Earnings Call: Q3 2021

May 12, 2021

Good day, everyone, and welcome to the Lumentum Holdings Third Quarter Fiscal Year 2021 Earnings Call. All participants will be in a listen only mode. Please also note today's event 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 Lumentum's 3rd quarter fiscal year 2021 earnings call. This is Jim Fanucchi from Darrow Associates assisting Lumentum with its Investor Relations. Joining the call today from the company's management team, we have Alan Lowe, President and Chief Executive Officer Wajid Ali, Chief Financial Officer and Chris Colvin, Senior Vice President of Strategy and Corporate Development. Today's call will include forward looking statements, including statements regarding the markets in which we operate and our position in such markets, the impact of COVID-nineteen and responsive actions thereto on our business and continuing uncertainty in this regard, trends and expectations for our products and technology, Our markets, market opportunity and customers and our expected financial performance, including our guidance as well as statements regarding our future revenues, our financial model and our margin targets. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings, including the company's quarterly report on Form 10 for the fiscal quarter ended April 3, 2021, which the company expects to file later today. The forward looking statements provided during this call are based on Lumentum's reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements except as required by applicable law. Please also note, unless otherwise stated, all results and projections discussed in this call are non GAAP. Non GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with GAAP. Lumentum's press release with the Q3 fiscal 2021 results and accompanying supplemental slides are available on its website Thank you, Jim. Good morning, everyone. I want to first say our thoughts and prayers are with everyone affected by the continuing COVID-nineteen pandemic. While vaccinations and case rates are declining in the United States and a few other countries, in many places around the world, the situation is not good. What is happening in India is absolutely heartbreaking. Again, our thoughts are with everyone affected. Turning to our business. Our 3rd quarter results highlight a product portfolio increasingly rich in new and differentiated products and aligned with favorable long term multiyear market trends. Revenue from key new product lines that position us well for long term growth were each up by double digit percentages year on year. These include indium phosphide based coherent components and modules, Next generation contentionless mxn ROADMs, high speed EMLs and 3 d sensing lasers. Non GAAP gross margin expanded by 4.40 basis points year on year driven by continuous improvements in our operations and Product mix. The accelerating transition to digital and virtual approaches in all aspects of work and life is driving staggering amounts of data in the world's networks and cloud data centers. The proliferation of 5 gs wireless will remove bandwidth bottlenecks at The computer and machine vision revolutions are in their early days and we expect 3 d sensing and LiDAR capabilities will expand to many more applications in multiple markets. These include augmented and virtual reality, 3 d machine vision for industrial applications, frictionless and contactless biometric to the manufacturing of the devices that enable the digital transformation and transition to 5 gs wireless and electric vehicle and energy storage. These multiyear trends combined with our product and technology leadership positions bode well for us over the long term. Growing end market demand for their next generation solutions where we have a wide range of design wins with highly differentiated products. Now it is about translating this growing end market demand into shipments and revenue. On this point, like others, we are seeing headwinds that may moderate near term market growth in telecom and 5 gs related For the remainder of this calendar year, we believe the telecom and 5 gs components market will reaccelerate midway through our Fiscal year 'twenty two. These views are driven by the combination of a tight supply of critical semiconductors that we and our customers depend on customer inventory build in anticipation of strong end market demand and potential delays in deployments in certain geographies more impacted by COVID-nineteen. We expect the lasers market recovery to continue and our business to return to pre pandemic levels by the middle of fiscal 'twenty 2. In 3 d sensing, we believe the net impact Certain customer design decisions will reduce the overall global market for 3 d sensing lasers in fiscal 'twenty two by approximately 20% to 25%. We expect laser based sensing to expand to more applications, customers End markets in fiscal 20222023 setting the stage for reacceleration of market growth in fiscal 2023. As well, our product roadmaps include new designs for the future where we integrate additional functionality to help customers further reduce size and their cost of incorporating 3 d sensing capabilities, while allowing us to capture more dollar content over time. At this time, putting these market trends, Supply constraints and customer forecasts together, we expect our revenue for the first half of fiscal 'twenty two to be down Approximately 5% relative to the first half of the fiscal 'twenty one. These near term External market headwinds do not diminish my optimism around our long term multiyear market outlook. Our product portfolio and design wins and the Positive changes in our business model and the industry over the past several years. I believe the future continues to be very bright at Lumentum. Turning to capital allocation. We are disappointed the Coherent transaction didn't turn out as we had initially hoped. We continue to believe strategic M and A will be a value creator for Lumentum over the long run. We will be thoughtful in our approach and timing. That said, we believe very strongly in our Organic opportunities for value creation. From a capital allocation standpoint, after analyzing We believe investing in our own stock is currently our best opportunity. As such, Lumentum's Board of Directors has authorized a share buyback program for up to $700,000,000 over the next 2 years. Now on to more details about our Q3. Within Telecom and Datacom, revenue from indium phosphide based coherent components and modules was up 28% year on year after adjusting for the extra week of the recent Q3. We had strong ROADM revenue with record contentionless mxn sales. These products are increasing in Our revenue mix due to their incorporation in our customers' latest systems, which they are just starting to ramp. The average selling price of these advanced ROADMs are significantly higher than the lower port count devices. This will help Accelerate revenue growth as new network deployments increase over the coming several years. In China, On our last call, we highlighted production shipments of MxN ROADMs to our largest Western NEM customer. And in the Q3, we started production shipments to our next largest NEM customer in the West. We are designed in or in final qualification stages with many other customers with our latest advanced ROADMs. Revenue from EMOT chips was up more than 40% year on year, again adjusting for the extra week in the recent Q3. These products serve the cloud data center market which is increasingly transitioning to 204 100 gig speeds. At these higher speeds, Our products are highly differentiated. We expect this differentiation will drive market share gains with non vertically integrated and vertically integrated transceiver suppliers. We expect our growth will accelerate as cloud operators continue their transitions to higher speeds. Underscoring this, during the Q3, we received $90,000,000 of orders for EMLs, primarily from webscale cloud operators and customers serving them seeking to secure our production output. This backlog will be delivered over multiple quarters as we are capacity constrained on EMLs. Our previously highlighted production capacity expansion is tracking well and will come online later this calendar year for significant Increased output starting in the second half of fiscal 'twenty two. Due to continued delays in 5 gs fronthaul deployments in China, Our 3rd quarter DML revenue was significantly below year ago levels and 4th quarter DML sales are expected to be down by more than $20,000,000 year on year. At this time, we expect 5 gs front haul deployments could resume this summer. This timing would drive increased demand for our products towards the middle of fiscal 'twenty two once customers ramp up and burn through existing inventory. Looking to the 4th quarter, we expect telecom and datacom revenue to be up quarter on quarter. 3rd quarter industrial and consumer revenue was up year on year due to increased dollar content and higher volumes and declined quarter on As expected due to seasonality. In the Q4, we expect industrial and consumer to be down sequentially due to normal 3 d sensing seasonality but up by double digits percentage year on year. Additionally, we have begun mass production of new laser chip designs for Upcoming major customer new products. We recently had an important Android customer launch a mobile phone with time of flight 3 d sensing camera capabilities enabled by our lasers. This is a notable design win as this customer is a large and leading supplier of camera components and their features frequently proliferate to much higher volume Android manufacturers. During the Q3, we announced industry leading advancements in VCSEL Technology that position us well for future applications in the industrial and automotive markets. For example, we announced high power, High efficiency pixel arrays leveraging industry leading 5 and 6 junction design. These multi junction arrays are of particular interest to the automotive and lidar markets. They have strong traction in solutions for autonomous vehicles, including in major retailers who are looking to deploy fleets of autonomous delivery vehicles. As well, we continue to receive design orders from other auto lidar and access control customers. Turning to commercial lasers. In the Q3, we had a significant increase in kilowatt fiber laser sales after 4 quarters of decline. Historically, during market downturns, macro material processing was among the slowest segment to recover and we are now Cautiously optimistic that we have seen the worst of the impact of COVID-nineteen in this segment. We expect 4th quarter lasers revenue to be up quarter on quarter. Throughout my remarks, I've highlighted that our markets are driven by strong long term trends And that we have invested heavily in differentiated new products, technologies and customer programs. With our latest products, we have Secured key design wins and are on track for more with market leading customers. Our product mix is becoming richer in these new products as customers are starting to ramp shipments of their next generation solutions. We are seeing some nearer term external factors that will moderate industry growth for the next few quarters, but these don't diminish our long term market outlook. Before handing it over to Wajid to review the numbers, I want to once again thank and acknowledge all of our employees around the world for their hard work to thank our customers, suppliers and shareholders for their continued support and partnership during these challenging times. With that, I'll hand it over to Wajid. Thank you, Alan. Good morning, everyone. Turning to the 3rd quarter's numbers. Net revenue for the Q3 was $419,500,000 which was down 12% sequentially and up 4% year on year. Out of an abundance of caution, we deferred $14,800,000 of revenue due to delays in 5 gs front haul deployments in China. However, despite the lower revenue and due to the strength of our financial model, Approximately 50% non GAAP gross margin and strong non GAAP operating margin and EPS, which both were within our guidance ranges. GAAP gross margin for the 3rd quarter was 44.1%, GAAP operating margin was 63.6% and GAAP diluted net income per share was $2.85 GAAP results include Act of the $217,600,000 we received in connection with the termination of the Coherent transaction. 3rd quarter non GAAP gross margin was 49.9%, which was down 350 basis points sequentially as expected, but up 4.40 basis points year on year due to our improving model with a better mix products and lower relative manufacturing costs. The sequential decline relates to the seasonal change in product mix and volumes, while the year on year growth was driven by improved gross margins in the Optical Communications segment. 3rd quarter non GAAP operating margin at 27.9 percent decreased 760 basis points sequentially, but increased 2 90 basis points year on year. The sequential decline was driven by the expected gross margin decline and increase in operating expenses quarter on quarter. The year on year increase was driven by the gross margin improvement year on year. 3rd quarter non GAAP operating expenses totaled $92,100,000 or 22 percent of revenue. SG and A expense was $40,800,000 R and D expense was $51,300,000 The sequential increase Operating expenses was primarily driven by the extra week of the 14 week quarter and the annual reset of benefits rates and payroll tax that occurs at the beginning of the calendar year. 3rd quarter non GAAP net income was 110,600,000 This includes $500,000 of net interest expense and $6,000,000 of tax expense. Other income expense was a net expense of $500,000 as interest income declined to levels lower than our expense due to lower interest rates on our cash and short term investments. Non GAAP diluted net income per share was 1.40 based on a fully diluted share count of 79,200,000. On the balance sheet, We ended the quarter with approximately $2,100,000,000 in cash and short term investments, up $354,000,000 quarter on quarter, Including the $219,000,000 coherent transaction termination fee paid to us, we have $1,500,000,000 in aggregate Principal convertible notes and no term debt. As Alan mentioned, Lumentum's Board of Directors has authorized a share buyback program of up to $700,000,000 over the next 2 years. Over the past 12 months, our cash Balance has increased by more than $600,000,000 and we are confident in our future long term outlook. Given relative valuations in the industry, we believe this is a good use of our growing cash. Now turning to segment details. 3rd quarter Optical Communications segment revenue at 387,900,000 decreased 14% sequentially due to seasonally lower revenues in telecom and datacom and industrial and consumer and the deferred 5 gs related revenue I discussed earlier. Optical Communications segment revenue was up 8% year on year Due to the extra week in the quarter and higher industrial and consumer revenues due to the increased dollar content and adoption of 3 d sensing in consumer electronic devices. Optical Communications segment gross margin at 50.1%, decreased 370 basis points sequentially, primarily due to lower industrial and consumer in the revenue mix, but increased 510 basis points year on year due to a more favorable revenue mix with newer and more profitable products and the benefits from operational improvements. Our laser segment revenue at 31 point $6,000,000 increased 6% sequentially due to the ongoing recovery from the impact of COVID-nineteen, but is 27% down year on year as the recovery isn't complete. 3rd quarter lasers gross margin was down 30 basis points Sequentially at 47.2 percent and down 250 basis points year on year due to significantly lower revenue levels. Now on to our guidance for the Q4 of fiscal 'twenty one, which is on a non GAAP basis and is based on our assumptions as of today. We expect net revenue for the Q4 of fiscal 'twenty one to be in the range of 360 to $400,000,000 Despite industry headwinds, this revenue guidance is consistent with our historical seasonality when normalizing for the revenue we 3rd and the recent 14 week quarter, I'd note over the past 4 years, the mean seasonal revenue decline from the 3rd to 4th fiscal quarter has been about 7%. Our revenue projection assumes telecom and datacom increasing quarter on quarter, Industrial and consumer declining due to normal seasonality and commercial lasers increasing quarter on quarter driven by further market recovery from COVID-nineteen. Based on this, we project 4th quarter operating margin to be in the range of 22.5% to 25% and diluted net income per share to be in the range of $0.92 to 1.14 These projections also assume an approximate share count of 79,000,000 and estimated other expense of 1,000,000 and an estimated tax expense of $9,000,000 With that, I'll turn the call back to Jim to start the Q and A session. Jim? Thank you, Wajid. Before we start the question and answer session, I would like to ask everyone to keep to one question and one follow-up. This should help us get to everyone before the end of our allotted time. Operator, let's begin the question and answer session. We will now begin the question and answer session. Our first question comes from Samik Chatterjee of JPMorgan. Please go ahead. Hi. This is Joe Cardoso on for Sanath Chatvi. Thanks for the question. My first one here, just wanted to touch on the first half guide you provided for fiscal 'twenty Starting with telecom and datacom, you're calling for moderate growth before reaccelerating in the second half of the year. Just wondering if you can parcel out the details there a bit. Where are you expecting to see the greatest strength? Where are you expecting to see the greatest weakness? How much is Supply related. And then in terms of the recovery into the second half, can you kind of rank a little bit of the drivers that's kind of giving you confidence that we see that recovery in the second Thank you. Sure. I'd say first half, going through the different product areas, As we said, Q4, we see telecom growth telecom and datacom growth in Q4. We expect Telecom to continue to grow in the first half but moderately from the exit rate of Q4. Datacom is going to continue to be hampered from our Perspective and expectations around the 5 gs rollout in China. And one of the reasons we had that revenue deferral in the 3rd quarter is The inventory in the various stages of deployment is moving very slowly. So We don't expect that to pick up. And as we said, the DML year on year reduction in Q4 is about $20,000,000 We expect that to continue to be a drag on our Datacom business. Offsetting that is the increased capacity we're putting in place on EMLs. And so You should see modest increases in EMLs, but overall datacom will be down in the first half. Commercial lasers is continuing to see a recovery from the pandemic. And as we said, we That we will by the middle of our fiscal year be back to pre pandemic level. So we'll see moderate growth in lasers. And then as we said also, Our expectation given the 3 d sensing market being smaller by 20% to 25%, mainly due to Design decisions that some of our customers have made around smaller chips and smaller chips lead to smaller average content per device. And so That's probably the bigger drag on the first half expectations. As far as second half and why we're confident that we'll see a rebound, I think If you look across our product portfolio, our design wins are phenomenal. Our team has done a fabulous job on our high port count and Contentionless ROADMs, those are designed in and we talked about new designs in the West. And so from our perspective, we are very much Poised for a rebound. Now that might happen before the end of the calendar year, but our expectations are that this is modest. Then in the second half of the fiscal year that picks up. Also in the second half of the year, our capacity will be coming online for our EMLs And that is going quite well. We talked about that 2 or 3 quarters ago. That's in motion and we expect that our EMLs due to our highly differentiated products And the orders that we talked about in Q3, we expect to capture major market share on our EML business on the 204 100 gig And then again continued growth in lasers and then the 3 d sensing is again a market issue that I think we'll all see on that one. The next question comes from Rod Hall with Goldman Sachs. Please go ahead. Yes. Hi, guys. Thanks for the question. I guess my first question is back to 3 d sensing. I think it has been pretty well telegraphed that ship size is going to go down, but I had also been assuming that you guys would have Higher share as a result of the redesign. So I just wonder if, Alan, could you comment on your share position In H1 and how you see that going? And then I've got a follow-up. Sure, Rod. Thanks for the question. We're highly confident of our ability to satisfy our customer. And for the last three and a half years, we've been The partner of choice, we continue to execute, deliver almost a 1000000000 units of 3 d sensing. And so I think from our perspective, We're the design lead. We're doing very, very well. Our market share, we've been saying for 3.5 years that our customer needs security of supply And that we would see a shift and we had we saw that last year. So I don't want to make expectations that we're going to go back to the kinds of Share that we had over the last 3 years because that was uncomfortable for our customer and for us quite frankly. So I think having 2 suppliers in our meeting customer is a good thing and one that gives us a comparison of how well we performed compared to our competitor. And I think we're continuing to perform very well from a quality delivery cost And so our expectations are that we're going to continue to have a solid share, especially at the front end of product launches. Okay, great. And then for my follow-up, I just wanted to check on I know that there's additional ROADM capacity planned for the summer. Just wanted to check that's still on track that you guys are going to expand that capacity. I guess now, well, maybe you could comment on what you think that means for ROADM New trajectory post that. Are we still are you still expecting to be short? It sounds like probably not given what's going on in the market, but I'd just be curious on the Supply versus demand balances as you bring that capacity online and whether it's still on track? Yes, we have added ROADM capacity mostly on the high end for the m by n as well as the very high port count ROADMs. And so as our Western customers have added our end by end to their mainstream product portfolio, we are not Going to be short from a capacity standpoint. So that because we're the sole source, we cannot let them down and from That perspective, we're adding capacity in anticipation of them continuing to grow that business in the first half of our fiscal year, but really dramatically in the second half. So that's on track. I'd say the other thing that's causing some angst is the semiconductor So I have been king expediter of semiconductors more than I'd like to be, but That is also putting some pressure on our ability to meet our customer demand on the high end. The next question comes from Alex Henderson with Needham. Please go ahead. Thank you very much. You've made a couple of comments It's around 3 d sensing that I just wanted to get some clarification on. So clearly, there's been some share shift going on. There's a reduction in your share and an increase in your competitors' share. Your comment that you expect to have solid share is not very Definitive in terms of whether you think that rate of change in shares have been altered. Can you talk about whether you think you've gotten to Point where shares stabilized or do you expect to continue to have share Erosion, how should we think about share trajectory as opposed to whether it's just simply solid? Solid is not Very descriptive. All right, Alex. I think our track record That speaks for itself. As new products have been announced, we are the dependable supplier that our customer counts on. And if you want to have a different word for solid, that's how I describe it. And so my perspective is It is the share equilibrium that has been reached in the last quarter is Probably where we're going to end up. And I think over the long term now every quarter is going to be different based on new products and The models that get built and where we are versus our competitor, but I think overall, our The numbers speak for itself and I think if you talk to our competitor, do the comparison and see where we are. I mean, we're pretty transparent with our 3 d sensing numbers in our press release and in our earnings. So the conclusion Your share has stabilized relative to where it has been in the most recent couple of quarters. Is that the fair statement of what you I think so. I mean from my perspective, I'm extremely paranoid about this all the time And that keeps us on our toes, make sure that we're attentive and responsive to our customers' needs. And we don't want to give them any reason or Excuse to move any more share than they already have. And I think they're comfortable with it. I'm comfortable with it. And I think from that perspective, We're just continuing to work on next generation and next generation for our customer to make sure we're there for them. The next question comes from Simon Leopold with Raymond James. Please go ahead. Thank you for taking the question. I've got 2. I want to ask the sort of more complex one first and second to easy. So on the 3 d sensing market decline that you've talked about, There's obviously 2 key dimensions. 1 is volume and the other is ASP. I appreciate you can't be Specific on the values, but could you help us get a better understanding of how we should think about what's going on with ASPs With the smaller chip other than the fact that they're last? Yes, Simon, I'd say that just like any semiconductor, the cost of that device Scales with both chip size as well as yield. And so Our customers' expectation is that ASP scales with chip size. And we're working on yield. And I think we've done a great job and our team has done a great job in getting to yields that I think our competitor and our customer never thought we could get to. So I think from that perspective, you can imagine that the discussions with our customers around, hey, the chip is X percent Smaller in price in size and therefore it should be X% smaller in ASP. And I think that holds true for the most part given Any different complexity of processing or testing or any yield variation, but From our perspective, wafer size is a good indicator of cost and therefore it becomes a good indicator of price. And from our perspective, we price for a given margin and the market dynamic and we're very confident even at Lower ASPs that our margins will continue to maintain where they have been. But that implies those profit dollars are lower then? Yes, I mean absolutely. I think on a percentage basis, the margins are going to be stable With the top line coming down because of market shrinkage, the dollars at the bottom will be lower. Okay. And then the easy question I had hopefully is just trying to unpack the datacom products a little bit. It sounds To me, the DML chips and the 5 gs exposure China is pretty decent sized, probably bigger than I was guessing, and maybe EMLs Maybe a little bit smaller. So, can you give us a little more color on how to think about The proportion is coming from different products within Datacom, so helps us think about this trending? Thank you. Sure. I'd say that our EML business grew 40% year on year. So the growth in datacom is Coming from EMLs. And we sell DMLs to the 5 gs front haul. We sell DMLs to transceiver suppliers that sell into Hyperscale data centers, although that is starting to soften as well as those hyperscalers are moving from 100 gig transceivers 204 100 gig transceivers. And so we're going to see a rapid shift not only from the reduction in 5 gs deployments, But also the shift from 100 gs in the data center to 204 100 gs. And so our focus And pressure is really on how do we add capacity or shift capacity from DMLs to EMLs and it's not Straightforward as you might think because there is difference in complexity with respect to the processing of an EML compared to a DML. I think you can assume that pre-five gs slowdown, it was probably around fifty-fifty ish and I think you can model that In the datacom business, but if you look at Q4 business, I'd say it's dramatically EML heavy And that will continue to grow through the first half of the fiscal year. The next question comes from Meta Marshall with Morgan Stanley. Go ahead. Great. Thanks. A couple of questions for me. Just one on The Coherent deal and deciding to do a share repurchase. Just kind of what is kind of your current appetite for M and A, particularly Given that Silver Lake had been a potential partner when you were looking at the coherent acquisition, It would seem as if by opting for a share repurchase, you were looking to be maybe less active in the near term. And then on the second question, Just as you look at your telco forecast kind of going forward, have you incorporated what could Yes, that's looks like 3 questions, Meta. Okay, let me take the M and A. I'll have Wajid talk about the share repurchase. We still believe that M and A is strategic for us and will create inorganic value for our shareholders and we're still Focused on doing that. I think we have a track record of successful M and A and that's what we're looking for. I think we are disappointed that The Coherent went the way it went, although I think it also is an opportunity for us to step back and say what is the next Acquisition and at this point in time, management and the Board believe that the value of organic Value creation is the best place to put our cash. I'd say, Wajay can talk about the cash generation we've had and the decision on the share repurchase and I'll come back to the telecom question. Go ahead, Wajid. Yes. No, I think we've struck a perfect balance in terms of our capital allocation strategy. As you know, We've historically invested heavily in CapEx to support our growth as well as in selective M and A transactions. And the beauty of the $700,000,000 share buyback that our Board has authorized is That it's just a little bit larger than the amount of cash we've generated over the last 12 months and it still leaves us with a lot of firepower To go ahead and do M and A transactions as we choose to. So I think it gives us optionality and it allows us to maintain flexibility moving forward as well. So we're looking forward to putting some cash to work in order to be able to buy Back some shares, especially at current levels. And then on your third question on telecom forecast and incremental impact So things like what's going on in India, it's hard to say. I think Our perspective is that we've seen a continued slow Ramp up of telecom even through this time, our expectations are that that continues. And if it doesn't go to India and I think in talking to our customers, They're still deploying in India today. And so if things get much worse, which I hard to believe or hard to imagine, that could be impacted. But so far today, it's still deploying, but not as the rate it would otherwise if there had not been Such an influx of cases. The next question comes from John Marchetti from Stifel. Thanks very much. Maybe just following up for a minute, Alan, on that telecom comment. With Some of the new wins that you have for the end by end with some of the Western vendors, on your sort of first half Do you expect those sorts of deployments to continue to ramp? And I guess, has your expectation for that ramp slow relative to maybe where you were a quarter or so ago? I'd say no. I'd say we're pretty much Tracking to where we expected, I mean, I think we had expected that there'd be muted growth as a result of Challenges of deploying during the pandemic, but we're very, very happy with the progress of the design cycle of our products in next Generation systems for not just Chinese NEMs, but also the Western NEMs that we talked about in the script. So I think from our perspective, we're poised for end by And indium phosphide coherent components and modules. And so, as or if the deployments accelerate, we'll be ready. And then maybe just as a follow-up on the 5 gs deferral side. Is it your sense that inventory levels got Way ahead of themselves because of some of the risks associated with all the prior administration's efforts to hamper some of Growth there or is this a result of the delays in some of those tenders? And just curious where you think maybe those inventory levels are right now. And if If it's a couple of quarters to move that out or if we still have to wait and see what some of these new expected tenders actually deliver. Thanks. Yes. I mean, I think if you go back in time, last year, there was expectation that there'd be a 1,000,000 base stations in China or Some number like that. There was approximately 60% of those deployed. Same kind of outlook was for calendar 21 and I think it's similar kind of disappointment, if you will, in that 600,000,000 to 680,000,000 base stations Look like they're going to be deployed, but not a lot have been deployed in the first half. And so our belief is that that starts picking up this summertime, But won't have meaningful impact on our business until the mid part of the fiscal year. And so That's where we think the inventory throughout, whether that's at the radio base station supplier or at their Seeber customer supplier or in our WIP, I mean, there's that much inventory where I think that It needs to ramp up and it needs to start deploying before we see any meaningful deployment. I'd say it's solely due to the U. S, China geopolitical issues and their ability to get chips for the base stations. And so that redesign is happening. And our expectation is that, that will start picking up in the second half of the calendar year. The next Question comes from Ananda Baruah with Loop Capital. Please go ahead. Hey, thanks guys for taking the question. Yes. 2 for me if I could as well. Really clarification is the first one. You guys talked about on 3 d sensing, There both being a market down component and then the price mix and then the pricing component. How much of the guidance is market down Versus the pricing on the smaller design? And then also are you seeing pricing pressure? You call it pricing pressure. And then I have a quick follow-up. Thanks. Hi, this is Chris. Good morning. I think, well, the market down is the combination of normal price erosion And the smaller chip size, which reduces the dollar content, if you will. We've made no To be clear, and I think Alan mentioned this in the prepared remarks, we're not opining on anything around volumes Or mix within the market, if you will. This is purely sort of normalizing for those factors, Just about lower dollar content and normal price erosion. I would say that pricing environment is normal. There's not unusual pressure, right? We've provided price downs for our customers Every year since we got into this business and then we've seen price increases as chip sizes have gone up And prices come down with normal price erosion or in this case when there's a redesign and the chip is smaller. That said, We also have a product roadmap well aligned with our customers that Includes designs that integrate additional functionality, enable lower cost, higher performance, maybe integrates other capabilities, reduces packaging costs, package sizes, etcetera. That will help us capture more dollar content Over time as those products are launched. But going back to the question about the market in fiscal 'twenty two, There's other customers coming online in other markets and other applications, but they won't come online fast enough to Set the impact that we're seeing at some of the major customers with the dollar content and normal price erosion. So But as they come online through fiscal 'twenty two and into fiscal 'twenty three, then we believe the market will reaccelerate. That sounds good. Thank you. Sorry, maybe just one other thing to add on the market outlook that's different than where we were on the last earnings call, which was Our expectation is to have a major Android customer incorporate 3 d sensing and recently they made the decision not to do it in this Generation of products. And so that also puts pressure on expectations around the market when the major Android customer decided not to Incorporate 3 d sensing. So that puts some pressure on our outlook for the market in fiscal 'twenty 2. That was actually my follow-up. So I appreciate that. Do you think just to that end, do you see other opportunities sort of in the Android space Aside from that, that one vendor that still could be included and what was your thought process 90 days ago? Thanks. Yes. I mean, I think we continue to be very excited about the Android Adoption, it's obviously been slower than we've expected, and I'm sure everybody's going to expect it. But this year has, I think, been rough For Android suppliers overall, given it seems like COVID-nineteen has really impacted them compared to Our largest customers. I think Alan, there's strong interest across the board For kind of the LIDAR based approach or time of flight based approaches for world facing, for photography, ARVR applications. And Alan highlighted in the script a what we think is a very positive data point that we had a customer Launch a great smartphone with world facing capabilities really focused on photography. This is a customer who also sells components, if you will, image sensors and others to the Android Universe in mass and therefore their technologies or their designs frequently proliferate Much larger Android manufacturers and that's really been one of the technical barriers to the Android world is that This is harder technology and then some of the more low cost Android manufacturers need help with the technology. So Great to see a leading technology, maybe not a leading volume manufacturer of phones adopted so that, that technology will proliferate a bit further. The next question comes from George Donner with Jefferies. Please go ahead. Hi, guys. Thanks very much. I guess I wanted to kind of keep going on the 3 d sensing discussion here. Any changes In the performance characteristics that you're seeing out of the marketplace either through world facing or front facing, Is that driving the ASP and chip size changes or is this more of a sort of natural evolution of the market? Yes. George, I think it's more of a capability that we've been able to provide to our customer jointly. These are chips that we've talked about with our customer 2 3 years ago. And so as our capability and technology improves, We can combine develop a product that has more functionality at a smaller size. And I think Chris talked about our ability To then go from that stage of the game to adding more functionality on the chip that now our customer needs to go to 3rd parties and add different As we roll out those types of functionalities that are embedded in the chip at a lower cost, we will capture more dollar content. So I'd say this is no different than just the evolution of driving lower cost solutions at higher functionality and features. And one thing to add to that, I think that maybe got lost is, on the ships maybe smaller, there's still a lot of lasers, in fact, As many lasers, if not more than in the past, so that presents a lot of technical challenges to accomplish that. As Alan said, that's why it's taken us several years in working with the customers to achieve that level of density on the chip. The reason I highlight that it also provides a level of differentiation and barrier to entry for other folks in the market. So it's not like the chips getting smaller and dumber, it's Getting smaller and more complex, if you will. Thanks. The next question comes from Michael Genovese with Westpark Capital. Please go ahead. Thanks very much. So there's a lot of hand wringing on this call About the market share, but I feel like you answered it better in the prepared remarks. And I want to make sure I understand correctly because You're saying that the market is going to be down 20% to 25% in the second half of the calendar year and your revenues are going to be down 5%. So doesn't that Suggest some share switch as swinging back to you as this new chip is as this new smaller chip is Doesn't the math just tell us that you're gaining share? Well, keep in mind, 3 d sensing is a portion of our business. And so as we look at our different other businesses, lasers is going to grow, telecom is going to grow, datacom is going to be under pressure. And so our commentary was around the market and the market being down 20% to 25% in the fiscal year, not just the fiscal first half, in the Fiscal year, our belief due to the chip size and the lack of adoption by a major Android customer that the market itself will be down 20% to 25%. Now how that translates into our revenue is hard to say, but it's going to have a negative impact on our revenue assuming we Maintain the share that we have today and I think that's what you can model into your first half model and it turns out that we gained a bunch of share then great, But our expectations and our guidance don't count on that. Got it. Okay, great. And then I just wanted to ask Your perspective, I mean, the indium phosphide news is good news. As we track that market, There's a lot of interest in pluggables and 400 in ZR and ZR Plus. And so what's your Perspective on that market, does momentum need to play there? Is it going to inhibit or drive the growth rate of indium phosphide going forward? Just any Any general commentary there would be appreciated. Thank you. Yes. Thanks, Mike. Yes, I mean, certainly, we're very excited about our opportunities for indium phosphide platform, Very differentiated capabilities. We are already supplying high performance components into 800 gig applications as an example. We're also very focused on 400 gig Plugable modules, there's a whole range of performance requirements, all the way from your metro long haul then down to DCI and ZR type modules working on all of them. Some of them are in production, others are in the sampling phase, and We're kind of prioritizing our investments based on our ability to differentiate our products and size of the opportunity and customer feedback. That's a great opportunity for us given the unique indium phosphide platform we have. The next question comes from Christopher Rolland with Susquehanna. Please go ahead. Hi, guys. Thanks for the question. I guess my first one is pretty broad. I guess looking out Into the next year, kind of with the best crystal ball you guys have, do you expect to Grow revenue year over year. And then secondly, you talked about the reacceleration maybe in the back half. Maybe talk about what this looks like, how it kind of manifests itself through your various segments as well? Thank you. Yes, Christopher, maybe I could comment and Chris or Wajid can chime in. Our focus is to give you what we know when we know it And our outlook for the first half of the fiscal year changed. And so that's why we made the exception and gave you guidance for the first half so that You knew as soon as we knew and I think that's why we gave first half guidance. We're not going to talk about the year. I think It's too hard to predict, let alone what's going to happen 2 quarters out as opposed to 4 or 5 quarters out. So I think what we can comment on is our progress on new product, new design wins with customers and that's going extremely well. So as the market picks up or as deployments pick up, we'll be there for our customers and we'll be really Focused on making sure we give them what they need. That said, we are investing in capacity for those key products. ROADMs, we talked about. We're investing in our wafer fabs both in Datacom as well as our indium phosphide capabilities for coherent components. So We are investing in anticipation of that picking up and we'll be ready for our customers. The next question comes from Fahad Najam with MKM Partners. Please go ahead. Thank you for taking my question. I have a clarification first. The deferred revenue from DMLs of $2,000,000 Is that accounted into your guidance or is that completely out of your guidance or 4Q? Yes. Fahad, it's Wazak here. So the impact of the $15,000,000 was on fiscal Q3. And any type of recovery we see of that, whether it's in Q4, whether it's in the first half Our fiscal 'twenty two has already been incorporated in our guidance that we provided. Okay. And now to my question. So, Alan, it's not surprising that ASPs were coming down. Our checks had indicated that ASPs will come down as Your lead customer moves to a combined projector and flood eliminator module. But if our checks are also right, And the next generation of this customer, presumably they're going to move to a behind the glass model. And there I think your technology is significantly far better or more advanced Then some of your peers. So to that extent, you expect acceleration in fiscal 2022, is that based on an assumption of 1, Your share gains or is that based on an assumption that there is primarily more proliferation of 3 d sensing Across most SKUs with this customer and also generally speaking more broader adoption by Ed, if you could parse that comment about Reacceleration in fiscal 2022. Sure. Look, well, I think from reacceleration in fiscal 2022, what we had Tended to say or what we had expected to really message was a lot of design wins happening now For different industries, whether that be automotive, security biometrics and Access control and things like that are happening now that should accelerate through fiscal 'twenty three. We're still hopeful that Android comes online in fiscal 'twenty three. But I think our outlook is really more around Added customers, added markets. And as far as next generation of devices for our lead customers, We're working on many, many different things and until they get close to deciding what's the plan of record, We're working on many, many different things without knowing what is actually going to be the plan of record for fiscal 'twenty three. So we're just making sure we're the design source for them And we will be there whether that's a continuation of existing designs or new designs where they choose to put them in. We have time for one more question in our allotted time. The next question comes from Tom Diffely from D. A. Davidson. Please go ahead. Yes. Good morning. Thanks for squeezing me in here. I had a question on this, the nice margin Expansion on a year over year basis. Based on the cost reduction in some of the new products that you're rolling out, has most of the benefit now been realized? Or is there a runway for You have extended the expansion going forward on a margin basis. Yes. Hi, there. I'll Start off, it's Wajid here. So on our gross margins, you're right to point out a lot of the year over year improvement that we've had Across our optical communications products, our lasers margins have come down year over year, Primarily because our volume levels have been lower. But as Alan noted in his remarks and even in the Q and A session, we're expecting our lasers business to continue to improve Not only in Q4, but throughout fiscal 'twenty two, that should have a corresponding positive impact on the gross margins as it relates to lasers. Now within Optical Communications, we're continuing to expect margins to hold quite well, primarily because of Some of the product mix benefits we'll start seeing as EML capacity comes on board. Matt talked about our 50% gross margin model A couple of quarters ago as we put it out there and as you can see even with our fiscal Q3 actual results year to date As well as what we're forecasting for Q4, our current expectation is that fiscal 2021 will end up with gross margins north of 50% And we're targeting a 50% margin model for fiscal year 'twenty two as well despite some of the puts and takes that we've talked about During the call. So I think that that continues to be our target and our product and Our customer deployments that we're seeing support that. This concludes our question and answer session. I would like to turn the conference back over to Jim Fanucchi for any closing remarks. Thank you. This concludes our call for today. We would like to thank everyone for attending and we do look forward to talking with you again when we