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spk11: Good day, everyone, and welcome to the Lamentum Holdings first quarter fiscal year 2023 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 Tarr, Vice President of Investor Relations. Ms. Tarr, please go ahead.
spk18: Thank you, Operator. Welcome to Lumentum's Fiscal First Quarter 2023 Earnings Call. This is Kathy Ta, Lumentum's 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 Neophytonics, 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, macroeconomic 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 1, 2022, and those in the 10-K for the fiscal year ended July 2, 2022. forward-looking statements provided during this call are based on Lumentum's reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements except as required by applicable law. Please also note, unless otherwise stated, all 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. Lumentum's press release with fiscal first quarter 2023 results and accompanying supplemental slides are available on our website at www.lumentum.com under the investor section. This includes additional details about our non-GAAP financial measures and a reconciliation between our historical GAAP and non-GAAP results. With that, I'll turn the call over to Alan.
spk08: Thank you, Kathy, and good morning, everyone. Our first quarter financial and operational performance was excellent, and we achieved a record revenue quarter. I would 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 strengthens our optical communication 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 the 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, a 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, Lumentum's revenue exposure to infrastructure markets through our communications and commercial lasers product lines has never been stronger. we expect that greater than 85% of company-wide revenue will come from infrastructure markets outside of consumer in fiscal 23. This is due to the share normalization in 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 upon our strategic plan. We plan to expand our product offerings in communication networking with our combined R&D teams, realize 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. These acquisitions position us to accelerate long-term technology trends in advanced networking hardware and adjacent markets and to expand our share in the growing telecom infrastructure market. Since closing these acquisitions, we have 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 23 business. Since then, there have been several developments in the supply and demand landscapes. In telecom, I see supply shortages are not improving as quickly as previously anticipated. We now expect these shortages to gate our revenue throughout fiscal 23. In addition, like many others, we are now seeing incrementally lower cloud and consumer in-market demand from our customers. Taken together, these changes result in a new outlook for fiscal 23 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 400G 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 and 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 at the end of 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 with tunable lasers, tunable products for edge networking applications, and coherent components for high-speed coherent modules and line cards. Our narrow line with tunable laser business performed to our expectations in the quarter. I'm 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 photonic toolkit in leading edge modules, silicon photonics, high bandwidth coherent components, ultra narrow line width external cavity tendable lasers, coherent DSPs, and RF integrated circuits. Regarding DSPs, we are focused on our production tape out of a 400G 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 5G front haul applications. We are expanding both our front end wafer fab and back end 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 will further 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 400G and above coherent components also reached a new revenue record in the quarter, with approximately one-third coming from 800G applications. We are very excited about our robust product pipeline of next generation 800G and above components and modules. In the quarter, Rotem 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 contentionless M by N Rotems 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 in transport product innovation. In the quarter, we began shipping the next generation of transport products, including Rotem node-on-a-blade architectures and our next generation of contentionless M-by-N WSS blades to leading customers, further distancing ourselves from our competitors. In Datacom, we saw a sequential decline in EML 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 23. We continue to drive the next phase of the Datacom industry roadmap with our 200G per lane EMLs for 1.6 terabit per second applications. We expect these to enter production as we exit fiscal 23, and we are engaged with multiple customers in design and activities for these leading edge chips. In addition, we are excited about enabling the transition from copper to optical fiber in data center applications with our 100 gig per lane Vixels. We expect to ramp this product line during fiscal 24. Turning to industrial and consumer, Q1 was up from Q4 due to the new smartphone product launch. As expected, share normalization caused our Q1 3D sensing revenue to be approximately half of last year's level. We are optimistic about our 3D sensing business as 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, commercial lasers revenue was up 4% sequentially and 26% from the same quarter last year. Fiber lasers 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 revenues to grow again quarter on quarter. I'd like to take a moment to share the significant progress we have made toward achieving our corporate social responsibility goals toward a low carbon future. In September, we published our second CSR report, which outlined the excellent progress our team has made in ESG initiatives. Our company-wide use of renewable electricity has expanded from 3% to 31%, and we are 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 23 and beyond. I'm very excited about Lumentum's strategy, our competitive position, and our unique opportunities to grow in advanced communication and networking technologies, edge and cloud computing, industrial 4.0, and machine vision markets. To capitalize on these trends in the communication, consumer, and industrial end markets, and consistent with our prior earnings call, we are increasing R&D investments during fiscal 23 which we believe will accelerate top line growth in fiscal 24 and beyond. Lumentum 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 Y.J.
spk05: 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 20.1% sequentially and up 13% year on year. Gap gross margin for the first quarter was 39.7%, gap operating margin was 2.7 percent and gap diluted net income per share was a net loss of one cent first quarter non-gap gross margin was 48.2 percent which was down sequentially and year on year primarily driven by product mix including neophotonics revenue as expected during the quarter we incurred 7.3 million dollars in extraordinary 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 neophotonics and our DSP investment with the IPG telecom acquisition and was above the high end of our guidance range. 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 $60.8 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 $1.625 billion in cash and short-term investments. During the quarter, we repurchased 300,000 of our shares for $25.7 million. As of the end of the first quarter, we have purchased a total of 9.4 million Lomentum shares for $815.5 million over the last six quarters, reflecting our confidence in long-term growth. Turning to segment details, first quarter optical communication segment revenue at $453.4 million increased 22.2% sequentially due to robust demand in our telecom business and the addition of neophotonics revenue. Optical communications segment gross margin at 47.6% decreased sequentially and year-on-year, primarily due to product mix and neophotonics. Our first quarter laser segment revenue at $53.4 million was up 4.3% 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 23. We continue to experience IC supply shortages, which are not improving as quickly as previously anticipated and are now expected to gate our revenue throughout fiscal 23. In addition, like many others, we now expect lower cloud and consumer and 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 and still is greater than 15% growth from fiscal 22. Our fiscal 23 operating margin outlook is in the range of 19 to 22% and annual EPS is in the range of $4 and 65 cents to $5 and 65 cents per share. The delay in the improvement of the supply of a small number of ICs is the largest factor within our lower fiscal 23 outlook. Within this outlook, we are reducing spending in discretionary areas while increasing our R&D investments in growth initiatives, both in existing markets and new markets. As we execute on acquisition synergies and work down shortages in 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 in the longer term. Now let me move to our guidance for the second quarter of fiscal 23, 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 23 to be in the range of $490 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 projections assume an approximate share count of 70.2 million shares. Given continued IC supply constraints, 3D 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?
spk18: 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.
spk11: 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. And please ensure you're unmuted when speaking. Our first question comes from Samik Chatterjee of JP Morgan. Samik, please go ahead.
spk10: Thank you. Thanks for taking my questions. I guess for the first one, if you can delve into the full year guide a bit more, you're guiding down the full year by about 200 million. The fiscal second quarter, though, when I look at compared to consensus, the shortfall was about only 35. So it does imply the headwinds sort of become greater relative to sort of at least what consensus was thinking in F3Q and 4Q. So I'm just wondering if you can Maybe share some insights on that as well as break down this sort of $200 million into how much of that is supply versus the lower cloud demand as well as the lower 3D sensing demand that you highlighted. If you can break down the pieces for us and how do we think about sort of the risk to sort of further cuts on lower demand? That's one question I'm getting as well. I'm sorry for the long question here. I have a quick follow-up after this.
spk08: Great. Thanks, Amit. so i think you can look at it a couple ways and as wajid said the prepared remarks the biggest impact of the reduction is our expectation that the chip shortage will continue through the year um and into the beginning of fiscal 24. so that's the biggest part of the of the reduction in the full year guide um i'd say that you know the the combination of um the hyperscale customers or subset of customers and 3D sensing is probably about the same impact. But keep in mind, we still have $150 million range of outlook. So there's certainly a lot of uncertainty as to shifts in that business and how we look at potential upsides and potential impacts. To your point, there's 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.
spk10: The other question that I'm getting, and just to follow up here, is that overall, based on all the companies that have reported till date, we're definitely not hearing sort of supply shortages get worse. It's been more sort of in line to previous quarters or improving. So investors are a bit surprised about sort of the worsening that you're seeing in the supply landscape and the sort of greater headwinds, particularly, again, implied in sort of your full year guide for the back half here. So maybe share some insights on what you're seeing on the supply chain at this point. What could drive it to come in better than expected, and what are you baking in for F3Q and 4Q in terms of supply headwinds at this point?
spk08: Yeah, I mean, certainly supply is getting better, as you saw from our telecom growth in Q1 and our forecasted telecom growth in Q2. 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 expected to 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 output. So we're not catching up with that demand given supply chain shortages. And it is 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 of suppliers with a couple handfuls of parts that are restricting our ability to meet this very, very strong telecom demand.
spk11: Thank you, Samik. Our next question comes from Simon Leopold of Raymond James. Simon, the line is yours.
spk09: Thank you very much. My question may be a bit nuanced, so I apologize if it's not clear, but I guess one of the things I'm struggling with is on 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 of. 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 you're short of. Thank you.
spk08: Okay, Simon, I'd say that 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 hardcore EML chips inside the data center. So they have inventory. I do think they are rebalancing inventory. But at the same time, that rebalancing leads to softer demand on us. 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, and we believe they'll 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 24, that demand will pick back up. Does that answer your question, Simon?
spk09: It does. It does. No, I appreciate that. And just wondering whether or not you would be able to break out what was the neophotonics contribution to the quarter, and if in particular there's VR-related products, both lasers and transceivers, were disproportionately affected by this.
spk14: 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 Synergy, so we're not going to break out, you know, NEO versus Momentum revenues, if you will. We'll get in trouble if we even mention NEO inside the company, right? We're one company at this point moving forward. That said, you know, product lines like ZR for us continue to grow. It's in very early days. I think as Alan alluded to, We're seeing this more of an inventory correction on more mature product lines, if you will, that we've been shipping for quite a while.
spk09: Thank you very much.
spk11: Thanks, Simon. Our next question comes from Meta Marshall of Morgan Stanley. Please go ahead.
spk02: Great. Thanks. Maybe first question for me. wanted to verify that kind of all the icy shortages that you're seeing are restricting your ability to deliver. These aren't necessarily icy shortages that your customers would have that are slowing kind of their demand, just trying to make sure that it's kind of your supply chain and not customers. And then maybe second question for me, just in terms of kind of the cross-sell process, you know, between or the ability to kind of cross-sell some of the neophotonics and momentum products into customers, just how that process or communication of joint portfolio that they can buy and just how that process has been going. Thanks.
spk08: Sure, Amanda. So 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 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 at the end of Q1, that's demand we were unable to satisfy to our customers in the quarter. As far as cross-selling, having the broad portfolio that 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, you know, qualification does take quarters. And so we should expect to see some of that in the back half of the year. But, you know, certainly our customers are very happy with the acquisitions we've made and are excited about the future product portfolio. And the 800 gig and above product and component technology that we bring to the market.
spk11: Great, thanks.
spk03: Thank you, Amita.
spk11: Our next question comes from George Notta of Jefferies. George, please go ahead.
spk17: 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 R&D in. And then also, I guess specifically on that, I wanted to ask about the IPG photonics 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 $20 to $25 million in R&D investment there. I'm just wondering if that's still the right number to think about. Thanks a lot. Sure.
spk08: Thanks, George. So I'd say 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 markets. And as we look at the markets that are emerging that could capitalize on our technology and photonics in general, we're 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 in the DSP area, where we have a very, very talented team that had been working on a 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 DSP and really drive cost efficiencies as we have been full vertical integration for our ZR and ZR plus componentry that should give us the best in class cost. 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, yeah, I'd say that's in the ballpark of what we're looking at to complete that. But then we're going to continue to invest in DSP technology with next-generation DSPs that we're developing in our roadmap.
spk17: Got it.
spk08: Thank you.
spk02: Thanks, George.
spk11: Thanks, George. Our next question comes from Vivek Arya of Bank of America. Vivek, the line is yours.
spk12: Hi. Thank you. This is Blake Friedman. I'm for Vivek. Thanks for taking my question. Just a quick one on gross margins, looking at the guide. I know you mentioned you have, you know, to realize synergies in the neophotonics acquisition, but there's some mixed issues. So as we kind of progress forward, I was hoping you can kind of provide maybe any high-level commentary on the trajectory of gross margins, specifically in the back half of the year as well, with revenue projected to decline half over half. Thanks.
spk05: Yeah, hi there. So I'll start off on answering this, and Alan and Chris can jump in if they'd like. So yeah, so quarter on quarter, moving into Q2, we're seeing negative seasonality on the on our 3D sensing business, quite certainly, that's dropping, you know, greater than 25% going into Q2 versus Q1. And so, given that that's a chip business, that certainly has an impact on our gross margins. You know, Alan already talked about some of the challenges that we're seeing with our cloud customers or a subset of our cloud customers, and that business is also a chip business, and so that's having a negative impact on our gross margins as well as we move through fiscal Q3 and Q4. With the overall lower revenue levels, we'll also see some negative manufacturing overhead absorption throughout our fiscal year. Now, offsetting that, we are doing very well 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. The facilities consolidation takes outside of the fiscal year, and so we'll see most of that benefit in fiscal 24. But for operating expenses, we're already starting to see some of that benefit in the first half of this fiscal year, and we'll certainly see more of that And it's embedded within the outlook that we've provided for Q3 and Q4 of our fiscal.
spk12: Thank you. And then just kind of a quick follow-up on the 3D sensing side, just because we've heard, you know, some of the smartphone vendors kind of also exposed to your largest customer in that area have, you know, some relatively resilient results. I just wanted to confirm that, you know, the lower outlook is more related to like a unit issue and less of higher than anticipated share loss.
spk14: Yeah. Hi, Vic. This is Chris. Yeah, certainly, you know, our 3D sensing outlooks based on, you know, our expectations as of today and, you know, as a reminder, obviously, we had, say, are expecting a large year-over-year change given we had a very high share of that business, you know, over the past several years. So, the largest driver of our year-over-year change is share normalization and And it's a transition year. We expect to build upon that normalized business as we look ahead. But nearer term, there are obviously other dynamics that impact our assumption, including manufacturing supply chain disruptions around the world and the ecosystems we play into and our overall expectations around the demand environment. So that's caused a little bit of adjustment in our updated outlook.
spk03: Thank you, Blake.
spk11: Our next question comes from Alex Henderson of Needham. Alex, the line is yours.
spk04: Thanks. So last quarter, you had Datacom sold out of 17% quarter to quarter, and you were adding significant amount of capacity in the headlights. And now you're telling us that your Datacom products 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 simply a function of inventory or is there a shift in the type of Datacom products that the hyperscalers are using as a result of shifting to AI? And is there a pricing pressure in it or And are you changing your production timing targets or anything of that sort to bring the time of new capacity coming on in more in line with this lower demand?
spk08: Thanks, Alex. I would say, as we said in the prepared remarks, this is a subset of our hyperscale customers burning off inventory and of existing chips. We're not changing our production targets and our production investments, given that it takes 18 to 24 months to have an impact on our ability to grow our wafer fab business. 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 the 200 gig per lane EMLs, as well as the 100 gig per lane DMLs. And so we need that capacity as we expect continued growth as we look at fiscal 24 and beyond. So I'm not disappointed with our, our, innovation engine in Datacom. I think it's exciting and our customers are telling us it's exciting. I'd say more of a six-month air pocket with respect to a subset of hyperscalers that are burning off inventory and lowering the demand on us. I think we're still excited about the business and we think a long-term Datacom business for EMLs, DMLs, silicon photonics, all that we have access to in our broad portfolio make us confident that that's a long-term growth business for us.
spk04: Just to be clear, there's no change in competitive dynamics or in erosion in price underneath that. And then the second question I wanted to ask is on the 3D sensing. you know, your share has come down very substantially. Where do we think we are at this point? Is it, you know, are you just splitting it with your primary competitor or is there still downside risk to share? I mean, this is, these are very steep declines. And then additionally on 3D, is there any change in the pricing? You didn't mention, you said share mean factoring disruption demand, but you didn't mention pricing. Is your pricing under further pressure?
spk08: Thanks. Thanks, Alex. I'll take the competitive dynamics and data comm and ask Chris to take the 3D sensing question. I'd say, you know, in our markets, all of our markets that we participate in, pricing is, there's competitors and there is pricing pressure. I'd say with the consolidation of the industry over the past 10 years, it's a very different dynamic than it has been in the past. But as you get into the second or third year of an existing product, some of your competitors catch up with you, and therefore there is competitive pricing dynamics, and we're seeing that to a certain degree in the Datacom business. But that's not what has impacted our outlook for fiscal 23 as much as the overall lower demand and burn-off inventory of a subset of our hyperscalers. I'd say that as we look forward, pricing at 200 gig and above EMLs 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 1.6 terabit compared to where they are today. So I'd say from that perspective, you get a reset in pricing, and we're very excited about our progress there. Chris, you want to take the 3D sensing question?
spk14: Sure, sure. So I think, hey, Alex, good morning. You know, can't comment on specific numbers of share, but I would say that a safe assumption is that it is normalized, that it is much more equitable now than 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 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 we're not really seeing anything unusual from a pricing standpoint. In terms of the comments around you know, demand 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%. And that's now we're, you know, at the higher end of that, given the incremental changes that have happened in the demand environment. Hope that answers your question.
spk04: So to be clear, there's no pricing issue, no change in the pricing. Pricing was declining, but it's declining on schedule.
spk14: I think that's a safe, good way of saying it. Yes, that 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, competitor catching up, that adds to pricing declines year over year, but we're not seeing anything accelerating or unusual at the current time and don't expect that really to be a major factor moving forward throughout the remainder of this fiscal year.
spk02: Great, thanks.
spk11: Thank you, Alex. Our next question comes from Tom O'Malley of Barclays. Tom, the line is yours.
spk07: 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, there's more mixed towards the telecom side. I guess question one is, you 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 NEO, you guys are talking about getting back to a 50% gross margin model longer term, but just inherently given what you're seeing in the mix away, the Datacom business and just the NEO contribution, is it realistic to think that you guys will ever get back to that margin structure just given the new mix of business? Thank you.
spk05: Yeah, here, I'll start off, and then Alan and Chris are welcome to jump in. Yeah, so we are continuing to see growth in our telecom business, and so the figure you mentioned of greater than 20% still holds. Our neophotonics business coming in is adding to the product mix, which we had already talked about in our August conference call. But in addition to that, as we look at some of the chip-based businesses coming down in demand outlook, both on the 3D sensing side and on the data comp side, that's having 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 we'll see within our data con business in Q3 and Q4, that's adding some operating margin pressure. Like we said in our prepared remarks, we're continuing to invest in R&D. And so 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 an operating margin outlook of 19% to 22%, which is well below what we had outlook back in August. Now, as far as the longer-term goal is, you know, we're continuing to invest in our Datacom business. Alan 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. You know, we're continuing to invest 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. Synergies is something that I spoke about in one of the earlier questions that was asked. The facilities consolidation portion of the synergies that are going to happen in neophotonics does take longer than 12 months to do, and so as you see or as we all see some of that flow through, that will also provide us 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.
spk07: Helpful. And if I could just sneak one more in. On the data comp side of the business, and this got asked before, but I'm trying to get a little more clarity. You guys, I think Alan mentioned pockets of weakness, which in my eyes means certain customers, not across the board. Could you just talk about when during the quarter you started seeing that weakness? Just because some of your peers are actually guiding to continued strength on the data center side. Some guys are talking about inventory, but this is really the first time we're hearing about potentially demand deterioration. Can you just give the timing of when you saw that change? Just because going from capacity constrained to sequential declines is a pretty material turnaround. Thank you.
spk08: yeah i mean i don't know the specific date that our customer told us they had inventory but um i'd say it whether the investments in infrastructure are different than they were three months ago hard to say i think you know this is a uh i think one of the other analysts called it a 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 I think maybe our customer didn't think we were going to be able to do that. So as we did that, the inventory showed 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, you know, long-term Datacom business for us is going to be very, very strong.
spk11: Thanks. Thank you, Tom. Our next question comes from Christopher Rowland of Susquehanna. Christopher, please go ahead.
spk01: Hey guys, this is Matt Myers 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 FPGAs? And then as a follow up there, what, when do you think you'd no longer need to be buying these products through brokers?
spk08: Yeah, Chris, I mean, it really varies and it also depends upon, um, what products to go into. So, uh, you know, we, we see, um, anything from two times to a hundred times, uh, uh, the, the, the ASP for a given component. And if it goes into a low ASP product for us and the broker's asking for a hundred times the price, we typically say no, because it doesn't make any sense at all, um, to do that. So I, I'd say it's, um, It's not necessarily in FPGAs 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 paying 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 output for fiscal 23.
spk01: Perfect. Thank you.
spk11: Thanks, Matt. Our next question comes from Ananda Bora of Loop Capital. Ananda, please go ahead.
spk13: Hey, thanks, guys. Good morning. And thanks for taking the question. Yeah, two quick ones for me, if I could. On the operating margin fiscal year outlook reduction, proportionally, how much of it is from gross margin and how much of it is from incremental outbacks? And I have a quick follow-up to that. Thanks.
spk05: Yeah, so our view on operating expenses hasn't really changed that materially. I mean, you know, we're continuing to ramp up our R&D investment throughout the quarters and our fiscal Q2 operating expenses will be above, you know, probably high single digits above our Q1 operating expenses. And so, you know, much of the decline that we are seeing is in the gross margin line, you know, simply because of some of the product mix matters that we had talked about earlier with 3D sensing, Datacom, as well as reduced factory utilization in the back half of the fiscal year. So that's how we're seeing the P&L playing out throughout the quarters.
spk08: Just to add to what Jed's comment about operating expenses in Q2, yeah, we've got one extra month of the neophotonics and 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.
spk13: Thanks for that, Alan. And just a quick follow-up, Wadja, you began to touch on it, is on the gross margin, proportionally, how much is mixed and how much is revenue leverage or utilization change in the fiscal year? Yeah, so...
spk05: Yeah, so just very high level, probably a little bit more than 50% is product mix, and then the remaining is factory utilization. Probably most of it is product mix.
spk11: Thank you.
spk18: Thanks, Amanda.
spk11: Our next question comes from Michael Genovese of Rosenblatt Securities. Michael, please go ahead.
spk15: Great. I'll just ask two questions in one. Thanks for getting me in here. I just want to ask very directly, is there any change in the telecom outlook in terms of demand? I mean, this sounds like it reads well for telecom demand to me, but are you seeing any change with the change in the revenue guide? And then in terms of solving this supply problem, It seems like it's going to line up with the beginning of fiscal 24, sort of mid-calendar 23 is the current expectation. And I'm wondering, is that because the analog vendors will be adding new fabs or new lines of this 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 that's why that timing is? Thank you.
spk08: Yeah, thanks, Michael. I'd say you're right. The telecom demand continues to be very strong. I continue to get escalated phone calls from executives and our customers. So it tells me that it's real demand and not necessarily inventory build. So I think the outlook and fundamental demand drivers for telecom continue to be very solid. So I'd say that remains a good product, set of products for us. As far as the supply chain problem goes, Yeah, I'd say it's a combination of our expectations that our suppliers are adding capacity and freeing up capacity for us, especially as they see some softening in other areas of their business. So that just takes time for them to transition over to our products as they start new wafers or add new capacity. And these are investments that they started know over a year ago that will come online in calendar 23. so that's kind of why we line up 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 you know by april in order to impact our june shipments and so that's our visibility and and that's why we believe that we're going to continue to be impacted especially as demand is expected to continue to grow.
spk03: Okay. Thank you, Michael.
spk11: Our final question comes from Dave Kang of B Reilly. Dave, please go ahead.
spk16: Thank you. Good morning. My first question is regarding the expedite fees. I think it was about 7 million first quarter. What was it previous quarter and how much are you baking in the current quarter, December quarter? And my second question is for 3DS projections that you provided at OFC being flat, do you need to update that for us?
spk05: Yeah, so I'll take the first question and then Chris can take the second one. So on the IC charges, yes, I think it was $7.3 million this quarter. It was actually higher, significantly higher in the quarter prior. You have to take a look at our filings to see what we reported on that. You know, going into 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 because 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.
spk14: Yeah, sure. So on the 3D sensing, right, we talked about a minus five to plus five three year kegger. So simple math, a little more than 15 percent down or 15 percent up over the next three years. And that was on a 400 to 450 million dollars 3D 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. So the sort of the shape of the curve is sort of a deeper V or 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. And in particular, building upon that base with multiple new customers and new applications. So we're not necessarily walking back those numbers at this point. I think the opportunity still remains to be able to add to the incremental revenue to get into that range.
spk18: 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 Alan for some concluding remarks.
spk08: Thank you, Kathy. I'd like to leave you with a few thoughts as we wrap up the call. I'm very excited about the tremendous opportunities ahead of us as we serve the exponential requirements for data bandwidth in the AI, 5G, and cloud computing market inflections. We have a proven playbook on how to win with our best in class products and technologies. We also have a unique opportunity to drive manufacturing scale in the 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 again during upcoming investor events, which you will find posted on our website. Thank you.
spk11: This concludes today's call. Thank you for joining. You may now disconnect.
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