Q1 2023 Lumentum Holdings Inc Earnings Call
Good day, everyone and welcome to the momentum holdings first quarter fiscal year 2000 seats. Once you free earnings call. All participants will be in a listen only mode. Please also note today's event is being recorded for replay purposes.
If you'd like to register an audio question you may do so by pressing star followed by one on your telephone keypad.
At this time I'd like to turn the conference call over to Kathy Tal Vice President of Investor Relations. Mr. <unk>. Please go ahead.
Operator, welcome to the mentioned its fiscal first quarter 'twenty to 'twenty three earnings call.
This is Kathy Todd momentum Vice President of Investor Relations. Joining me today are Alan Lowe, President and Chief Executive Officer, Wajid Ali Chief Financial Officer, and Chris Coldren, Senior Vice President and Chief strategy and corporate development Officer.
Today's call will include forward looking statements, including statements regarding our expectations regarding our recent acquisition of neo photonics, including market opportunity expected synergies financial and operating results and expectations regarding accretion.
Strategies of the combined company and benefits to customers and the markets in which we operate.
The impact of COVID-19 on our business and continuing uncertainty in this regard.
Economic trends 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.
We encourage you to review our most recent filings with the SEC, including the risk factors described in the quarterly report on Form 10-Q to be filed for the quarter ended October 1st 'twenty to 'twenty, two and those in the 10-K for the fiscal year ended July 2nd 2022.
The forward looking statements provided during this call are based on momentum as reasonable beliefs and expectations as of today.
Momentum undertakes no obligation to update these statements except as required by applicable law.
Please also note unless otherwise stated all financial 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.
Momentum is press released with fiscal first quarter 2023 results and the accompanying supplemental slides are available on our website at www Dot dot com under the investors section. This includes additional details about our non-GAAP financial measures and a reconciliation between.
Treating our historical GAAP and non-GAAP results.
With that I'll turn the call over to Alan.
Thank you Kathy and good morning, everyone.
Our first quarter financial and operational performance was excellent and we achieved a record revenue quarter.
Like to thank our global team for their solid execution, which drove first quarter revenue above the midpoint of our guidance.
Earnings per share at the high end of our range and operating margin above guidance.
We are well positioned for the long term.
The recent closure of two acquisitions further strengthened our optical communications business.
We now have the photonic industry's most comprehensive product portfolio to serve our networking and cloud data center customers.
We continue to see strong fundamental demand drivers for network infrastructure.
We are seeing strong demand from our customers, who have reported record order backlog levels.
Leaders in optical fiber are reporting record shipments of new fiber to handle unrelenting need for bandwidth.
Our products and capabilities are well aligned to telecommunication market inflections now occurring.
In fiscal Q1 compared to the same quarter last year, we delivered $136 million of incremental revenue dollars in telecom is 79% increase which includes two months of revenue from our recent acquisitions.
Organically, we grew telecom, 38% year over year.
Over the years, we have built a foundation of customer trust as our differentiated solutions have been proven within network architectures.
Also momentum revenue exposure to infrastructure markets through our communications and commercial laser product line has never been stronger.
We expect that greater than 85% of company wide revenue will come from infrastructure markets outside of consumer in fiscal 'twenty three.
This is due to the share of normalization and consumer discussed on previous calls and recent strategic investments.
As we are now three months into the integration of our recent acquisitions I am even more excited about the high quality of the products and the technology expertise that we have added to our global team.
We are in an excellent position to capitalize on our strength in optical communications.
And we are executing on our strategic plan.
We plan to expand our product offerings and the communications networking with our combined R&D teams.
Realized synergies and greater benefit of manufacturing scale with an overall higher volume of business and enter adjacent markets now accessible to us with more tools in our tool belt.
Yeah.
These acquisitions position us to accelerate long term technology trends and advanced networking hardware and adjacent markets and to expand our share in the growing telecom infrastructure market.
Since closing these acquisitions, we had even higher confidence in accomplishing our goals.
We look forward to sharing more on our progress in the upcoming quarters.
Last quarter, we gave a full year financial outlook to help the investment community model, our fiscal 'twenty three business.
Since then there have been several developments in the supply and demand landscape.
In telecom.
Supply shortages are not improving as quickly as previously anticipated.
We now expect these shortages to gate our revenue throughout fiscal 'twenty three.
In addition, like many others, we are now seeing incrementally lower cloud and consumer end market demand from our customers.
Taken together. These changes result in a new outlook for fiscal 'twenty, three revenue, which wajid will discuss in detail later.
Overall demand for our telecom products remains strong, especially in edge networking applications, which are transitioning to wavelength tunable technologies.
Higher speed components and modules.
And advanced transport products.
All of these play into the industry's transition to 400 and above speed networks.
Now, let me provide some detail on our first quarter results.
Telecom and Datacom revenue was up 67% year on year with organic telecom or datacom up 33% year on year.
Our supply chain team continues to work diligently to close the gap on IC chip shortages as we work to fulfill robust demand for our products.
We expect the revenue impact of these chip shortages will be approximately $80 million.
And to the second quarter.
Similar to that of the first quarter.
In the first quarter, we achieved record quarterly revenues in three transmission product leadership areas.
Narrow line width tunable lasers.
Tunable products for edge networking applications.
And coherent components for high speed coherent modules and line cards.
Our narrow line width tunable laser business performed to our expectations in the quarter.
I am impressed with the deep bench of talent that we have added to our team with the recent acquisitions.
Our R&D teams are very excited about the expansion of our photonics toolkit in leading edge modules silicon photonics high bandwidth coherent components.
Our narrow line with external cavity tunable lasers.
Coherent yes PS.
And RF integrated circuits regarding DSP is we're focused on our production tape out of the 400 G capable coherent DSP to enable significant cost reduction in our growing ZR and ZR plus module business.
Our tunable products for network edge applications have unique capabilities that help to expand bandwidth in metro access.
Fiber deep.
And wireless five G front haul applications.
We are expanding both our front end wafer fab and backend assembly and test capacity to serve these growing applications.
We doubled our Q1 revenue from the same quarter last year and the next phase of manufacturing expansion in the coming quarters.
Another increase our capacity by another 80% to 100%.
As edge network data rates increase we are uniquely positioned to serve the growing demand from a diverse set of cable and wireless networking customers.
Our 400 G and above coherent components also reached a new revenue record in the quarter with approximately one third coming from 800 G applications.
We are very excited about our robust product pipeline of next generation 800, G and above components and modules.
In the quarter wrote them revenue grew 23% sequentially and 34% from the same quarter last year.
Due to continued strong demand along with better access to critical Ics.
Shipments of contention with Emma by N wrote them grew over 50% sequentially as next generation networks need to increase scalability to handle new fiber deployments.
In the quarter, we also closed a significant new opportunity for pump lasers in the area of satellite communications.
We continue to lead the industry and transport product innovation.
In the quarter, we began shipping the next generation of transport products, including.
Wrote them node on a blade architectures and our next generation of contention list M. By N. W. S. S blades to leading customers further distancing ourselves from our competitors.
In Datacom, we saw a sequential decline in email revenue from a record fourth quarter.
The decline was due to lower demand by a subset of cloud data center customers.
We anticipate continued softer demand from Hyperscale operators, which has lowered our datacom revenue outlook for the balance of fiscal 'twenty three.
We continue to drive the next phase of the Datacom industry roadmap with our 200 G per lane emails or one six terabits per second applications.
We expect these to enter production as we exit fiscal 'twenty three and we are engaged with multiple customers and design in activities for these leading edge chips.
In addition, we were excited about enabling the transition from copper to optical fiber and data center applications with our 100 gig per lane Nixle.
We expect to ramp this product line during fiscal 'twenty four.
Turning to industrial and consumer Q1 was up from Q4 due to the new smartphone product launch.
As expected share normalization caused our Q1 <unk> sensing revenue to be approximately half of last year's level.
We are optimistic about our three D sensing businesses applications in automotive and industrial markets begin to ramp.
Underscoring this in the first quarter, we recognized approximately $4 million in revenue from automotive and Iot applications and we expect this to grow significantly in the coming years.
In the first quarter, our commercial laser revenue was up 4% sequentially and 26% from the same quarter last year.
Fiber laser serving industrial applications grew 25% from the same quarter last year.
We have a growing set of applications with the introduction of new laser products, which is generating new customers for us such as in solar cell and EV battery processing.
Looking ahead to the second quarter, we expect laser revenue to grow again quarter on quarter.
Yeah.
I'd like to take a moment to share the significant progress we have made towards achieving our corporate social responsibility goals toward a low carbon future.
In September we published our second CSR report, which outlines the excellent progress our team has made in ESG initiatives.
Our company wide use of renewable electricity has expanded from 3% to 31% and were poised to increase this percentage again this year.
We have extended our award winning diversity inclusion and belonging program to include training at all of our global sites.
We've established new employee resource groups for career development Mentorship and employee retention.
We look forward to realizing the measurable benefits of this year's initiatives in fiscal 'twenty three and beyond.
I'm very excited about momentum strategy, our competitive position and our unique opportunities to grow and advance communication and networking technologies.
Hedging cloud computing.
Industrial 4.0 and machine vision markets.
To capitalize on these trends and the communication consumer and industrial end markets and consistent with our prior earnings call. We are increasing R&D investments during fiscal 'twenty, three which we believe will accelerate top line growth in fiscal 'twenty four and beyond.
Momentum is extremely well positioned to win in the current environment.
Execute our strategy to invest in our product portfolio.
Grow in existing and adjacent markets and expand profitability over the long term.
I would like to thank our employees around the world for all of their hard work and resilience that has put us in such a great position today with that I'll turn it over to watch it.
Thank you Alan net revenue for the first quarter was $506 $8 million, which exceeded the midpoint of our guidance range and was a record in quarterly revenue.
Net revenue was up 21% sequentially and up 13% year on year.
GAAP gross margin for the first quarter was 39, 7% GAAP operating margin was two 7% and GAAP diluted net income per share was a net loss of one cent.
First quarter non-GAAP gross margin was 48, 2%, which was down sequentially and year on year, primarily driven by product mix, including new photonics revenue as expected during.
During the quarter, we incurred $7 $3 million, an extra ordinary charges to acquire IC components from various brokers to satisfy customer demand.
These incremental charges were excluded from the non-GAAP gross margin as disclosed in our filings.
First quarter non-GAAP operating margin was 27, 1%, which decreased sequentially and year on year due to product mix, including new photonics, and our DSP investment would the IPG Telecom acquisition and was above the high end of our guidance.
<unk>.
First quarter non-GAAP operating income was $137 $4 million and adjusted EBITDA was $161 $9 million.
First quarter non-GAAP operating expenses totaled $106 $7 million or 21, 1% of revenue.
SG&A expense was $45 $9 million R&D expense was $68 million interest and other income was a net income of $2 million on a non-GAAP basis.
First quarter non-GAAP net income was $119 $2 million and non-GAAP diluted net income per share was $1 69, which was at the high end of our guidance range provided on our last call.
Our fully diluted share count for the first quarter was $70 6 million shares on a non-GAAP basis, our non-GAAP tax rate remains at 14, 5%.
Moving to the balance sheet, we ended the quarter with $1.6 billion to $5 billion in cash and short term investments during the quarter, we repurchased 300000 of our shares for $25 $7 billion.
As of the end of the first quarter, we have purchased a total of $9 4 million momentum shares for $815 $5 million over the last six quarters, reflecting our confidence in long term growth.
Turning to segment details first quarter optical communications segment revenue at $453 $4 million increased 22, 2% sequentially due to robust demand in our telecom business and the addition of new photonics revenue opt.
Optical communications segment gross margin at 47, 6% decreased sequentially and year on year, primarily due to product mix and new photonics, our first quarter laser segment revenue at $53 $4 million was up four 3% sequentially.
And up 25, 9% year on year.
First quarter lasers gross margin of 52, 6% was sequentially down but up year on year.
Before we turn to our guidance I would like to add some color to what Alan said regarding our outlook for fiscal 'twenty three.
We continue to experience I see supply shortages, which are not improving as quickly as previously anticipated and are now expected to gate our revenue throughout fiscal 'twenty three.
In addition, like many others, we now expect lower cloud and consumer end market driven demand from our customers.
Based on these factors, our new revenue outlook is $1 $9 billion to $2.05 billion.
At the midpoint. This is a reduction of approximately 9% from our August outlook.
It still is greater than 15% growth from fiscal 'twenty two.
Our fiscal 'twenty three operating margin outlook is in the range of 19% to 22%.
And annual EPS is in the range of $4 65.
The $5 65 per share.
The delay in the improvement of the supply of a small number of Ics is the largest factor within our lower fiscal 'twenty three outlook within this outlook, we are reducing spending in discretionary areas, while increasing our R&D investments and growth initiatives, both in existing markets and.
New markets.
As we execute on acquisition synergies and work down shortages and IC supply and we begin to realize the benefits from the accelerated R&D investments, we expect to return to our target financial model of 50% gross margin and 30% operating margin.
And the longer term.
Now, let me move to our guidance for the second quarter of fiscal 'twenty, three which is on a non-GAAP basis and is based on our assumptions as of today.
We expect net revenue for the second quarter of fiscal 'twenty three to be in the range of $490 million to $520 million. Our Q2 guidance incorporates approximately $80 million of impact to revenue driven by shortages of third party components.
Based on this we project second quarter operating margin to be in the range of 20% to 22% and diluted net income per share to be in the range of $1 20 to $1 45 per share.
Our non-GAAP EPS guidance for the second quarter is based on a non-GAAP annual effective tax rate of 14, 5%. These.
These projections assume an approximate share count of 72 million shares.
Given continued IC supply constraints three D sensing seasonality and the lower Hyperscale data center spending embedded in our outlook. We now expect Q3 revenue to be down a high single digit percentage from Q2, followed by a stronger Q4.
With that I'll turn the call back to Kathy to start the Q&A session Kathy.
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 as many participants as possible before the end of our allotted time.
Operator, let's begin the Q&A session.
As a reminder, if you'd like to register an audio question. Please press star followed by one on your telephone keypad. If you change your mind. Please press star followed by two am please ensure and muted when speaking off.
First question comes from stomach Chatterji of J P. Morgan stomach. Please go ahead.
Oh, hi, Thank you. Thanks for taking my questions I guess for the first one if you can.
Does it mean to the full year guide a bit more youre guiding down the full year by about 200 million.
The fiscal second quarter, two when I look at compared to consensus.
Hartford was about only 35 so.
So it doesn't imply that headwind sort of become greater relative to sort of like Eastwood consensus was thinking three Q4 Q. So I'm just wondering if you can maybe share some insights on that as well as breakdown. This sort of 200 million into how much of that is supply versus the lower cloud demand as well as the lower <unk> sensing.
Demand that you highlighted if you can break down the pieces photos and how do we think about sort of the risk.
For those thoughts on lower demand. That's one question I'm getting is what I'm sorry for the long question, you'll have a quick follow up after this.
Yeah.
Great. Thanks, Thanks, so much.
So I think you can look at it a couple of ways as Wajid said in the prepared remarks, the biggest impact of the reduction is our expectation that the chip shortage will continue through the year and into the beginning of fiscal 2000 and for it. So that's the biggest part of that.
Of the reduction in the full year guide.
I'd say that you know the the <unk>.
Combination of the hyperscale customers or subset of customers and and three D. Sensing there is probably about the same.
The impact, but keep in mind, we still have $150 million range.
Outlook. So there's certainly a lot of uncertainty as to shifts in that business and and how we look at a potential upsides and potential impact to your point.
There is no crystal ball in our future to know what's going to happen in the economy and that's why we still have a wide range given that we only have the second half guide so.
Certainly some uncertainty there, but I think we're very very confident in the outlook for telecom as the demand is extremely strong and our commercial lasers business continues to grow as we enter new markets and gain share. There. So I'd say those are kind of the moving pieces as we look at the full year guide.
Okay. Okay. The other question that I'm getting and just to follow up here is that.
But overall based on all the companies that have reported deed, we are definitely not shooting sort of supply shortages get was its been more sort of in line to previous quarters or.
Moving to.
So investors at Big Spring.
I use about sort of the worsening that you are seeing in the supply landscape look so greater headwinds, particularly in flight and sort of your full year guide for the back half fueled so maybe share some insights on what you're seeing on the supply chain at this point, what's sort of the whats what could drive it to come in better than expected and what have you.
And for <unk> in terms of supply headwinds at this point.
Yeah, I mean, certainly supply is getting better as you saw from our telecom growth in AR in Q1 in our forecast the telecom growth in Q2. So the situation is getting better, but it's not catching up with the growth in demand as we talked about at the end of Q2, our shortages are.
It would be $80 million, plus or minus some and that's the same as when we exited Q1. So we're growing telecom pretty strongly at the same time the demand is growing.
Just as strong as our our output so we're not catching up with that demand given supply chain shortages.
And it has fewer suppliers and fewer components that we're chasing.
But at the same time those few components are needed to ship product and so I'd say that we're still constrained by a handful or a handful of suppliers with a couple of handfuls of parts that are restricting our ability to meet this very very strong telecom demand.
Okay. Thank you thanks for taking my questions. Thank you sound like.
Our next question comes from Simon Leopold of Raymond James So I'm on the line is yours.
Thank you very much my question, maybe a bit nuanced. So I apologize if it's not clear, but I guess one of the things I'm struggling with is the softer cloud demand.
You've called out it's been my impression that some of the cloud operators are trying to rebalance inventory.
Basically trying to get everything in line, what they have plenty of versus what they don't have enough up and that to me sounds different than softer demand you described and if I'm splitting hairs tell me, so but I'm just trying to understand it and if it's not softer demand maybe you could help us understand what specific chips youre.
<unk>. Thank you.
Okay. So I mean, I'd say that the when we talked about the hyperscale softness it's a subset certainly not all of them are showing softness and I do think it's a combination of rebalancing inventory to your point, where they were driving this extremely hard court.
Yeah, Merle chips for inside the data center. So they have inventory I do think they are rebalancing, but at the same time that rebalancing leads to softer demand on us and so as they burn down that inventory, we expect that demand on us to pick up but to your point.
There is inventory of these chips at their suppliers are in.
We believe they will burn through those in the next couple of quarters. So that we would expect that.
As we get into the end of the fiscal year and into fiscal 'twenty for that demand will pick back up.
Does that answer your question.
It does it does no I appreciate that and just wondering whether or not you would be able to break out what was the Neil photonics contribution to the to the quarter and in particular their XE are.
Related products, both laser and Transceivers were disproportionately affected by this.
Yeah, Hey, Simon this is Chris So you know moving forward, we're not going to we're one company and we've already started executing on synergies sort of not a breakout.
Yeah Neal versus momentum our revenues if you will we get in trouble if we even mentioned neo inside the company right. We're one company at this point moving forward that said.
Clients like ZR for US continue continue to grow it's in very early days.
I think as Alan alluded to.
Where we're seeing this more of a inventory correction on on more mature product lines. If you will that we've been shipping for quite a while.
Thank you very much.
Thanks Simon.
Our next question comes from meta Marshall of Morgan Stanley . Please go ahead.
Great. Thanks, maybe first question for me just wanted to verify that kind of all of the IC shortages that you're seeing are restricting your ability to deliver these arent necessarily I see shortages that your customers would have that are slowly kind of their demand.
I'm, just trying to make sure that it kind of your supply chain and our customers.
And then maybe second question for me just in terms of kind of the cross sell process, you know between where the ability to kind of cross sell some of the neo photonics and momentum tonics into into customers, just how that process or communication of joint thinking.
I'm joined portfolio that they can buy and just how that process has been going.
Sure meta.
So on that when we talk about the supply chain shortages, that's the impact on our ability to supply to our customers certainly our customers are having challenges as well as well as the whole industry, having challenges getting what they need to supply, but when we talk about the $80 million at the end of Q2 and $80 million.
In Q1, that's demand we were unable to satisfy our customers in the quarter.
As far as cross selling you know having the broad portfolio. We have now we will see the benefit of that.
When we're able to.
Go to a customer with our broad portfolio I think that just takes time as we go and say Ah.
Yeah.
Qualification does take quarters, and so we should expect to see some of that in the <unk>.
Back half of the year, but certainly our customers are very happy with the acquisitions. We've made and are excited about the future product portfolio and 800 gig and above product in component technology that we bring to the market.
Great. Thanks.
Okay. Thank you.
Our next question comes from George Notter Jefferies. George Please go ahead.
Hi, there. Thanks, very much I guess I was curious about your plan to increase R&D investment I guess I was wondering what areas of the business, you're looking to grow warranty and.
And then also I guess, specifically on that I wanted to ask about the IPG Photonics a division that you guys acquired I know the plan was to invest in that DSP development program I think at one point you guys said.
$25 million in R&D investment there I'm just wondering if that's still the right the right number to think about it. Thanks a lot.
Yeah.
Sure. Thanks George.
So I'd say it's.
The R&D increase is in a couple of areas one of which is continuing to have the best products that are differentiated in our core business and so that's the ongoing growth in R&D that we expect I'd say that we're also investing in R&D for new <unk>.
As we look at the markets that are emerging that could capitalize on our technology and click clinics in general.
Sure do.
Doing product development and technology development to be able to enter those markets and then to your point, we are increasing our R&D with the acquisition of IPG.
Telecom transmission product lines, specifically into DSP area.
Where we have a very very talented team that had.
<unk> had been working on 400 gig ZR DSP and as I said in the prepared remarks, our focus now is to complete the production tape out of that 400 gig ZR ZR, plus a DSP and really drive cost efficiencies as we have been full vertical integration.
Or are ZR, and ZR, plus componentry that should give us the best in class cost are for the market. So that's continuing we're excited about the progress. The team is great. We're growing that team and we continue to make those investments.
As far as the $25 million, but yeah, I would say that that's in the ballpark of what we're looking at that to complete that but then we're going to continue to invest in DSP technology with next generation D. S piece that will well, we're developing in our road map.
Got it thank you.
Yeah.
Yeah. Thanks, George Thanks, so much.
Our next question comes from Vivek Arya of Bank of America is that the lung issues.
Hi. Thank you. This is Blake on for Vivek. Thanks for taking my question just a quick one on gross margin. So looking at the guide I know you mentioned you have to realize synergies from the Neo photonics acquisition, but there's some mix issues. So as we kind of progress forward was hoping you can kind of provide maybe any high level commentary on the trajectory of gross margins.
Typically in the back half of the year as well with revenue projected to decline half over half.
Yeah, Hi, there so.
So I'll start off on answering missed an element of Chris can jump in if they'd like so yeah, so quarter on quarter moving into Q2, we're seeing you know negative seasonality on our.
On our three D sensing business quite certainly that's that's dropping.
Oh, you know greater than 25% going into Q2 versus Q1.
And so given that that's a chip business that certainly has an.
And impact on our on our gross margins.
You know Alan already talked about some of the challenges that we're seeing.
Within our cloud customers are a subset of our cloud customers.
And that business is also a chip business and so that's having a.
A negative impact on our on our gross margins as well as we move through fiscal Q3 and Q4.
With the overall lower revenue levels, we will also see some.
Some some negatives manufacturing overhead absorption.
Throughout our fiscal year now offsetting that.
We are doing very well with our.
With our synergies that we had communicated out to all of you as part of the acquisition both on the operating expense side as well as.
On some of the consolidation from a facility standpoint as well.
Facility's consolidation takes outside of the fiscal year and so we'll see most of that benefit.
In fiscal 'twenty for but you know for operating expenses, we're already starting to see some of that benefit.
The first time for this fiscal year, and we will certainly see more of that.
And that's embedded within the outlook that we provided for Q3 and Q4 of our fiscal.
Helpful. Thank you and then just kind of a quick follow up on the three D. Sensing side, just because we've heard from some of our smartphone vendors that are also exposed to your largest customer that area have some relatively resilient results. I was just wanted to confirm that the the lower outlook is more related to like a unit issue and less of higher then.
Anticipated share loss.
Yeah.
This is Chris Yeah, certainly you know our three D sensing outlook based on our expectations as of today and as a reminder, obviously, we had say a are expecting a large year over year change given we had a <unk>.
Very high share of that business you.
You know over the past several years, so the largest driver of our year over year change in share normalization.
And you know, it's a transition year, we expect to build upon that normalized business. As we look ahead, but nearer term other obviously other dynamics that impact or assumption, including manufacturing supply chain disruptions around the world are in.
In the ecosystem that they play into our overall expectations around the demand environment. So that's that's caused a little bit of.
The adjustment in our updated outlook.
Thank you Blake.
Our next question comes from Alex Henderson of Needham I look salon issues.
Thanks, So last quarter, you had datacom sold out up 17% quarter to quarter, and you were adding significant amount of capacity in the.
The headlights.
And now you're telling us that your datacom.
Products are are anticipating much weaker demand and guiding down in it. So I guess, there's a couple of related questions related to that one is are we sure that this is a simply a function of inventory or is there a shift in the.
Type of Datacom products that the hyperscale or as you're using as a result of shifting to AI and is there a pricing pressure in it or any other variable and are you changing your production timing targets or anything of that sort to to bring the time.
New capacity coming on and more in line with this lower demand.
Thanks, Alex.
So I would say as we said in the prepared remarks. This is a subset of our hyperscale customers burning off inventory and of existing chip.
Chips were not changing our production targets.
Targets in our production investments.
Given that it takes 18 to 24 months to have an impact on our ability to grow our wafer fab business. So those investments that we've made over the last couple of years are coming online and I'd say, they're right on track with aligning with that next generation of product for us which is good.
200 gig.
Per lane E M Els as well as the 100 gig per lane D. M. Ellison, So we need that capacity as we expect a continued.
Continued growth as we look at fiscal 'twenty, four and beyond so I'm.
I'm not disappointed with our innovation engine and Datacom I think it's exciting and our customers are telling us it's exciting I would say more of a you know a six.
Six months air pocket with respect to a subset of the Hyperscale lives that are burning off inventory and and.
Low into demand on us so.
I think we're still excited about the business and we think our long term datacom business or email with BMO silicon Photonics, all that we have access to our broad portfolio make us confident that that's a long term growth business for us.
Just to be clear, there's no change in the <unk>.
Competitive dynamics or in erosion in price underneath that and then the second question I wanted to ask is on the three D sensing.
You know your share has come down very substantially.
Where do you think we are at this point.
Or you're just splitting it with your primary competitor or is.
Is there still downside risky share I mean this is these are very steep declines.
And then additionally on the Treaty is there any change in the pricing you didn't mention said sure.
In fact, when disruption demand, but you Didnt mentioned pricing is your pricing under further pressure. Thanks.
Thanks, Alex I'll take the competitive dynamics in Datacom and ask Chris to take the three D. Sensing a question I'd say in our markets all of our markets that we participate in pricing is.
Competitors and there is pricing pressure I'd say with the consolidation of the industry over the past 10 years, it's very different dynamics than it has been in the past, but as you get into the second or third year.
The <unk> product.
Some of your competitors catch up with you and therefore, there is competitive pricing dynamics and we're seeing that too.
To a certain degree in the Datacom business, but that's not what has impacted our outlook for fiscal 'twenty three as much as the overall.
Lower demand didn't burn off inventory of a subset of our hyperscale or so.
I'd say that as we look forward.
You know pricing at 200 gig and above emails.
We will have a very very competitive product, that's going to be very economically compelling for our customers to shift to as their costs will go down at.
At 1.6, Terabits compared to where they are today, so I'd say from that perspective.
So you get a reset in pricing and we're very excited about our progress there.
Chris you want to take the three D sensing question.
Sure sure. So I think yeah, Hey, Alex good morning.
Can't comment on on it.
Specific numbers of share, but I would say that a safe assumption is that it is normalized that it was much more equitable now.
And then it has been in the past.
Prices do come down year over year, and if you recall last year. There was a lot of new chips are introduced if you will and so the steepest part of the year over year price down typically happens the second year. After you introduce a new chipset, so not really seeing anything unusual from a pricing.
Standpoint in terms of the comments around.
You know demand in and disruption if you will to the earlier question that was really focused on the incremental changes in our outlook that we're talking about this quarter relative to last quarter versus the overall envelope of our revenue, which we had highlighted last quarter would come down 40 to 50.
Were sent to Max now were at the higher end of that given the incremental changes that have happened.
And the demand environment.
Hope that answers you want to be clear, there's no pricing issue no change in the pricing the pricing was declining but it's declining on schedule.
I think that's a safe good way of saying it yes, but we're not seeing anything unusual that as Alan highlighted in his comment about datacom certainly with the competitor in the mix and new chips that are in the second year of catch your competitor catching up that.
Ads.
Two two pricing declines year over year, but were not seeing anything.
Accelerating or unusual.
At the at the current time and don't expect that really to be a major factor moving forward throughout the remainder of this fiscal year.
Great. Thanks.
Thank you Alex.
Our next question comes from Tom O'malley of Barclays told Milan as yours.
Hey, Thanks for taking my question guys I, just wanted to dive a little bit further into the fiscal year guide so you're taking down top line high single digits, but you're taking down the operating margin structure, you know almost 20%.
Can you just talk to.
What's causing that clearly theres more mixed towards the telecom side I guess question. One is your prior had thought the telecom business was going to grow greater than 20% is that still the assumption and then question. Two is you know given the new mix of the business with adding me Oh, you guys were talking about getting back to a 50% gross margin model longer term, but just.
Inherently given the given what you're seeing in the mix away from the Datacom business than just the neo contribution is it realistic to think that you guys will ever get back to.
Did that margin structure, just given the new mix of business. Thank you.
Okay here are all I'll start off and then Alan and then Christopher Walken can jump in yeah. So you know we are we are continuing to see growth in our telecom business and so the figure you mentioned up greater than 20% still holds or our neo photonics business coming in.
Hum is adding to the product mix, which we had already talked about are in our August conference call. But in addition to that you know as we look at some of the chip based businesses coming down are in demand outlook. Both on the three D sensing side.
And on the <unk>.
And on the Datacom side, that's having more than Oh.
More than a negative impact on our overall operating margins versus the growth we're seeing in telecom just because of the product mix.
Of that business and so you know that combined with just some of the manufacturing overhead declines will be.
Within our our Datacom business in Q3, and Q4, that's adding some operating margin pressure.
We said in our prepared remarks, we're continuing to invest in R&D and so you know we're not cutting back on that because of what we deem to be some temporary demand shortfalls and so that's why you're seeing on operating margin outlook of 19% to 22%, which.
Which is well below what we had outlook back in back in August now as far as the the longer term goal as you know we're continuing to invest in our Datacom business Allen talked about the fact that it took US 18 to 24 months to add capacity in Datacom and so you know our thesis around the secular.
Growth in that part of our business still holds it was changed to invest them in automotive and Iot and so both of those are chip based businesses and as that turns around we should see improvements in our overall operating margin profile. Our synergies is something that I spoke about in one of the Earth.
Earlier questions that was asked by the facility's consolidation portion of the synergies that are going to happen in new photonics is it does take a longer than 12 months to do and so as you see or as we all see some.
Some of that flow through that will also provide us with a with a tailwind and so that's the reason we really haven't moved our overall target model is because we have confidence around all three of those things.
Helpful and if I could just sneak one more in on the Datacom side of the business and this got asked before but I just I'm trying to get a little more clarity you guys. I think Alan mentioned pockets of weakness, which are in my eyes, I mean certain customers not across the board could you just talk about when during the quarter you started seeing that weakness just just because some of your peers are actually.
Adding to continued strength on the on the datacenter side. Some guys are talking about inventory, but this is really the first time, we're hearing about potentially demand deterioration could you just give the timing of when you saw that change just because going from capacity constrained to sequential declines as a pretty material turnaround. Thank you.
Yeah.
No specific date that a customer told us they had inventory but I'd.
I'd say it whether the investments in infrastructure are different than they were three months ago hard to say I think.
This is a I think one of the other analysts called the inventory balancing I'd say, it's more of an inventory balancing than anything else. Because we did receive large orders. If you remember a year ago, our book to Bill on Datacom was huge.
And as we added capacity, we were able to fulfill that demand and.
Think maybe our customer didn't think we were able to going to be able to do that so.
As we did that the inventory.
Fill it up and.
They took down their future demand with respect to this product.
So again I don't think this is a fundamental.
Change in overall demand I think it's an inventory correction.
At a subset of our customers and so I'd say that long term datacom business for us is going to be very very strong.
Thanks.
Thank you Tom.
Our next question comes from Christopher Rolland of Susquehanna Christopher Please go ahead.
Hey, guys. This is Matt Meyers on for Chris I wanted to ask on your broker IC purchases I was just kind of curious what the ASP premium is purchasing from brokers versus directly from customers.
And was this for FPGA is and then as a follow up there what when do you think you would no longer need to be buying these products through brokers.
Yeah, Chris It really varies and it it it also depends upon.
What products that go into so we.
We see.
Anything from two times to 100 times.
The ASP for given component and if it goes into a lower ASP product for us and the brokers asking for 100 times. The price, we typically say no because it doesn't make any sense at all.
To do that so I'd say, it's it's.
Not necessarily in S E T as as much as it used to be so that's one area that we've seen improvement on this is more.
The.
Analog stuff and power Ics and typical jelly bean stuff that.
We're seeing the need for pain brokers, but again, we don't see this we see it improving but we don't see it getting resolved over the next six months and that's why our it's incorporated into our new outlook for fiscal 'twenty three.
Perfect. Thank you.
Yeah. Thanks, Matt.
Our next question comes from Ananda Baruah.
Luke capital.
Please go ahead.
Hey, Thanks, guys. Good morning, Thanks for taking the question yet Q a few quick ones for me if I could on the operating margin our fiscal year outlook reduction proportionally how much of it is some gross margin how much of it is from incremental Opex and I have a quick follow up to that.
Right.
Okay.
Yeah.
Yes.
Hi.
Our view on operating expenses, it hasn't really changed that materially I mean, we're continuing to ramp.
Ramp up our R&D investment throughout the quarters in our fiscal Q2 operating expenses will be above our you know.
Probably high single digits above our.
Our Q1 operating expenses and so much of the decline that we are seeing is in the gross margin line.
Simply because of some of the product mix.
The matters that we had talked about earlier with three D sensing datacom as.
As well as a reduced factory utilization in.
In the back half of the fiscal year, so that that's how we're seeing the.
The P&L playing out throughout the quarters.
That's helpful.
I can add to.
Yeah.
So I'd just add to what you did comment about our operating expenses in Q2.
Yeah, We've got one extra month of video photonics in IPG.
Acquisition in Q2, whereas we only had two months in Q1. So that's one of the key drivers for why Opex is going to be up in Q2.
Thanks for that Alan and and just a quick follow up why do you you'd be going to touch on it is on the Grace margin proportionately how much it is mix and how much of a revenue leveraging our IV utilization change.
In the fiscal year guide change that's it for me thanks, Yeah. So.
Yeah. So just just very high level, probably a little bit more than 50% is product mix.
And then the remaining is the remaining as factory utilization.
But probably most of it is product mix.
Yeah.
Thank you.
Okay.
Thanks Amanda.
Our next question comes from Michael Genovesi of Rosenblatt Securities. Michael. Please go ahead.
Sure.
I'll just ask two questions in one I think you're getting in here.
I just wanted to ask very directly is there any change in the telecom outlook in terms of demand I mean.
It sounds like it reads well for telecom to manage me, but are you seeing any change with the change in the revenue guide and then in terms of solving the supply problem.
It seems like it's been a lineup with the beginning of a fiscal 'twenty for sort of mid calendar 'twenty. Three is the current expectation and I'm wondering is that because the analog vendors will be adding.
New fabs or new lines of of this like older stuff like a to D converters and power supplies and things like that that you guys need and that's what's going to solve the problem and then that's why that timing is.
Thank you.
Yeah.
Yeah. Thanks, Michael I said, you're right that the telecom demand continues to be very strong I continue to get escalated phone calls from executives at our customers. So it tells me that it's real demand and not necessarily inventory build so I think the outlook.
The fundamental demand drivers for telecom continues to be a very solid so I'd say that that that remains a good a good product set of products for us as far as the supply chain problem. Yeah, I'd say, it's a combination of our expectations that our suppliers are adding capacity.
Freeing up capacity for us, especially as they see some softening in and other areas of their business. So that just takes time for them to transition over to our products as they are starting to wafers.
Or add new capacity and these are investments and they started.
Over a year ago that will come online.
In calendar 'twenty three so that's kind of why we lineup with continued impact through the balance of our fiscal year and keep in mind, we have a cycle time of production as well so we need to get the chips in by April in order to impact our June shipments and so that's our visibility.
And that's why we believe that we're going to continue to be impacted especially as demand is expected to continue to grow.
Okay. Thank you Michael.
Our final question comes from Dave Kang of B Riley. Please go ahead.
Thank you. Good morning. My first question is regarding the expedite fees I think it was about $7 million.
First quarter, what was it a previous quarter and how much are you baking in.
The current quarter December quarter, and my second question is for a three D. S projections that you provided at OFC being flat.
You need to update that for us.
Yeah. So I'll take the first question and then Chris can take the second one so on the on the IC charges. Yes. It was a I think it was $7 $3 million. This quarter. It was actually higher significantly higher in the quarter Pryor I have to take a look at our filings to see what we report.
On that you know going into our fiscal Q2.
We're burning through some of the inventory that we purchased in Q1.
And so we'll report on that at the end of next quarter.
Cause we do pull it out of our non-GAAP .
Operating guidance.
It will not have an impact on that.
It'll be a reconciling item within our results.
Chris.
Yeah sure. So on the three D sensing right, we took about a minus five to plus five three year CAGR, So simple math, a little more than 15% down or 15% up.
Over the next three years and that was on a 400 to 450.
Three D sensing business expectations at the time. So I think you know we what we've seen is the share normalization happen, perhaps faster than we had expected.
That's sort of the shape of the curve is.
Sort of a deeper V or a U shape, but we continue to believe that this is a strong growth business and we can build upon.
The business that is now normalized if you will from a share standpoint in a particular building up building upon that base with multiple new customers and new applications. So we're not necessarily walking back those numbers at this point like the.
Opportunity still remains to be able to add incremental revenue to get into that range.
Yeah.
Thanks, Dave Thank you.
Thank you so much Dave and I think that was our last question. So I'd like to pass the call back over to Allen Tricia concluding remarks.
Thank you Kathy I'd like to leave you with a few thoughts as we wrap up the call.
I am very excited about the tremendous opportunities ahead of us as we serve the exponential requirements for data bandwidth in the AI <unk> and cloud computing market inflections.
We have a proven playbook on how to win with our best in class products and technologies we.
We also have a unique opportunity to drive manufacturing scale photonic industry and we are committed to strongly invest in both innovation and manufacturing capacity and capability to deliver on customer needs today and in the future with that I would like to thank everyone for attending and we look forward to talking with you at.
Again during upcoming Investor events, which you will find posted on our website.
Thank you.
This concludes today's call. Thank you for joining you may now disconnect your lines.
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