Lumentum Holdings Inc. (LITE) Earnings Call Transcript

Okay, folks, thanks a lot for patience, elevator challenges here at the hotel. So that's the nature of, I guess, being in person again, which is exciting. My name is Simon Leopold, Raymond James data infrastructure analyst. And I'm joined now by Chris Coldren, who is the SVP, Strategy & Corporate Development Officer for Lumentum. So for instance, we sort of dig into this, maybe just a little bit of kind of intro about your background and role and then you've got fireside type outline here [indiscernible] questions, try to get my attention. We'll take questions from the audience as well.

Great. Yes. Thanks, Simon. Thank you for having me here, and thanks for everybody attending. I've been with Lumentum since we spun off from JDS Uniphase and so back prior to that, I was responsible for corporate development at JDS Uniphase for this business. And prior to that, have been in engineering roles and marketing roles, so kind of done multiple tours of duty and that gives me a nice rounded background to do the job I do today.

So I've got a few sort of macro E kind of questions. I don't want to dig into the various business, so maybe one of the things I've been asking folks is the macro economy implications. And so I think the overriding themes are around a strong U.S. dollar as well as worried about recession, how are you seeing these various macroeconomic factors playing into your business?

Sure. So I'll -- the vast majority of our revenue is denominated in dollars. So we haven't seen a lot of revenue uplift, let's see or decrease due to change in dollar as an example. We have some OpEx that's not denominated in dollars. So we've seen a little bit of help from a profitability standpoint, but that's not a major driver of profitability. It's really been revenue product mix that drives us. So certainly, that's not a huge driver of our thinking. I mean certainly, we keep an eye on macro economy, we watch the news and read the newspaper like everybody else. But as we see here -- sit here today, certain parts of our business, as we talked about on our last earnings call, have been more impacted by either supply challenges we have or our customers have. And in most other places, we continue to see healthy demand, but we continue to keep an eye out knowing that those things can change very rapidly.

Now I do have a feeling that as a community, the investment communities got a little bit of supply chain fatigue, so it feels like that was the only thing we talked about months ago. I still have to check the box and see where you are in terms of supply chain constraints? And how are you thinking about the process of recovery of your supply chain?

Yes. So we have seen significant improvement in the number or a significant reduction in the number of problems we've had supply chain. However, which is unfortunately what we talked about on our last earnings call that we still have some lingering challenges that are not improving as fast as we had originally thought. So illustrating that products that we have that aren't really constrained by supply telecom kind of lower-level components, chips and package chips in our fiscal '22, they were up 50%, 60%, in some cases, 70% year-over-year, but other products that were more system-level products that have lot of high-end integrated circuits. They may have been down 30%, but they go right next to each other, consumed at the same time. So it really illustrates that challenge those products that are down were able to come up this last quarter. For example, we talked about ROADM being up north of 20%. Sequentially, as one of the bottlenecks in supply was removed, one of the ICs. However, there's still another one that remains that we thought would get better and enable the second half of our fiscal year to grow on that product line. But now the bad news a supplier delivered to us, so it would be another 6 months, so it's still a lingering problem in spot areas, but more broadly, it is getting better.

So one of the things I've been asking folks is lessons learned from the pandemic, whether it's strategies for the supply chain, whether it's your real estate management, whether it's your work from home policies. What have you taken away from this experience that maybe changes aspects of the company?

Yes. I mean certainly, whether it's new learnings or reinforces or accelerates action on learnings of the old, we've made a lot of changes in how we manage our supply chain around second sourcing and geographical diversity and where we do what, and those things take time, and we had been actually doing that starting some of that work pre-pandemic, obviously, pre-pandemic, there were some challenges geopolitically that put some of the regions we operate in, in a more of a risky category. And so we started moving things out of China, for example, and into Thailand, still have a presence in China to serve the Chinese customers, but it's those kinds of learnings that have really accelerated over the past several years. I think we all used to think global market, global supply chain, it's all okay, now realizing that I guess we all do wear a flag, if you will, in one way or another.

And at a high level, and I'm going to drill down to the segments, but at a high level, what are the current R&D priorities? What are you -- what's sort of the key focus right now?

Yes. Key focus of R&D is always to develop differentiated innovative products. I would say as well for us, we -- over the past years have acquired a couple of companies and sort of reshaped herself even from the spin-off, where we've unwound unprofitable product lines or at least product lines that did not have a lot of strong future outlook. And so in a sense, our R&D efforts have really focused on, in some ways, concentrating our revenue in a few areas. We've put a lot of focus now on diversifying and broadening our portfolio. For example, in the datacom space, which I'm sure we'll talk about. We've been -- we made a big transition getting out of datacom transceivers and move the chips, but we're selling the chips we made. Now we spent several years really broadening out our portfolio, and that will continue to be a huge R&D priority. But also, we've just closed to other acquisitions. And so there's a lot of effort to sort of rationalize and align our product roadmaps so that we can take ultimately fewer resources because there will be some level of synergies, but focus those resources on the right areas for growth.

So I want to shift over to the telecom business unit, telecom products, separate from the datacom. I know you reported as a single segment, but there are some different trends there. So maybe speak a little bit about essentially how you see that overall market trending and talk a little bit about what's going on in terms of the customer diversification there.

Yes. I think there's a couple of things that have been going on in the telecom market over the past several years that brings us to today. One is just at the start of the pandemic back in late '19 and early '20 was the start or at least what we thought would be the start of next-gen networks, 400, 600 and 800 gig in next-gen ROADMs. And that -- the start of that has been sort of delayed and maybe muted a little, but we're starting to see from a supply improving, having unfortunately mentioned supply again, but allowing us to ship more of those next-gen products and what we've seen, for example, in telecom, 400-gig and above components because a lot of the 600 and 800 gig are driven by components versus modules at least initially by components that doubled in '22 versus '21. So that's a huge uptick, if you will. So the trend in telecom is clearly to these next-generation networks, just pretty exciting because it allows us to differentiate and you take products like ROADMs, we're at an interesting point in history in telecom where you can't just keep turning up the speed dob or just adding more wavelengths. We're running out of sort of bandwidth in the fiber with regard to the wavelengths and speeds that are being used, so all of a sudden, that means people are lighting up new fibers. What is lighting up new fibers means, selling more amplifiers or pump lasers going amplifiers. That's great. But for products like ROADMs, all of a sudden, their complexity has to increase, not only do you sell more of them because you got a second fiber lit up. But you now have a lot more wavelengths, you've got twice as many wavelengths. So you need more ports and more ability to switch between those wavelengths. That's driving, if you ask our customers or customers' customers, wow, that's really expensive. But from our standpoint, it allows us to innovate to say, well, we can now make the scale not at an end squared or exponentially, but maybe more linearly, then we can create a lot of value for customers.

So one of the big themes that we've been trying to assess and talk about is what we refer to as the Huawei displacement. Some of the OEMs refer to it as geopolitical issues, which is a euphemism for Huawei getting kicked out. But Huawei faces challenges, partly because operators see security risk of deploying their gear, but also if they can't get all the leading-edge technology, they can't evolve their platform. So Huawei has a strong position outside of China. What's your take on that as an opportunity? And what's your view on the timeline of those opportunities?

Yes. So we don't -- Huawei would be a customer and Huawei's competitors would be customers of ours. So really for Lumentum. What the way we benefit, what the opportunity for Lumentum is ensuring that we have higher share of wallet with those customers that tend to win and take over sockets from Huawei, where we have a lower -- much lower share of wallet. And I think that is, in fact, unfolding and is true, but it's probably still pretty early stages. I do think there has been some probably faster than any of us thought rip and replace programs in various places in the world. But I think there's a much longer-term opportunity here that we have yet to see because I think even recently, I saw something with market share at our customers' level. Huawei still quite high market share. So I think as Western customers tend to win in the Western world against Huawei, we're going to benefit from that a much larger share of wallet with those customers.

And then more recently, one of your other customers, Ciena, had suffered supply chain issues. And so the concern I've had is if they can't get the golden screw. So even if your components aren't the ones in short supply, does that affect the market when a large customer is struggling to ship? Do they stop buying from you as well? What's been your observation and even if it's not specific, but where customers missing a key component, not yours, do they continue to buy your products?

I don't think there's a universal truth there. I would say that in some cases, if customers feel they want to bring on the inventory just to reduce the risk of their own supply, maybe they will. But ironically, often we're limited by the same limitations. We may be buying the same golden screw as our customers. And so that kind of nulls out the problem if we can't get it, then they can't get it. Vice versa.

And do you believe that these are sort of temporal issues and that the market demand is unchanged? Or do you think that this is maybe masking some slowing in the market?

I think certainly, there -- this is temporal in that you can't -- that we genuinely can't get supply and there's no reason why our suppliers ultimately should not be able to get us product or get our customers the same golden screws. And I think there's fundamental long-term demand drivers that are very intact. I think maybe what we all need to keep an eye on is, obviously, as supply does increase is all the demand that was promised to be there really there so far, it seems that way. But we -- it's convolved a little bit with the macro question you had earlier. Obviously, one of the disappointing pieces of news we delivered on our earnings call that was that we had some demand softness out of certain customers in our datacom business. I think -- and that was a case where supply came up and then they pushed out, but I don't think that was because the demand really wasn't there. I think that was also a situation where they really were slowing spending and preserving or optimizing their cash spending.

And that maybe is a good transition to ask about the device called the 400G ZR. So for folks who are maybe not so much in the weeds, it's a pluggable optic that can go into a router and instead of using a whole optical transport system, the optics gets absorbed by the routers. Is that a fair...

I think that's fair, although I think that might be even narrower than it is that it's also just a pluggable optics, offer size, space and sort of inventory management advantages over having a box with all of the wavelengths prepopulated being able to plug them in as needed, much the way tunable pluggables solved problems years ago, the same thing is now happening at the transceiver level.

So I suspect you've got probably a pretty unique vantage point on how this market plays out with the NeoPhotonics acquisition, they were a major provider of the lasers for these devices to just about everybody, almost everybody. And so you're probably happy if the market takes off. But one of the market research firms have suggested that adoption of $1 billion of ZR displaces $2.5 billion of optical systems revenue. And so it creates a headwind for some of your customers, a tailwind for other customers. How are you thinking about the net implications of ZR to Lumentum? is this a good thing?

I think it's neutral to good. We also supply other -- either some somebody is building a discrete solution or they're building their own transceiver or we're supplying a transceiver. In all cases, we participate. We're either supplying components in those first 2 situations when we supply a transceiver that has maximum Lumentum content. So ideally, we would love to see things shift as much as possible to that kind of level. That said, these kinds of solutions today, at least, I think that will change. Is it playing at a lower performance, therefore, lower price point portion of the market. Obviously, if that were to cannibalize higher portions of the market, that's not necessarily good for us, but we don't see that actually happening. So I think in general, this is a good thing. And in a more bigger picture, if it lowers the cost of optical transport for, say, cloud providers, then they're going to build more data centers. And I think that's better overall for driving the market forward.