Q2 2020 Earnings Call

I'd now like to turn the conference over to Mr., Jim Fanucchi of Darrow Associates, Mr friend, who keep please go ahead.

Thank you Sheryl welcome everyone to eliminate them second quarter fiscal 2020 earnings call. This is Jim Fanucchi from Darrow associates, assisting lumentum with its investor relations and joining the call today from the company's management team, we have Alan Lowe, President and Chief Executive Officer Wash It all Lee Chief Financial Officer, and Chris Coldren Senior <unk>.

One of strategy and corporate development.

Today's call will include forward looking statements, including statements regarding the markets in which we operate including potential market sizes market trends and our position in such market trends at expectations for our products and technology, including product development and projected new product releases purchasing trends and demands for our products are expected financial performance include.

Thing or guidance expenses risks associated with potential disruption caused by the Corona virus as well as statements regarding our business initiatives and the achievement of synergies following our acquisition of old clearer. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations.

Some encourages you to review our most recent filings with the FCC, particularly the risk factors described in our filings with the Securities Exchange Commission loading the company's quarterly report on form 10-Q for the fiscal quarter entered December 28, 2019 to be filed with the Securities and Exchange Commission later today and Momentums 10-K for fiscal year.

2019 ended June 29, 2019 forward looking statements provided during this call are based on lumentums reasonable beliefs and expectations as of today.

I meant undertakes no obligation to update these statements except as required by applicable law. Please also note unless otherwise stated all resolved and projections discussed in this call. Our non-GAAP non-GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with gas.

Mentions press release with the second quarter fiscal 2020 result is available on its website a triple W. Lumentum dot com under the Investor section and includes additional details about our non-GAAP financial measures and a reconciliation between our historical GAAP and non-GAAP results. Lumentums website also contains our latest SEC filings and supplementary.

Slides relating to todays earnings release and the company encourages you to review. These documents. In addition reporting of today's call will be available by 11, 30 am Pacific time today on our website.

Now prior to handing the call to Alan we wanted to provide an update on why NASDAQ halted the trading of the company stock yesterday after market.

The company discovered and employees computer password had been compromised yesterday.

As this employee had access to a portion of the financial information reported this morning, the company inform NASDAQ of the situation and they decided to whole trading until this information was made public as an 80 am eastern time. This morning trading had resumed.

Now I will turn the call over to Alan for his comments.

Thank you Jim good morning, everyone.

Second quarter performance was strong we achieved new record revenue gross margin and operating margin.

This performance is the result of strong customer demand for our differentiated products, increasing levels of new and innovative products and an improving financial model due to increasing scale and acquisition synergies.

Look into calendar year 20.

Telecom transport demand is now strengthening.

We expect telecom transmission demand to continue to grow further.

We expect a significant expansion in the market for world facing Threed sensing lasers and from a financial model improvement standpoint, we have made substantial progress, but we're not done yet attaining acquisition synergies and exiting the low margin products. We have highlighted on prior calls.

We believe we have sustainable technology leadership positions that make us indisputable indispensable to the multiple diverse growing markets, we serve today and into the future.

We plan to continue to invest strongly in R&D and new product capabilities to extend both our technology and market leadership positions.

Now for further product line end market details.

Second quarter revenue increased 2% sequentially and 23% year on year.

The largest driver of sequential and year over year growth was telecom and datacom driven by strong customer demand.

Telecom and Datacom revenue was up 7% sequentially and 29% from the prior year.

Growth was driven by strong demand for our differentiated coherent telecom transmission products and high speed laser transmitter chips for data center and Fiveg front haul applications.

The strong telecom and Datacom transmission growth more than offset the decline we experienced in telecom transport revenue.

We're now seeing however, telecom transport demand increasing.

Demand was and continues to be strong for our HCM modules and our DCIO module volumes are ramping now.

Demand exceeded our ability to supply across a range of products in the second quarter.

Products impacted by supply constraints included high end rodents.

Coherent transmission components and modules and laser transmitter chips.

We are working to improve supply of these products to meet strong customer demand.

We continue to sell off remaining inventory and satisfied customers last time buys for previously discussed.

Discontinued low margin telecom and Datacom products.

We continue to expect revenue from these products to effectively declined is zero over the next couple of quarters.

However, we now expect the largest revenue decline from these discontinued products of approximately $10 million to $15 million to occur in the fourth quarter.

We are optimistic about the long term outlook for telecom and Datacom product lines due to expected long term demand trends.

Our technology and product leadership positions and improving industry dynamics.

Demand over the long run should be strong based on the continued strong growth expected in global networks and data center traffic and the optical infrastructure needed to support Fiveg wireless bandwidth.

We are well positioned in the market with our industry, leading products in deep customer relationships.

Our next generation products are critical to the global customer base and include.

A high a range of high performance DCIO transmission modules and underlying highly integrated components, including those at four hundredg and above.

Hi, baud rate indium phosphide components, including those for 800 you transmission.

Contentionless AMD bite in and high Port Count Twin Roadms, where we are qualified or an advanced design phases across all major customer platforms.

And high performance laser transmitter chips, most notably our email transmitters.

These enable next generation for energy and higher speed data center architectures, and next generation wireless front haul and access solutions.

After significant M&A in the optical space over the past few years industry dynamics are improving.

We expect these dynamics to continue to improve and to compound overtime.

Looking to the third quarter telecom and Datacom demand strength should offset typically seasonal factors.

Our industrial and consumer product lines were down 15% sequentially, but up 20% relative to the prior year.

The smaller than anticipated sequential decline was due to strong customer demand for threed sensing enabled products.

Year on year growth was also driven by customers, incorporating threed sensing and a higher percentage of their product offerings compared to last year.

We expect Threed sensing that we expect to Threed sensing market will grow significantly over the next couple of years as Threed sensing is incorporated in more consumer products in both user and world facing applications, including computational photography, and augmented and virtual reality.

Our R&D teams are very busy working with a broad range of customers on their future generations of threed sensing needs, including for new products coming later this year and next as well as for products several years away.

We are well positioned to grow in this market and our experience is a valuable advantage that is proving difficult for competitors to replicate.

Look into our third quarter, our guidance contemplates threed sensing declining more than 20% due to normal seasonality in customer demand, but we expect threed sensing to be up year on year.

Over the past year, Threed sensing has penetrated deeper into customers product portfolios increase including increasing leave for world facing applications.

We expect this trend to continue.

Now onto lasers.

Second quarter lasers revenue increased to $48.4 million.

During the second quarter, we started shipping our new Pico bleed Picoway three ultrafast laser for Micromachining applications.

This product addresses both that display processing fiveg antenna fabrication and advanced via hole drilling in printed circuit boards.

These applications are all expected to see significant market growth in the coming years.

Over the long run because of our investments in unique new products and technology like the Picoway. Three we believe we have good opportunities for growth driven by new product introductions. In addition to market growth.

In the third quarter, we expect laser revenue to be down a bit due to customer seasonality.

Throughout my remarks, I've highlighted long term trends that make our product products and technology increasingly critical to the markets in which we participate.

I've also highlighted the progress we've made towards our strategic and financial goals.

Over the past several years, we've made significant investments in new products markets design wins and M&A.

We believe these investments in the long term trend in our markets position as well for the future.

Before handing it over to Wajid, some comments on the tragic and evolving grown a virus outbreak.

First our thoughts are with all of those affected.

Second our top priority is protecting the health and safety of our employees.

We have restricted employee travel into and out of the affected regions and we are reducing our participation in large group events with strong international attendance such as certain trade shows.

And our factory in Shenzhen, China employees had been impacted by travel restrictions and the extended lunar new year holiday imposed by the Chinese government.

For some more products the supply of externally purchase material is being impacted.

The situation is obviously very fluid, but we are in close contact with our factory in China impacted suppliers as well as our customers.

Well it will discuss the impact of the Corona buyers on our third quarter financial guidance.

I would now handed over to watch it.

Thank you Alan.

Good morning, everyone I'm pleased to be discussing our strong second quarter results.

Net revenue for the second quarter was 457.8 million, which was up 2% sequentially and 23% year on year GAAP gross margin for the second quarter was 41.3% GAAP operating margin was 16.3% and GAAP diluted net income per share was 63 cents.

Second quarter non-GAAP gross margin was 47.4%, which was up 160 basis points sequentially and 730 basis points year on year. The higher gross margin was primarily driven by improvements in telecom and datacom margins as well as acquisition synergies.

Yeah.

Non-GAAP operating margin for the second quarter was 28.8%, which was up 150 basis points sequentially and 680 basis points year on year.

Non-GAAP operating expenses totaled 84.8 million or 18.5% of revenue as Gionee expense was 38 million R&D expense was 46.8 million.

Second quarter non-GAAP net income was 119.4 million. This includes 0.6 million of net interest and other expense and $12 million of tax expense non-GAAP diluted net income per share was $1.53 based on a fully diluted share count.

Of 78 million.

We had very strong cash flows in the second quarter cash flow from operations was 162 million.

Also took a series of actions impacting our capital structure during the quarter.

We repaid in full the term loan that we took on in connection with the Oclaro acquisition.

We sold 1.05 billion of new convertible notes due in 2026, and we've repurchased $200 million of our common stock in connection with the note offering.

These actions along with the strong cash generation from the company's normal business operations resulted in an end of quarter cash and short term investments balance of $1.3 billion.

And now an update on synergies on our call in August 29 team, having achieved our initial $60 million target, we increased our annual run rate synergy target by $40 million to $100 million.

Through the second quarter of fiscal 20, we have achieved approximately half of the incremental 40 million of synergies and we have also identified an additional $10 million.

Therefore, we expect to a team another $30 million in annual run rate synergies over the next three to four quarters, bringing the total acquisition synergies to $110 million versus the prior forecast of $100 million.

Turning to segment details second quarter optical communications segment revenue at 409.4 million decreased 2% sequentially optical communications segment gross margin at 48% increased 190 basis points sequentially and 830.

Basis points year on year with a more favorable mix of products improved telecom and datacom margins and acquisition synergies.

Our laser segment revenue at $48.4 million increased 43% sequentially and was flat year on year.

Second quarter Laser's gross margins was 42.1% flat quarter on quarter.

Turning now to our guidance for the third quarter.

The projections, we are providing today are also on a non-GAAP basis and are based on our assumptions as of today.

Please note the guidance we are providing today incorporates an approximate 15 to 20 million dollar reduction in revenue at the midpoint and a wider than normal revenue range due to the Corona virus outbreak.

We project net revenue for the third quarter will be in the range of 400 million to 425 million.

At the midpoint. This revenue projection includes telecom and Datacom increasing sequentially.

Industrial and consumer decreasing due to threed sensor sensing customer seasonality and commercial lasers also decreasing driven by customer seasonality.

Based on this we project third quarter operating margin to be in the range of 21% to 23% and diluted net income per share to be in the range of a dollar to $1.17.

These projections incorporate an approximate share count of $78 million and an estimated other income of $3 million.

The share count and other income projections incorporate the impact of both of our convertible notes pay down of our term loan and share repurchases made in December.

I want to note again that our guidance incorporates a 15 to 20 million dollar reduction in revenue at the midpoint due to the anticipated impact of the krona virus outbreak and as aylwin highlighted earlier the situation is fluid and evolving.

With that I'll turn the call back to Jim to start to QNX session Jim.

Thank you Wajid and before turning the call over to share and to start the question and answer session I would like to ask everyone to please keep to one question and one follow up this should help us get to everyone before the end of our allotted time, Sharon let's begin the question and answer session. If you'd like to ask a question at this time. Please press Star then the number one.

A telephone keypad, if he would like to withdraw your question press the pound key please limit yourself to one question and one follow up question. Your first question comes from Rod Hall with Gold Goldman Sachs.

Hi, guys. Thanks for the question nice job on results here I wanted to.

Start off and see if you could talk about the 15 to 20 million adjustment further growing virus and give us some idea maybe where that lands is it mainly threed sensing or is it evenly spread across the segments and any other color you could give us on.

How that might impact things down through the PML than I've got a follow up.

Yes, Rob. Thanks for your question. This is Alan to 15 to 20 is as an estimate based on what we know today.

Both from a supply standpoint, as well as anticipated demand standpoint.

Given some of our customers are also in affected areas. So.

We don't have the granularity to say.

On the demand standpoint, where it comes from I'll say that.

Because our factory and Chen then is focused mainly on telecom transmission from a from a supply standpoint, that's primarily where the shortfall will come.

And right as far as your question is related to the PML, we've already incorporated.

The impact of the 15 to 20 million and our.

Operating margin and in our EPS guidance. So the dollar to dollar 17 already includes the impact of the 15 to 20 million dollar adjustment that we noted.

And our script.

Okay, Thanks watches and.

Now as well.

Wanted to follow up with a question on wall way.

Two things on that one the UK decision on the wall way, how does that impact you do you anticipate any impact from that.

Positive or negative I guess and then also just maybe an update on.

What.

You are thinking in terms of recent administration comments regarding walk away does that does that change anything do you have any thoughts on when we might find out more.

Just any update on that would be helpful.

Hey, Rob this is Chris.

I would say to both parts of the question.

Given our our footprint in the customer base.

We're largely agnostic to two which of our customers wins.

Business so whether.

In the UK la is restricted to little more limited portion of the network.

We don't believe is a significant change for us.

And then in terms of on understanding what the U.S. government is going to do here I don't think we have any more insight than than what you can read in the general news or media.

But we are monitoring the situation very closely.

Great. Okay. Thanks, guys appreciate it.

Your next question comes from Alex Henderson with Needham.

Great.

Wanted to see if I could delve into a little bit what's your comments were around the wrote them side of the business obviously is here.

I think some constraints at the high end to your production.

Segment, but have you seen a change in the demand there it sounded like.

What you are seeing in text.

That you're seeing a pickup in demand there.

And if you could tie that into what's your thinking around the krona viruses that would be appreciated.

It is corona going to result in a temporary demand hiatus on some supply or and then you get it back later in the year is it how do you see that playing out over time I'm, assuming the viruses got the same.

Traditional.

Seasonality of of all coal viruses.

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As the weather changes.

The debates.

Yes, so what we said Alex was.

If you remember going into our second quarter, we said, we're seeing some telecom transport flattening out or softening and we saw that in the second quarter and what we wanted to reiterate in the script was that through the quarter, we saw a pickup in that demand.

Across the board, but mostly on the high end.

And rodents as more and more of our customers are developing in designing systems around both our high port count wins as well as our Contentionless and by end. So we're starting to see that really pick up across the board at all of our customers.

And as far as the Corona virus impact on on road on demand.

I don't know that.

Bill until our big customers come back from the break we'll know exactly what what impact.

That will have that said I don't think we have a problem in demand for for the high end drones and so we're shipping as much as we can and I don't think that anything will impact that as we're adding more capacity over the over the next nine months.

I could follow up so looking at the Corona commentary.

I assume you're taking into account the full impact of the holidays in the extension.

You are also sounds like you're taking into account some supply constraints.

Are you assuming that that stays can you give us a sense of how long you expect that to stay within that guidance or whether you're assuming that there's some tempering of the damage overtime within that projection.

What's the sensitivity to further extensions of the delays or things of that sort versus.

The forecast assumptions.

Yes, so Alan maybe one of the differences with our factory in China and then.

Two others is that because of the very very strong demand for coherent components and modules, we had a workforce working.

Through the Chinese new year.

At about 50% plus or minus a little bit so those employees continue to work.

Through the lunar new year as well as the existing wege because they were in working in staying at the dorms and Didnt werent restricted by travel restrictions, we have a good handle on where the other employees, our and our guidance contemplates them not coming back immediately because.

As of the travel restrictions, but coming back slowly overtime and so we've had them kind of estimate what we think thats going to be and Thats, where we came up with the $15 million to $20 million of of impact.

Does that answer your question, yes, Thats very helpful. Thank you very much.

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Next question comes from Blayne Curtis with Barclays.

Hey, guys. This is Tom O'malley for Blayne Curtis My first question is around three D sensing.

Obviously, you have some big ramps coming up in the second half of this calendar year can you talk about.

What your expectations are for share has that changed recently, how do you see.

Competing in the second half.

Are you any more or less well position than you were say last quarter.

Well I'd say that.

We're going to continue to do what we need to do to satisfy our customer and give them no reason to want to buy from anyone else and so I think having shipped a half a billion or more units with no field returns is a pretty compelling argument to continue to give us a very large share the business.

I will say that that we do expect to introduce new products.

In the coming months.

That I think.

Push the technology, a little further and give us a.

So strengthen our differentiation over our competitors that then we will give us a getting a high share of those new products.

For quite some time, so I'm pretty confident on our position and feel good about where we are now as well as in the second half of the year.

Great and then on on the telecom and Datacom businesses, you're guiding them, both but thats cumulatively, you're talking about how the Shenzhen factory may be affected from a telecom transmission perspective, then you've also talked about some business is going away I know that that's a weighted towards the fourth quarter.

Can you talk about are you able to offset.

Both of those weaknesses in telecom, specifically and is it just the roads that are better there that you've described or is there anything else that's kind of helping macro.

Oh, we as I said in the script we're on.

Serious constraints and our ability to meet our customers demand for.

Coherent components Agios and now goes and so we are ramping those products.

As fast as we possibly can putting aside the corona virus impact on margins in factory.

So I think.

We are seeing growth in transmission, we seem to strength coming back and transport and our Datacom chips are.

Growing very rapidly.

Both in Q2 as well as expected throughout this year to support that Fiveg rollout the datacenter build outs.

And so I think from that perspective, that's why we said telecom datacom are going to offset with typically is a seasonally soft quarter in the March quarter.

I'd also just just to make sure we're clear that.

[music].

Not all of our telecom and Datacom revenue is flowing through our factory in China packed card Datacom CIT.

Revenue does not touch.

That factory and similarly, a lot of our telecom transport.

Not flowing through that factory. So we had we do have.

Significant portions of our revenue from a supply standpoint.

On impacted.

What's going on in China.

Thanks, guys.

Your next question comes from Samik Chatterjee with JP Morgan.

Hi, Thanks for taking the questions. If I can just startup Oh, sorry, following up on the all your question about well we understand you mentioned that there is limited visibility at this time on the changes in terms of regulation from the government on that front.

What are you ready.

Bidding in your guidance then relative to revenue from the customer I believe last quarter, you had mentioned newest expecting to see some slowdown.

And from that customer will have so just wanted understand of that's played out as you expected and are you expecting kind of similar revenue was up a pickup from that customer.

This is Chris I would say things are playing out as expected.

That customer was significant customer for a lot of our products that are being discontinued for example, the datacom modules, they've historically were the largest customer.

And similarly on on some of the products that we supply where we do have.

Competition.

Those products seem to be a little bit more impacted from a demand standpoint, whereas seller.

Hi end products, particularly the high end Roadms.

We're seeing less.

Slowing if you will.

With that said, obviously, it's difficult to handicap, what's going on with with us government et cetera.

And and any changes that they may two two rules.

Continue to point out that.

Our our manufacturing and supply chain is this is quite offshore.

We do have some manufacturing in the last of some.

Laser chips.

But other than that in general our manufacturing is is quite offshore.

So it's difficult to opine on what the impact of what people speculating changes what could be.

But I think.

Unless there's a.

Complete change in strategy I need to the questions of a ratcheting down percentages in de Minimis threshold, that's something that unless theres a radical change in definitions.

I wouldn't be as impactful to us given our supply chain.

Got it if it can just follow up on on the broader comment that you all had in the press feasible Cross put the Max then strengthening and you've talked about dealer strength as well.

If you can give any color on kind of which customers are geographies are you seeing right as driving that and how was that gets going from the drivers of the strength that you're seeing on the transmission site that'd be helpful. Thank you.

Yes, well as I said in the in the script.

The high end wrote items and the Contentionless and buy in our broadly being deployed in new systems across the boards I wouldn't say that it's any particular customer.

Nor would I comment if it were.

Just because I think we.

We have a very broad footprint of customers and our wrote them leadership.

Really puts us in the good place across the board.

Fishing.

No.

Thank you.

Next question comes from John John Marshaleck with Stifel.

Thanks, very much just following up a little bit on the transmission side I was just curious your old outside of some of the constraints that you have right now and easier DCIO you had mentioned it in the prior call that you were expecting that business to continue to build just want to get a sense from your perspective, if thats still the case, if you're seeing that broadly across different.

Geographies and how you think of that that transmission piece playing out here over the next several quarters.

Yes, we continue to see strength in AC goes and worse in the in the midst of ramping our DCIO product.

But I think even underlying those products is our capability at the indium phosphide level for higher baud rate components for.

Products that are up to 800 gig so we're seeing a broad range of customer demand.

For these enabling technologies from a component level through a CEO and DCIO and it's broad based.

And then if I could just follow up real quickly on the end by end commentary I just wanted to make sure you. Historically I think that was primarily a product designed or shipping into why way and I. Just wanted to follow up on your last comment but that is now shipping to a to multiple customers that not just to that one.

That is correct.

Thanks.

Next question comes from Simon Leopold with Raymond James.

Thank you for taking the question I wanted to come back on the Corona virus supply side of the question.

I think you you've moved a lot of operations out of China. So maybe help us understand what portion of your production or head count is based in China now and do you feel as if you have a competitive advantage because.

The folks who you're competing against maybe more exposed in terms of the supply side of this in terms of having more staff in China, and then I've got to follow up.

Sure.

Well, we have proximately thousand people in China.

Most of those are manufacturing people and then outside of China, we have contract manufacturers that.

Employee thousands of people on our behalf as well as our own factory in Thailand and so.

Over the last three years, we did move a substantial percentage of our production.

Out of a contract manufacturer in Shenzhen, China.

Most of that went to our own factory as well as into contract manufacturer in Thailand, and so those.

Those employees and contract manufacturers are not affected by the krona buyers, except from the standpoint of any kind of sourcing of components and we've looked at the sourcing of those components that could come from China, and we feel pretty comfortable that.

The our Thailand contract manufacturer and our own operations will be minimally impacted by.

The those sourcing of components coming from China. So I'd say to answer your question, Yes, I think we're in a much better positioned than some of our competitors who are highly.

China manufacturing based.

Great. Thanks, and then in terms of the follow up.

One of the things are rich that we've all talked about for some time is the idea that.

Why way in particular or Chinese Oems in general become more vertically integrated and we have the impression that that might be accelerating and just want to get your sense, whether you've seen evidence of this particularly in an area like a like a lower end wrote them type product or or other aspects. Thanks.

Yeah, I mean I think.

We're going to continue to focus on innovation and driving innovation and I think.

Well it over the last five years, there's been a drive for our Chinese based customers to be more independent I think our continued push on innovation and new product introductions has has kept us in a very very good position with respect to.

Those leading edge products.

Our participation at the low end road comes in China is not that big as most of those deployments have shifted and the Asps per unit are significantly higher on a twin high port count product or in by it.

Simon I'd add that our customers in China.

You know also compete on a global market and our customers our customers customers demand the ultimate and performance capability.

And that's how we differentiate our products is around performance and capability.

And we do have had and continue to have a competitors in most of the products that we make and we feel that.

If we can continue to put distance between ourselves and our competitors, it's pretty challenging for for a customer. If you will other than if they are willing to compromise performance, our capability, which they would struggle to do on a global.

Marketplace.

Great. Thanks for taking the questions.

Next question comes from George Notter with Jefferies.

Hi, there. Thanks, very much guys I wanted to ask about the gross margin strength I was really pretty surprised by it here in the December quarter.

Her the comments about a.

Mixed improvement as well as just straight up the strength in Datacom and telecom, but.

Any more flavor you can give us for that optical gross margin strength and then how do you see gross margins going forward. Thanks.

Yes, I think its watch it here I think you've captured a pretty well you know our gross margins came in a little bit better than we expected during the quarter, primarily because of the acquisition synergies continuing to flow through.

As we noted in our script, we're expecting those acquisition synergies to continue.

Through the calendar year 2020.

And we've increased that number from $100 million to $110 million.

If you take a look at our operating margin guidance, which is really a flow down of our gross margin improvements are for Q3, you can see that year on year, we're expecting to increase substantially I. Despite the fact that our revenues are going to be down year over year because of the corona virus situation.

And so we're continue to expect to see improvements in telecom and Datacom gross margins are now some of that is being driven by the new products that we have coming out which are.

Our our giving us higher standard margins on our products, but some of it is also because of the continued expectation of of acquisition synergies to flow through over the next three or four quarters.

The one one item just drawing on what Alan said earlier.

The continued strength in Threed sensing that we're expecting to see over calendar.

I should also provide us with a nice boost.

To gross margins as we enter the back half of of calendar 2020. So we're looking forward to that.

Yes, just went out and then.

Sorry, sorry, Georgia that 10 to 15 million dollar drop of of legacy low margin products going away Q4 that should also.

I should also help because those are very poor margins and those will go away. Okay. And then do the M&A synergies come in in chunks, then was that part of the story here in in March or do they still kind of flow in on a more sort of ratable basis is that your progress is like how should we think about that.

Yes, so I mean, some of it is flowing through and you'll see some of it in March and Thats why weve been able to guide the operating margins that we have but you'll see a nice chunk come in and our and in our first fiscal quarter of 21, and then flow through to the December quarter.

And in fiscal 2001 as well.

Okay. Thank you.

Next question comes from Michael Genovese with MKM partners.

Hi, Thanks, a lot as we think about Threed sensing seasonality for the year, obviously, you've given March guidance, but is there a reason should we think about normal seasonality. This year as a reason to think in June.

Either an earlier start to.

Programs with existing customers as they do world facing or new programs new customers are there any reason to think that.

You should be better than seasonally normal.

I don't think that theres anything that would be material.

Different with respect to seasonality in the June quarter.

Okay.

As we saw us pickup in the June quarter from new products last year and that usually starts late in the quarter and I don't see any reason to expected to be any different this year.

Okay got it and as we look at the much guidance, we've given for three D sensing.

And as we sort of trying to compare it with the main customer that we know about and what we think about about their units is there is there any reason.

That you'd be materially different.

ASP fees or market share or inventory or or would we think that.

These numbers should should actually lineup.

The customer numbers with your numbers.

Lighting likely we highlighted in her remarks, where we thought the.

Three D sensing revenue would be at least from a quarter on quarter change.

So I think that incorporates all all those all of those questions that you've asked.

Okay I appreciate it thanks.

Next question comes from to Jazz bank attached with UBI, yes.

Thank you I Wonder if you could comment on the inventory situation at Wawa in broadly in China.

Well I think.

It's hard hard to know exactly what's going on with inventories, but I'd say that.

The majority of our revenue that are going into our leading customers in China are four very differentiated products.

In particular high end wrote items it when high end Roadms and buy in roads, where the competition is far behind us and so I think.

Given that we are constrained in our ability to meet with Theyre asking for gives me confidence that theres not a warehouse full of high end wrote them.

I'd say that that the rest of the products weathers.

More competitors.

We're not selling a lot of those things and in fact as Chris mentioned, we're getting out of that Datacom module business and winding that down in the next several months and so.

We're not so concerned about.

Those types of products.

Thank you and as a follow up walk was Android TV sensing revenue in the December quarter, and how are you thinking about the next few quarters.

Thank you.

Yeah were not going to to continue to breakout Android revenue, obviously, we have a a large customer driving a.

We already have our of our revenue and so that in providing that will be disclosing.

Confidential information I think from a trajectory standpoint on we're certainly seeing.

Android funnel building up as more customers incorporate threed sensing and more models.

There has been a little bit of a.

For hits to the to the Android market with with obviously.

Wally being a major customer.

Or make major smartphone supplier and therefore, a major customer of Threed sensing lasers and with their inability to get things like Google apps and challenges around the Android operating system due to the current restrictions.

We believe their volumes of high end smartphones sold out outside of China.

Our more limited and that's that's muted some of the growth that we had to previously anticipated in annually, but with that said on the customers are lining up particularly around the world facing capability for computational photography.

And more or less saying, that's just a feature of their new dual triple and quad cameras moving forward.

And I think over the next 12 to 24 months is also a time period, where augmented reality virtual reality applications are potentially going to emerge.

For visibly for for consumer devices, and that will give other motivation to two Android suppliers to.

Adopt threed sensing.

Next question comes from met to Marshall with Morgan Stanley.

Great. Thanks, maybe just one clarification and one question on the clarification should all the incremental synergies that you guys are talking about the kind of 30, even are remaining should that mostly be in gross margins or should we expect some of that in Opex and then for my question.

You know a corona virus aside on kind of the supply constrained products, how much incremental capacity could you be adding kind of on a quarter on quarter basis or should we be thinking of incremental capacity that can be added. Thanks.

So on the synergies question it will be in our gross margins were seeing most of the benefits coming through in our cost of sales as a as our operations team has been able to to continuously be every target that we've put in front of the them. So so what we should see that in.

Gross margins, primarily flowing through our operating expenses.

We're continuing to invest heavily in R&D, especially with the growth that Alan talked about earlier and within our transmission product lines and so some of it will be reinvested.

Back in there.

As far as your question on one of our talented you want to take that.

I think the question was really setting aside the krona virus that the the capacity growth on unconstrained products I'd say.

On the biggest area for opportunity my mind, what two areas is our Datacom chip.

Revenue that grew substantially quarter on quarter last quarter, but we're still constrained I can imagine.

Adding 50% to that capacity over the next to four to six quarters, and where we're taking action to do that by adding capacity in our fab in Japan, moving equipment from our San Jose Fab to our Japan, fab and things like that that will give us that incremental capacity.

The other big areas and the telecom transmission.

As we shift to DCIO modules average selling price per unit is substantially higher than a hcl module given that we have a DC.

SP in it so that's one dynamic, but we are ramping up capacity there.

Were also having to increase our capacity in our UK wafer fab that supply is all these photonic integrated circuit chips for our coherent components and modules.

I hate to give a number on that but I can imagine you know a year and a half from now having 50% increased revenue and telecom transmission. So I think the vectors are lining up in demand is very strong.

Great. Thanks, Chris.

Next question comes from Georgia, Troy Jensen with Piper Sandler.

Yeah, John first off congrats on really good results you're on team did a great job on the operating margins too.

Thanks right.

Hey, So I guess, a and just on that point I'm just talk about the stability of the operating margins here and you guys reported here in the December quarter is pretty impressive great 20, 20% just.

I think about the longer term model, even all these cost synergies coming in that it makes the products.

I think operating margin look like in coming quarters.

Yeah, Hi, there traits I'll start off its wajid here.

So what we talked about over the last couple of quarters is our our goal is to improve is to improve our operating margins a year over year and so we've been able to do that in fiscal Q1, we clearly I did that in fiscal Q2, and if you take a look at our guidance for fiscal Q3.

I think last year, we were under 18% on operating margins and now we're guiding a 21% to 23% on lower revenues.

And so our operating margin trajectory is going as planned a lot of it is because we're being quite disciplined from a synergy standpoint, but when you hear capacity constraints that also means that were being quite disciplined from a pricing standpoint, as well and our general managers are doing outside.

Caustic job of balancing that with a with customer request and customer requirements.

In addition to that Alan mentioned earlier that we're putting in place capacity to increase supply for telecom transmission products as well as Datacom chip products and so because we've got so much leverage in our model, even though we're continuing to expect to invest in R&D I would that revenue leverage we should see oh.

Operating margins improve and the last thing is as we look back into the back half of calendar 2020, a with increasing content that we're seeing on Threed sensing.

And the margins you can expect on a world facing products, we expect to see operating margins benefit from that as well so like onset everything's lining up and we're doing our best to execute to it.

Great I guess my.

Good My hope would be that you know you guys can continue these year over year gross.

In the first half of next year next fiscal year.

Strict approached 30% model that I know you won't touch on that but maybe just for my follow up then just can you hit on industrial lasers.

He hopes in that deal in the fiber laser business start to pick up.

Yeah, I mean is you know the fiber laser.

[noise] pricing is pretty aggressive really due to.

Aggressiveness of the Chinese suppliers.

They are putting pressure across the board on fiber lasers.

That said, we do supply a very large percentage of those customers with that with the fiber laser chips that fuel those engines and you can imagine those are at semiconductor type margins and so we're going to continue to do that I'd say that that theres, a lot of new product introductions coming as.

And that equally three entering new applications for us and ultrafast cutting of oil levies and.

Fiveg antennas as well as printed circuit board via drilling and so we're going to continue to invest in new products and lasers or new fiber laser platforms that drive our cost to the point, where we needed to be to keep up with the competition or actually.

You see the competition. So I think you know, we're we're seeing ups and downs, because we have a pretty concentrated customer base, but as we enter into these new markets new applications, our customer service should broaden and.

And we should see long term growth.

Perfect well keep its a good work gentlemen.

Thanks.

Next question comes from Richard Shannon with Craig Hallum.

Hi, guys. Thanks for taking my question, maybe a quick question for Alan on the overall the optical industry environment here.

You just raise a convert got a nice balance sheet here Youve closed a nice acquisition of Oclaro here Wonder if what's your views are on further industry consolidation specifically in lumentums participation in that you do you expect or or continue to looking for acquisitions and potential large ones.

I mean, we I think we always look for acquisitions that provide shareholder value.

I think the challenge with some of those are that you have to have a willing seller at the right price and we're going to continue to have a funnel of targets that we look at all the time and when we reach agreement with one of them. We'll let you know I think that industry is getting healthier the dynamics are much healthier with a lot of the acquisitions that have already taken.

Place, but I do think that theres still more to come.

Even even make the dynamics of the industry more healthy I think Richard something you brought up is participate in the benefit of it I'm not only and we participated in the benefit bye bye.

Acquiring companies and integrating and achieving synergies as we've done but also by being a bystander end and others consolidating in the industry everybody benefits from from.

They are being a fewer fewer players competing for.

The customer opportunities.

Okay fair enough. Thanks for those thoughts my.

Follow up questions on Threed sensing.

Specifically on the kind of the pricing dynamics expect going forward throughout this year your discussion on previous questions around competition suggests you don't see.

A big change in that environment. So are you expecting pricing curve, so I'm kind of being similar at least on a like for like basis. This year that you've seen in past years.

Well I mean, I think we continue to focus on driving our cost down to satisfy our customers desire and need for lower cost solutions, especially as they add more content per phone or per device I'd say and so you know we're focused on maintaining our gross margins in that.

In that business and we're confident that.

Continuing to come down on the price curve and cost curve will allow us to continue to have a huge share of that market and happy customers and so at the gross margins that we need so I think from that perspective I.

I think as we refreshed the products and we're expecting a pretty good refresh on all the products.

Most of the products I should say this this coming year, we have an opportunity for.

You know pricing to not have gone through three years of price reductions and so I think from that perspective, we're pretty comfortable with where we are from a gross margin standpoint.

Okay fair enough. Thanks for taking my questions.

Next question comes from Tim Savageaux with Northland capital.

Hi, good morning, and congrats on the results of our initial question on the demand from maybe a quick follow up on gross margins.

From a demand perspective, but it can we get your thoughts on what appears to be you're almost historically strong.

Telecom Datacom demand it looks like X the impacted the virus you might be guiding up.

Maybe even high single digits in the normally seasonally down quarter.

Historically in the March quarter, we've seen that before and it's very strong surge in China back a few years ago, but I.

I Wonder if you could characterize what's what's driving that whether it is can we be fiveg driven demand strength, our china or to what extent your own share gains or perhaps the new normal.

That you previously referenced from an MSP standpoint are driving what looks to be pretty extraordinarily strong demand and telecom and datacom.

Yes, I'd say that we have a competitive advantage with respect to a lot of our products and technologies that that drive demand and in particular, if you look at our Datacom chip business, we have an enabling technology with our emails.

To really drive next generation product introductions at 400 GE for data center. So I think we're seeing.

A lot of strength and Hyperscale data center growth and we're in the early stages of Fiveg demand using similar type of technology and chips and so.

I'd say, we're in the front end of that but the demand across the board is quite quite strong on datacom chips on the telecom side I again, I think it's it's a differentiation standpoint, and our roads or.

We have a huge lead and technology and product on that and on our transmission side, we're enabling customers to produce 800 gig a transmission coherent transmission with the enabling technology at our photonic integrated circuits level. So I think that's what's driving a lot of the demand and.

You know, having the leadership that we had had ace jozy now hopefully on DC goes in the coming years will drive incremental.

Growth in our telecom transmission business.

Yes, I think out thanks.

On the headcount and summarized it well its strong market fewer competitors and very differentiated products. All three the two are all three compound.

ER positively.

Sounds like a decent environment.

And to follow up on that Datacom Chip me, maybe that was the real surprise driving gross margins, maybe a little bit better than you expected, but a lot better than I expected, maybe three 400 basis points.

With optical comm margins looking to get into the mid Fortys here.

You know, we would it be fair to characterize as Datacom device.

Drivers is sort of key to that and as you look forward.

Into at least some growth even with the virus.

Impact in the March quarter.

You know from a mix standpoint, or any other is there any or reason to believe those margins with declined sequentially in optical calm or.

Your or is most of.

The the sequential gross margin decline a result.

Your lower Threed sensing volumes and margins.

Yes, So let me start off and then Alan can can jump in so.

Historically, we've we've seen a seasonal decline in both revenues and gross and operating margins going from our fiscal Q2 to fiscal Q3, and just a reminder, last year, our operating margins for fiscal Q3 were under 18% and so that normal seasonality does give us a normal gross.

The margins come down because we have a pretty substantial manufacturing infrastructure that weve that we've got to support and so revenue levels do matter. We provided guidance from March to the best of our abilities, but what you've heard from Alan.

Is that we've got a number of tailwinds that are working in our favor obviously, the datacom chips are being on supply constraints and us investing in more capacity because we see demand there is giving us a tailwind.

Three D.S. growing into the back half of the year, that's giving us a tailwind we've got acquisition synergies that are flowing through all of calendar year 2020, and then we've got topline growth and transmission, that's going to give us leverage on the topline and allow us to have better operating margins as the calendar year flows through so we've got everything working in our favor.

In order to help us improve gross margins and resulting operating margins I mentioned earlier that we are investing a little bit more in Arne R&D, especially in France transmission business, but that shouldn't be so much that offsets the leverage and the tailwinds we see.

In Datacom, three D.S. as well as acquisition synergies, so where it's going to be in March we guided to but what we see you for the balance of calendar year 2020, I think you've got I'm kind of all you need to to help you with your model.

Thanks.

Weve reached the end of the allotted time I'll now turn the call back over to Mr. Alan Lowe.

Great. Thank you operator, we regularly to discuss our business at Investor events. These events are listed on our website in the Investor Relations section and our regularly updated.

Please recall for today, we'd like to thank everyone for attending and we look forward to speaking with you again another few months. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.

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