Lumentum Holdings Inc (LITE) 2021 Q4 法說會逐字稿

Good day, everyone, and welcome to the Lumentum Holdings Fourth Quarter and Fiscal Year 2021 Earnings Call. (Operator Instructions) Please also note today's event is being recorded for replay purposes through August 25, 2021. (Operator Instructions)

At this time, I'd like to turn the conference call over to Jim Fanucchi of Darrow Associates. Sir, please go ahead.

Thank you, operator. Welcome to Lumentum's Fourth Quarter and Fiscal Year 2021 Earnings Call. This is Jim Fanucchi from Darrow Associates assisting Lumentum with its Investor Relations.

Joining the call today from the company's management team, we have Alan Lowe, President and Chief Executive Officer; Wajid Ali, Chief Financial Officer; and Chris Coldren, Senior Vice President of Strategy and Corporate Development.

Today's call will include forward-looking statements, including statements regarding the impact of COVID-19 and the response of actions on our business and continuing uncertainty in this regard; trends and expectations for our products and technology, our markets, market opportunity and customers; and our expected financial performance, including our guidance as well as statements regarding our future revenue, our financial model and our margin targets. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings, including the company's quarterly report on Form 10-Q for the fiscal quarter ended April 3, 2021, and in the company's annual report on Form 10-K for the fiscal year ended July 3, 2021, which the company expects to file within 60 days of its fiscal year-end.

The forward-looking statements provided during this call are based on Lumentum's reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update these statements, except as required by applicable law.

Please also note, unless otherwise stated, all results and projections discussed in this call are non-GAAP. Non-GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with GAAP.

Lumentum's press release with the fourth quarter and the fiscal year 2021 results and accompanying supplemental slides are available on its website at www.lumentum.com under the Investors section. This includes additional details about our non-GAAP financial measures and a reconciliation between our historical GAAP and non-GAAP results.

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

Thank you, Jim. Good morning, everyone. The fourth quarter capped off a fiscal '21 that, by all financial measures, was our best year ever with record revenue, margins and earnings per share. This was despite the tough macro environment and impact of COVID-19, which caused our Lasers segment to be down more than 25% in fiscal '21. Growing demand from new customer opportunities drove Optical Communications segment revenue up 7% and total revenue to a new record level in fiscal '21.

We are focused on end markets that are driven by durable multiyear trends. We have been successful in developing differentiated new products and designing them into market-leading customers for their next-generation solutions, many of which are just starting to ramp. Our demand mix is increasingly shifting towards these products, which we believe could be signaling the start of a new accelerated growth phase in our markets.

Supporting this belief were robust demand trends in the fourth quarter. We had very strong bookings resulting in a book-to-bill of 1.2. Telecom transport component revenue in the fourth quarter was higher than it has been in several years. I'll provide more details on this later, but increased shipments of telecom transport components is typically a leading indicator of higher future telecom demand.

Year-on-year, revenue from EML chips for data centers was up more than 50%. During the fourth quarter, we had record Datacom chip backlog as cloud data centers are transitioning to higher speeds where we have differentiated market-leading products.

In 3D sensing, fourth quarter revenue was up 39% year-on-year. This was the highest fourth quarter 3D sensing revenue we have ever had, and demand has been strengthening in the first quarter as well. The recovery in our commercial lasers business continued and resulted in a 17% sequential increase in revenue and a Lasers book-to-bill of 1.2.

We expect a favorable demand environment throughout fiscal '22. Customers have communicated that they are seeing accelerated end market demand for their next-generation solutions. And this should not be a surprise as our markets are driven by powerful long-term trends.

The accelerating transition to digital and virtual approaches in all aspects of work and life is driving staggering amounts of data in the world's networks and cloud data centers. The proliferation of 5G wireless will remove bandwidth bottlenecks at the edge of the networks and will create the need for even more capacity in metro and core networks as well as in cloud data centers.

The computer and machine vision revolutions are in their early days, and we expect 3D sensing and LiDAR capabilities will expand to many more applications in multiple markets. Laser-based material processing is critical to the manufacturing of these devices, enabling the digital transformation and the transition to 5G wireless, electric vehicles and energy storage.

Now turning to additional product line details. For fiscal year '21, Telecom and Datacom revenue was up 4%. Excluding the low-margin product lines we exited over the past 2 years, revenue from Telecom and Datacom each were up by 10% or more in fiscal '21.

While customer demand is very strong, fourth quarter Telecom and Datacom revenue was approximately flat quarter-on-quarter and year-on-year. Revenue growth is being muted temporarily by supply constraints, which have increased recently as we have consumed much of our buffer stocks.

In Telecom, revenue growth in higher-level module products, including ROADMs, is being constrained by the supply of critical semiconductor components. We are intensely focused on minimizing the impact of these shortages on our customer deliveries. At this time, however, semiconductor supply shortages are negatively impacting our first quarter revenue outlook by more than $30 million. But again, our team is working diligently to improve upon the situation.

As I mentioned earlier, in our telecom transport component product lines, which are not impacted by semiconductor shortages, we had fourth quarter revenues higher than we have seen in several years. For example, fourth quarter terrestrial pump laser revenue was at the highest quarterly level in the last 3 years and the second-highest in more than a decade. Fourth quarter submarine components revenue, which is primarily from high-reliability pump lasers used in undersea cable applications, was also at the highest quarterly level in several years.

These data points are particularly important as pump lasers are critical to lighting up new optical amplifiers, which historically has happened early in both greenfield deployments and network expansions. Because of this, elevated pump laser shipments have typically been a leading indicator of future deployments of other telecom products. We expect this strong telecom demand to continue to increase in fiscal '22.

Demand for Datacom chips for cloud data centers is also very strong. Our highly differentiated products are enabling cloud data centers to transition to 200 and 400 gig speeds. As I mentioned earlier, during the fourth quarter, we had record high Datacom chip backlog and record high EML revenue, which was up more than 50% year-on-year. This backlog will be delivered over multiple quarters because we are production capacity constrained on Datacom chips.

Our previously highlighted Datacom production capacity expansion is tracking well and will result in significant increased output starting in the second half of fiscal '22. Due to expected long-term demand growth, we are making additional production capacity increases beyond those we previously discussed.

Looking to the first quarter, Telecom and Datacom demand is continuing to grow. However, we expect revenue to be down quarter-on-quarter as the semiconductor shortages I spoke about earlier have, in the near term, become increasingly impactful to our ability to meet our growing customer demand.

Fourth quarter industrial and consumer revenue was down 25% sequentially but up 34% year-on-year to the highest fourth quarter level we have ever delivered. We continued to increase our design-ins and traction in the automotive space in the fourth quarter, especially with our high-power, 5-junction VCSEL technology for LiDAR applications but also with VCSELs for in-cabin driver monitoring systems. In the first quarter, we expect industrial and consumer revenue to be up sequentially as production continues to ramp from major customer new products.

Turning to commercial lasers. In the fourth quarter, we had significant revenue increases in most major product lines. The most notable increase was in our kilowatt fiber laser. The growth in our laser service business was also meaningful as utilization of our lasers in the field continues to increase. Our Lasers segment is now recovering ahead of our original expectations and will be a contributor to growth in fiscal '22. We expect first quarter Lasers revenue to be up again quarter-on-quarter.

Throughout my remarks, I've highlighted that our markets are driven by strong long-term trends and that we are well positioned with differentiated new products and key design wins with market-leading customers. We believe the continuing shift in our demand mix towards differentiated products that enable next-generation customer solutions is a leading indicator for growth over the coming years.

Before handing it over to Wajid to review the numbers, I want to once again thank and acknowledge all of our employees around the world for their hard work and contributions during these challenging times. Our employees are absolutely the company's greatest asset. They are the ones responsible for our outstanding and record fiscal '21 results and for putting us in such a great position for growth in the coming years. I would also like to thank our customers, suppliers and shareholders for their continued support and partnership. The future is truly bright at Lumentum.

With that, I'll hand it over to Wajid.

Thank you, Alan. Good morning, everyone. As Alan highlighted, fiscal '21 sets a new bar for us financially with record revenue, margins and earnings per share. On margins, we achieved our previously announced target model a year earlier than originally projected. Based on our confidence in our long-term financial performance, we started aggressively executing on the $700 million share buyback program we announced last quarter, purchasing 3.1 million shares or 4% of our outstanding shares or $241 million.

Before jumping into the results, I'd like to highlight some changes we decided to make on how we calculate our non-GAAP tax provision. In order to give a more meaningful perspective of our tax burden over a longer-term period, reduced quarter-to-quarter variability in our non-GAAP tax rate, and in light of our growing profitability and utilization of our historical tax attributes, beginning in our fiscal fourth quarter, we are changing our method of calculating our non-GAAP income tax provision.

For this quarter only, to help with comparisons, we are providing our non-GAAP tax provision using both the prior method and our new method. On our Investor Relations website, we have provided additional data to help with historical comparisons.

To be clear, this change in methodology does not affect our non-GAAP operating profit, annual cash tax payments or cash flows, but it should result in more consistent but higher reported non-GAAP tax provisions going forward, and it will have no effect on any of our GAAP results. Based on our analysis, we expect our non-GAAP long-term tax rate under the new method of calculation to be in the range of 13% to 16%.

Now turning to the fourth quarter's numbers. Net revenue for the fourth quarter was $392.1 million, which was in the upper half of our guidance range, down 7% sequentially and up 7% year-on-year. GAAP gross margin for the fourth quarter was 41.5%, GAAP operating margin was 11.7% and GAAP diluted net income per share was $0.28.

Fourth quarter non-GAAP gross margin was 47.7%, which was down 220 basis points sequentially as expected but up 50 basis points year-on-year with a better mix of products and lower relative manufacturing costs. The sequential decline relates to the seasonal change in product mix and volumes while the year-on-year growth was driven primarily by improved gross margins in the Optical Communications segment.

Fourth quarter non-GAAP operating margin was 24.6%, which decreased 330 basis points sequentially and 20 basis points year-on-year. The sequential decline was driven by the expected gross margin decline and increase in operating expenses quarter-on-quarter. The year-on-year decline was driven by increased operating expenses. Fourth quarter non-GAAP operating expenses totaled $90.6 million or 23.1% of revenue. SG&A expense was $41.5 million. R&D expense was $49.1 million.

Fourth quarter non-GAAP operating income was $96.6 million, and adjusted EBITDA was $117.5 million. Other income and expense was a net expense of $0.7 million on a non-GAAP basis. Our fully diluted share count for the fourth quarter was 77.5 million shares.

Under our prior method of tax calculation, fourth quarter non-GAAP net income was $89.5 million and non-GAAP diluted net income per share was $1.15. Under our new method of tax calculation, fourth quarter non-GAAP net income was $81.9 million and non-GAAP diluted net income per share was $1.06.

Our non-GAAP results include the additional cost of goods sold we are incurring related to procuring semiconductor components that are in short supply globally and the measures we are taking to prevent the spread of COVID-19 in our sites.

Turning to the full year results. Fiscal '21 net revenue was $1.74 billion, which was up 4% from fiscal '20. Excluding the low-margin product lines we exited over the past 2 years, revenue was up 8% in fiscal '21 over fiscal '20. GAAP gross margin for fiscal '21 was 44.9%. GAAP operating margin was 30.2% and GAAP diluted net income per share was $5.07. Full year fiscal '21 non-GAAP gross margin was 50.9%, which was up 440 basis points relative to fiscal '20 due to our improving model with a better mix of products and lower relative manufacturing costs.

Fiscal year '21 non-GAAP operating margin at 30.8% increased 420 basis points from that of fiscal '20 driven by the gross margin expansion, offsetting increases and R&D spending year-over-year. Fiscal '21 non-GAAP operating income was $536.1 million and adjusted EBITDA was $621 million.

For fiscal '21, our fully diluted share count was 78.4 million shares. Under the prior method of tax calculation, fiscal '21 non-GAAP net income was $495 million and non-GAAP diluted net income per share was $6.31. Using our new method of tax calculation, fiscal '21 non-GAAP net income was $458.2 million and non-GAAP diluted net income per share was $5.84.

On the balance sheet, we ended the quarter with approximately $1.95 billion in cash and short-term investments. We continue to have $1.5 billion in aggregate principal convertible notes and no term debt. Cash flow from operations in the fourth quarter was $124.2 million and for the full year was $738.7 million. The full year cash flow from operations includes a net of $207.5 million from the Coherent termination.

Turning to segment details. Fourth quarter Optical Communications segment revenue at $355.2 million decreased 8% sequentially due to seasonally lower revenues in industrial and consumer. Fiscal '21 Optical Communications segment revenue was up 7% over fiscal '20. Optical Communications segment gross margin at 47.7% decreased 240 basis points sequentially due to lower industrial and consumer in the revenue mix and due to increased cost of procuring certain components impacted by worldwide shortages. Fiscal '21 Optical Communications segment gross margin at 51.2% was up 470 basis points relative to fiscal '20 due to a higher mix of higher margin product lines and improvements in operational efficiency and footprint.

Our fourth quarter Lasers segment revenue at $36.9 million increased 17% sequentially due to the ongoing recovery from the impact of COVID-19. Fiscal '21 Lasers revenue was down 25% relative to fiscal '20 due to COVID-19-related slowdowns in end market demand. Fourth quarter Lasers gross margin was up 130 basis points sequentially at 48.5%. Fiscal '21 Lasers segment gross margin was up 30 basis points relative to fiscal '20.

Now on to our guidance for the first fiscal quarter of fiscal '22, which is on a non-GAAP basis and is based on our assumptions as of today. We expect net revenue for the first quarter of fiscal '22 to be in the range of $430 million to $445 million. Our revenue projection assumes Telecom and Datacom decreasing quarter-on-quarter, industrial and consumer increasing due to normal seasonality in the consumer portion and commercial lasers increasing quarter-on-quarter, again, driven by further market recovery from COVID-19.

And as Alan noted earlier, demand is very strong but our revenue outlook includes a negative impact of more than $30 million due to semiconductor component supply shortages. Based on this, we project first quarter operating margin to be in the range of 30.5% to 32.5% and diluted net income per share to be in the range of $1.47 to $1.61.

Our non-GAAP EPS guidance for first quarter is based on a non-GAAP annual effective tax rate of 14.5% or $19.9 million at the midpoint. These projections assume an approximate share count of 76 million shares and an other income and expense that is a net expense of approximately $1 million. These projections also include the additional expenses we are incurring related to procuring semiconductor components and COVID-19 protective measures.

With that, I'll turn the call back to Jim to start the Q&A session. Jim?

Thank you, Wajid. (Operator Instructions) Operator, let's begin the question-and-answer session.

(Operator Instructions) The first question comes from Tom O'Malley with Barclays.

It sounds like in the Telecom, business trends are really strong on the pump laser side. Can you talk about what you're seeing in terms of transport deployments into the back half of this year?

And then with what you just reported in June, it kind of implies some weaker transmission. Can you talk about -- is that COVID-related? Or is that some slowing demand in the transmission side?

Yes. Tom, this is Alan. As we said in the script, the transport component growth usually is a leading indicator for future other growth. And that's what we're seeing play out -- what we think is going to play out in the first half of fiscal '22. And so we are seeing broad demand of ROADMs, ROADM line cards that usually go along with these transport components that really build out the initial either greenfield or the expansion of existing networks. And so I think outlook for transport is extremely strong. I need to get some semiconductor chips in to really be able to satisfy customer demand when they want it.

As far as transmission is concerned, we are seeing strength in transmission outlook in coherent components, on our tunable lasers, on our tunable -- on our modulators, high-bandwidth modulators as well as, surprisingly enough, on 10-gig tunables. And so across the board, ACOs are continuing to go strong while down from peak levels, but there's a lot of chassis out in the market and in networks that are waiting for ACOs. And so I think we're in pretty good position there. And as we start to get qualified on our 400-gig DCO modules, I think we're going to see a pickup in our transmission business throughout the year.

That's helpful. And then my follow-up is on the commercial lasers business. If you look at your peers, there's been just calls for weakness kind of across the board. You obviously have a different customer concentration than some of your peers. Can you talk about your success there? Is that more related to the geography? Or are you really seeing a bounce off the bottom that's related to some weakness over the past year? Can you just walk through the puts and takes of what's driving that strength versus others who are seeing some weakness?

Sure. I think twofold. You're right. Our customer base is different. We have limited exposure into China, especially with our kilowatt fiber laser customer. And from that perspective, we're seeing a good bounce-back in overall demand on our kilowatt fiber lasers that typically go outside of China end markets.

We are seeing, certainly, as everyone has seen, a pickup in semiconductor demand. And that's why we commented on our service -- our laser service business picking up, which is usually a good indicator of usage of our lasers in the field. And then we are seeing also our micromachining business pick up. That typically goes with semiconductor upswings, both be it on the dealing of semiconductors or the components that they go on and PCBs and things like that. So I do think it's a different customer base and a different end market that we address compared to some of our peers.

The next question comes from Rod Hall with Goldman Sachs.

I guess I wanted to kick off with 3D sensing share. I know, last quarter, you guys had talked about -- you talk pretty cautiously about share. And now the numbers look pretty good. So I'm just curious how share is tracking for you now and on into the back end of the year relative to what you were thinking last quarter. Then I have a follow-up.

Yes. Rod, thanks for the question. Our commentary last quarter was around the market size and our expectation for average selling prices due to the smaller chips and the next generation of our leading customer products. And so I'd say given the Q4 revenue, our biggest Q4 ever in 3D sensing, I think we bode pretty well with respect to share.

I do think that the product is -- has not even been announced yet. So it's really in the early stages with respect to how share is going to play out over the long term. But I would say that we're positioned very, very competitively. And as we've proven to our lead customer, we are there for them with high quality, meeting their production output and their expectations. So I feel really good about our share.

Okay. Great, Alan. That's good. And then my follow-up was on the $30 million. I know you commented ROADM was supply constrained. Datacom is capacity constrained. I'm just curious like how that $30 million kind of breaks down across the business. Is it mostly ROADM? Is it -- could you give us any color on what's in the $30 million, what particular lines are affected there?

Yes. In the $30 million, we did not include our internal capacity constraints, like, to your point, on Datacom. This is our product that our customers want that we can't deliver because we can't get the semiconductors. And that is mainly around our transport products, ROADMs, ROADM line cards, a little bit on our transmission products. But most of the $30 million really comes from our telecom transport area.

Right. And you guys do have plenty of capacity on 3D if that were to flex upward in terms of demand, right, Alan?

Yes, absolutely. I mean we have contractual obligations to have inventory there in case there is an uptick in demand or share shifts. And so we're ready for our customer and they know it, and we're going to continue to be there for them. So you're right. We have plenty of 3D sensing capacity.

And in our foundry model, we really have worked well with our supply chain to make sure that they are ready if and when upticks do occur.

The next question comes from Alex Henderson with Needham.

So going back on to the 3D sensing for a second. Clearly, the supply conditions broadly are causing everybody to be very anxious about supply. And so it seems like the 3D sensing production probably is anticipating potential risks to supply as the products get launched.

So are we pulling forward some of that demand into the June quarter that might have been something that was produced later in the year? Does it change your outlook for the overall FY '22 outlook to have pulled that much volume into the June quarter?

Hey, Alex. This is Chris. I would say it's a little early to tell exactly what's going on overall. But we don't believe this is necessarily a significant pull forward. You got to remember last year, there was a delay, if you will, in the customers' product cycles due to COVID-19.

And so kind of if we look back in years before, in more normal seasonal trends and then considering the additional dollar content and volume relative to, say, 2 years ago, 3 years ago, things look relatively normal that -- but again, with that caveat that it's very early to tell what's going on in this product cycle.

So have you changed your thoughts on the full year FY '22 kind of growth potential?

Yes. I would say we have not changed our view necessarily on the market outlook. But I think, as Alan indicated earlier, that market outlook has a lot of variables like overall market pricing and what volumes and mix are going to be. And those -- we only have guesstimates to one quarter's worth of the product cycle so far. So our previous views on the aggregate opportunity are not changed materially at this point.

The next question comes from Meta Marshall with Morgan Stanley.

Great. Maybe I wanted to ask a question. Last quarter, you had noted not expecting kind of a pickup in transport until kind of early '22. Just trying to get a sense of is this some of those projects that you thought wouldn't hit until calendar '22 hitting today? Or just any commentary about how it's tracking to kind of previous expectations.

And then the second just China has clearly had a buildup of some inventory that you were expecting clearly later on in the year. Just any update there.

Yes. Meta, yes, I would say that we have seen a bit of a demand change from expectations of 3 months ago in that the demand for transport -- and I think it's real demand. I don't think it's a bunch of double ordering, but it's hard to say. And I can usually gauge that by how many CEOs call me and ask for deliveries. And I can tell you it's brisk.

So I would say that the transport demand is real. It's picked up more than we had expected. And if we were able to get the semiconductor chips that we need, I think we would be able to really ramp up our transport revenue. We're continuing to work on that. So don't get me wrong.

I think the challenge we had is we built up some inventory that -- for flex demand. And more demand came in than we had expected and, therefore, we're unable to satisfy all of that demand.

I would say that the longer-term demand trends from our perspective are very solid. As we talked about, the, transport components and some marine cables going in throughout the world really are leading indicators for future demand. And our product positioning for our MxN, where now it's starting to proliferate significantly outside of China, is very, very strong.

Your question about China inventory, is that specific to 5G and our Datacom chips, Meta, or more general?

Well, I think you had mentioned last quarter that you thought there may be some inventory within China that should be clearing kind of in the calendar Q4 period. And so just trying to see if any of the pickup you were seeing in China is kind of ahead of expectations.

Yes. I'd say for the inventory, we were specifically talking about our 5G Datacom chip inventory that, in fact, we had a revenue deferral in prior quarters. We have seen activity around 5G, but that inventory is slow moving, so far. We expect that to start picking up over the next several months. And to your point, hopefully, that will be flushed through the system by the end of the calendar year and then start meaningful DML laser chip shipments into calendar '22.

The next question comes from Samik Chatterjee with JPMorgan.

I guess, Alan, if I could just start with the supply constraints here. And from the tone of your conversation, it does sound like things are getting a bit worse. So I just wanted to get a sense. I know it's a bit early for fiscal 2Q and onwards, but should we be thinking about more material headwinds than the $30 million or maybe some headwinds on margins as you go out and procure inventory?

And then the second part to that, seasonally, we've seen Telecom and Datacom move up from 1Q to 2Q. Does kind of the supply chain constraints limit your ability to deliver to that in this year?

Yes. I would say it's a little early to say because I am having discussions with the executives at the semiconductor companies that are continuing to work to try to support us, and we're hopeful we can make further progress with them. And we've booked out long, long lead times orders for these critical semiconductor chips that we'll not -- we will consume because there's long tails, long life in our ROADMs and ROADM line cards.

And so I think from that perspective, it's hard to say what's going to happen in Q2 because, in fact, later today, I've got a call with the CEO of a semiconductor chip company that's one of our big bottlenecks. And I'm hopeful to get good news but that news would only impact Q2.

I would say that on the margin front, unlike others, we've included the cost of expediting semiconductors or paying brokers higher charges. We've included those costs in our non-GAAP numbers, and so you saw that impact in Q4. And it's in our guidance to continue to pay those higher prices and expedite fees to semiconductor companies in our Q1 guide, and I expect them to also be in our Q2 performance as well.

The next question comes from George Notter with Jefferies.

I guess I wanted to dig into the sort of Huawei discussion going back 1 year, 1.5 years ago. And if I look back, I think the narrative from you guys is really around as the Huawei business ramped down given the U.S. government controls, you would see opportunities to win more sockets, more market share in other traditional system suppliers as they take share from Huawei around the world. And I'm kind of wondering like if you can revisit that narrative. And what are you seeing in the marketplace in terms of share, your traditional customers vis-à-vis Huawei?

Yes, George, thanks. This is Chris. And I'll take a first stab at it and let Alan come in and add to it. But certainly, on the Huawei front, right, we continue to have business with Huawei. It has significantly declined year-over-year, and that's really driven by the fact that they have opportunities to buy some of what we were supplying from non-U.S. suppliers. They're tending to buy from non-U.S. suppliers when they can do that. Fortunately, for us, many of those situations are product lines that, prior to the U.S. actions against Huawei, we decided to get out of, for example, with modulators and Datacom modules.

Countering that is some of our more bleeding-edge technology, for example, in ROADMs. There may not be a non-U.S. supplier and there may not be another supplier in the world with our capabilities. And so we've seen those product lines grow within Huawei and sort of push back a little bit on the headwind, the net headwind we have with them.

That said, there certainly is activity around the world where service providers are looking to use Western suppliers more extensively. And that has resulted perhaps in some near-term increased sales for our Western network equipment manufacturers. But to be clear, that's a long-term opportunity for our customers and, therefore, us given you can't switch network vendors overnight. That's a multiple quarters, if not multiple-year, process to do that.

And as we've highlighted in the past, our share of wallet with our Western customers is significantly higher than with Huawei. And therefore, as that transition continues to unfold over the next few years, we should be a net beneficiary of that given that share of wallet.

The next question comes from Simon Leopold with Raymond James.

I wanted to see if you could update us regarding the comments you made on the prior earnings call on the 3D sensing market, when you indicated you expected the market would be down 20% to 25% in your fiscal '22. I discerned maybe a little bit more optimism on today's call with the additional commentary around the automotive opportunities. If you could just update us on how you're thinking there, and then I've got a follow-up.

Sure, Simon. This is Alan. Thanks for the question. I would say that, again, our commentary around our fiscal '22 3D sensing market was really around the average selling price of chips going into next-generation devices, going down as a result of smaller die sizes.

And so 2 things, one of which is, again, record Q4 results positioned very well. That's not part of our perspective on market because share is still not clear but we're feeling pretty good about that. I would say until a device gets announced and the traction of the end user -- end customer really comes through, it's going to be hard to say what is going to happen to overall unit demand. And so our commentary was around, "Hey, if unit demand is flat, we believe the market is going to be down 20% to 25%."

Now does it look like that's playing out? Maybe. You might sense a softening with respect to those numbers, but it is going to be down assuming units are flat. Now is our lead customer gaining share? I think so. And therefore, maybe, there could be higher unit volume that would offset some of that average sales price per chip in our fiscal '22.

I appreciate that. And then in terms of the supply chain issues in the Telecom component, specifically Telecom, not Telecom plus Datacom, I'm sort of discerning this implies a sequential decline probably in the mid- to high-teens percent. And I'm wondering how you're thinking about once the supply chain gets better, not necessarily when but when it does, do you expect to see really a catch-up spend? So essentially, it sits in backlog and we get a better-than-seasonal recovery at that point?

Chris, do you have the expectation with respect to trends in Telecom Q1, year-on-year, Chris?

We expect telecom to certainly decline sequentially as we highlighted in the guidance. I'm not certain it's of the magnitude that you're saying, Simon. But certainly, the supply constraints are seriously handicapping growth in that space.

Yes. And then as far as your other question about is that demand there when we're able to satisfy it, I'd say, yes, mostly because a lot of that demand is very high-end ROADMs, where we are the leader and, in most cases, if not all cases, sole-sourced. And so that's why we're working extremely hard to get the semiconductors we need because our customers bet on us, and we certainly don't want to let them down.

So I'd say that demand is there when we are able to satisfy it. And so it will get pushed out if we're not able to satisfy it and don't think we will be able to satisfy all of it in Q1, for sure. But whether we are able to satisfy that in Q2 is another question that we'll answer on the next call.

The next question comes from Ananda Baruah with Loop Capital.

Congrats on the strong execution. Question 2, if I could. I guess the first one is on 3D sensing, going back to 3D testing. Is there any opportunity to get more favorable pricing through fiscal '22 than what you were originally thinking 90 days ago? Any context there would be great. And then I have a quick follow-up.

Yes. I mean we're not going to talk specifically about our price discussions with our customers. I would say that we do sign up for multiyear agreements. And those tend to be intense negotiations that we're very happy with where we ended up. We'll put it that way.

That's really helpful. And just going back to telecom and China, 5G specifically, could you just give us like the context as to where they are in the requalification process or whatever the right way to think about it is, sort of given the displacement that happened with Huawei sort of last August and September and that they were -- sort of the carriers were going through, I'm calling it, a requalification process but whatever the right terminology is and where they are today? And are you seeing a pickup off of sort of what's been the last sort of 9, 10 months cadence for you guys? And that's it for me.

This is Chris. On 5G chips in China, what I would say is it's -- I would -- well, there's probably an element of requalification, where our customers have needed to obtain alternate sources of semiconductor chips for their base station designs. But I think the way that a lot of folks are tracking it is around tender activities and tender awards for base stations. And this summer, there has been some tender activity, tenders awarded to network equipment manufacturers by the China Mobiles, China Telecoms of the world to deploy additional base stations.

I would say the activity there was moderate. There wasn't a huge uplift, if you will, in expected volumes. But on the other hand, good to see that those tenders were released and awarded. And we expect, as Alan highlighted earlier, that once the overall supply chain is -- works down the inventory of product that we've already provided, which should happen over the next few quarters, that as we get into the middle of our fiscal year or into the new calendar year, that we would then see a resumption in growth for us for those products.

And maybe if I could just add as well. The good news is there is a lot of activity in China, not with just our large customer but with others on transport deployment. So metro and long-haul deployments are continuing. And I believe that's usually an indicator that there is a commitment to build out the 5G networks because, once you do that, then the bottleneck at the edge of the network really gets alleviated, and you need to make sure you have the metro and core networks built out, and we're seeing a lot of activity in that area.

The next question comes from Christopher Rolland of Susquehanna.

The first one is the shortages that you guys see out there. Is this changing your desire for external versus internal capacity, both front end and back end?

Yes. No, I don't think so. I mean these are unique semiconductor chips, in most cases, that we are not going to be manufacturing ourselves in any situation that I can see. So we're reliant on our semiconductor suppliers and their foundry partners to increase the wafer output and allocate some chips to us.

In the bigger scheme of things, our consumption of semiconductor chips is relatively small. And so we don't need millions of these chips. We need thousands of the chips or tens of thousands of the chips. And then from that perspective, it would make no sense for us to get into the FPGA business, for example. We're going to continue to rely on them and partner with them to get what we need.

For sure. And I know we've talked a lot about transport, but maybe you can double-click on that kind of next level of demand that we're seeing there? You did talk about, I think, this prebuild of China inventory. And any status on that? What are the transport applications ultimately going to be used for here? And geographically, what does this mix look like? Is it -- are there moving parts other than China here?

Yes. I think it's a global demand pickup that we've seen on transport, both ROADMs, ROADM line cards. And what we did talk about is our transport components and submarine components. And we are growing that output as a result of the demand. And there are no semiconductor component shortages with respect to our transport component output.

And so we've seen strength of that and our pump lasers in China as well as outside of China as well as submarine cable deployments that use a lot of our components under the -- at the bottom of the ocean, high reliability. So I'd say that it's a broad increase in demand even in the last 3 months since our last earnings call for those components as well as the ROADM line cards, both inside of China as well as the rest of the world.

Chris, do you have anything else to add on that?

No, Alan, I think the key point is that it is global in nature. And if anything, I mean China is growing on the telecom transport and transmission side, but it's really the Western world that is picking up so significantly at present. And this is as, I think, if you go back on prior calls, we've highlighted that, that China kind of led a little bit on some next-generation architectures. And we fully expected the West to come on strong, and that's only been delayed by COVID-19.

And while unfortunately, COVID-19 continues to be a problem, I think the world is moving on at least in telecom deployments and figuring out how to get going and deploy that bandwidth because, at the end of the day, with Internet bandwidth growing 30% per year, you can't skip a lot of years of expanded deployments or else you run into a big problem very quickly. And as Alan highlighted, 5G opening up the edge of the network, you need to put in that core capacity, and that's what's happening.

The next question comes from Michael Genovese with WestPark Capital.

Okay. My first question, I want to understand the margins a little bit better. It seems like in the quarter you reported, the gross margins were a little bit weak, which I assume had to deal with the supply chains and the ROADM constraints. But then the outlook, it seems like the constraints are getting worse, but the operating margin guidance is very, very strong. So just -- can you just help me reconcile margins for these 2 quarters and what's going on?

Yes. Michael, it's Wajid. I'll take a crack at it, and then Chris and Alan can jump in as well. Yes. So margins in fiscal Q4, you're quite correct. They were impacted negatively by some of the increased costs that we had, both because of some of the site measures we've been taking for COVID-19 and also because of some of the expedite fees that Alan talked about that we're incurring and some of the brokerage fees that we're incurring, having to do with getting in some semiconductor products.

Moving into Q1, again, our operating margins of 30.5% to 32.5%, we're quite pleased with those margins, where we're expecting to continue to have the same type of cost that we had in Q4 into Q1 as well. And we've reflected that in the operating margins that we've communicated from a guidance standpoint. What's really benefiting us is a really good product mix. Our Lasers business is increasing quarter-over-quarter, and that's helping us quite a bit as well.

And even looking forward, you heard from the prepared remarks, Alan commented on the backlog that we've got for EML chips is at a record. And so when you have that type of favorable product mix, that's going to flow down to our operating margins as well. So those improvements in product mix are combating some of the headwinds we're seeing from a supply chain cost standpoint.

Great. Okay. And then my second question is I guess we're expecting the transport -- I mean transport seems okay but we're expecting to get -- sorry, transmission, we're expecting transmission to get better at some point given what we're seeing in transport.

My question is, is 400ZR relevant to that conversation. Is that an important market as transmission demand increases at some point in the future? And is it something that you guys need to play more in?

At least in the near term, I mean, the ZR market is certainly an important market. It's only a small portion of the overall 400-gig-and-above market. And as Alan highlighted earlier, our currently and what we expect will be ramping up earlier is more the coherent components. So high-speed -- for example, high-speed modulators at 600 and 800 gig narrow line with tunable lasers that made up with those modulators, those are in production and ramping at present as well as other components that go into folks that are building 400, 600, 800 gig modules or line cards.

And again, as we mentioned earlier, our 400-gig DCO modules, which are either DCO, ZR plus, however you want to think about the sort of format or standard they adhere to, ZR is certainly something we're targeting on our road map, but it's not to be an end-all for us because it's a pretty small portion of the market relative to how big the pie is going to be in the fastest-growing portion of it. It's just a new portion. It's probably why there's a lot of focus on it, but it's certainly not the largest opportunity ahead of us and our top focus.

And we have time for one more question in our allotted time, and that comes from Fahad Najam with MKM Partners.

I know it will come out in the 10-K, but can you tell us your 10% customers in the year?

Fahad, this is Chris. Yes, as you said, it will come out in the 10-K. So I don't want to get too quantitative, if you will., But maybe perhaps the easiest way to answer that question is to say we've had 3 folks in our 10% customer list over the past several years from time to time, not all 3 of them on that list in any particular year. And the same folks are in the mix. There should not be anything surprising in the greater-than-10% customer. As we've highlighted, our top Western customers are growing significantly by double-digit percentages year-over-year. And our largest customer in China, Huawei, is declining by double-digit percentage year-over-year. Where they will exactly land in that 10% customer list, we'll have to wait and see in the K.

Okay. So can you -- I was trying to get an answer around Huawei. So how material Huawei is to your revenue and to your outlook? Can you provide some insight to that?

Yes. I think, as I said, Huawei is hanging around and is around a 10% customer. That's why we want to wait and comment on the specific number on when the K comes out. They have been much larger and are declining year-over-year. And we expect to continue to decline over time as well given both our reduction and being in a limited set of SKUs, if you will, primarily high-end ROADMs with them as well as Western service providers moving away from Huawei and moving to Western network equipment manufacturers, where we have larger footprint. So we don't see it as a reduction in our overall global market share despite a reduction within Huawei.

Yes. Just to add to that, Chris, I think the other thing we've seen is a pickup in demand from other network equipment manufacturers in China that perhaps are gaining share in domestic China deployments. And so I think, overall, we're in a pretty good position with the China market.

This concludes our question-and-answer session. I would like to turn the conference back over to Jim Fanucchi for any closing remarks.

Great. Thank you, Drew. This does conclude our call for today. We would like to thank everyone for attending, and we look forward to talking with you all again when we report the first quarter of fiscal '22 results in early November. Thank you, and have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.