where Chris started. This decade is going to be the decade of photonics also in the manufacturing space. And by combining our two companies, we will fully be able to not only utilize it, we will be able to drive this change and be at the front end of it.
Got it. If I can just quickly have a follow-up question here on Lumentum's preliminary results today. You had solid revenue trends on the top line, on the headline number. Just curious, given the kind of strong results or beats we've seen from most of the Apple supply chain, any changes in relation to the segment level as to how things came in relative to your guide last quarter, particularly in terms of upside or downside to 3D sensing? Thank you.
Yeah. Hi, Samik. So like we said at the beginning of the call, we're going to talk about the great acquisition that we've just done, the combination with Coherent. We have a conference call scheduled for February 2nd. We'll talk more about our results at that time. And we had strong results in Q2, but we'll talk a lot more about the details as well as our guidance for Q3 at that conference call. Okay?
Thank you. This concludes our question and answer session. I'd like to turn the conference back over to Jim Fanucchi for any final remarks.
Thank you, Wajid.
Sorry, Jim. Just before you get started, I want to just say one more thing before we wrap up, and that's around how excited I am about combining the two teams. And I think what we saw when we put the two brilliant teams between Oclaro and Lumentum together, they come up with incredible ideas about how to really out-innovate our competitors, and I think we have even more opportunity with the Coherent team. I've been super impressed with them, and I can't wait till we are able to get the two teams together and come up with some incredible ideas about how we allow our customers to win, so I just wanted to say that at the end because it is an incredibly exciting day for us and for all of our customers and hopefully all of our stockholders as well.
So, Jim, why don't you go ahead and wrap up?
Great. Great, Alan. Thank you very much. And thank you, everybody, for joining our call today. We do want to thank you for attending, and we do look forward to talking with you again in the future. Have a great day.