Lumentum Holdings Inc (LITE) 2017 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Lumentum fiscal second-quarter 2017 results conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to Chris Coldren, Vice President, strategy and corporate development. Sir, you may begin.

Thank you, Takea. Welcome to Lumentum's second-quarter FY17 earnings call. This is Chris Coldren, Vice President of Strategy and Corporate Development. Joining me on today's call are Alan Lowe, President and Chief Executive Officer; and Aaron Tachibana, Chief Financial Officer.

This will include forward-looking statements including statements regarding the markets in which we operate, trends and expectations for products and technology, as well as purchasing trends; Lumentum's expected financial performance expenses and position in our markets. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations.

We encourage you to review our most recent filings with the SEC particularly the risk factors described in our 10-Q filing for our fiscal second quarter ended December 31, 2016 that will be filed later today. The forward-looking statements we provide during this call including projections for future performance are based on our 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 are non-GAAP. Non-GAAP financials should not be considered as a substitute for or superior to financials prepared in accordance with GAAP. Our press release with our second quarter FY17 results is available on our website, www.Lumentum.com under the investor section and includes additional details about our non-GAAP financial measures and a reconciliation between our GAAP and non-GAAP results.

Our website also has our latest SEC filings which we encourage you to review and supplementary slides related to today's earnings release. Finally, a recording of today's call will be available by 7.30 PM Pacific time this evening on our website. Now I would like to turn the call over to Alan for his comments and second-quarter business highlights.

Thank you, Chris. It is an exciting time at Lumentum. Our strategy to invest in growing markets, develop the best products and technologies, and foster the closest relationship with market leading customers is succeeding. I am pleased to announce that we have achieved both record revenue and margin once again.

Strengthened demand for our 100G Datacom, pump laser, and submarine products drove our second-quarter revenue to $265 million up 21% relative to a year ago. Optimal communications revenue grew 8% sequentially, and 27% year on year based on continued strength in telecom and Datacom markets. Datacom growth was notably strong increasing 54% sequentially and 95% year on year. Despite the increased output for 100G datacom products, our customers wanted more.

Both growth and operating margins expanded significantly to record levels as our revenue mix continued to be richer in newer higher-margin products. At Lumentum, we are focused on using our photonics technologies to accelerate the speed and scale of cloud, networking, advanced manufacturing, and next generation 3-D sensing applications. The rapid growth in cloud computing, streaming video, mobile, and other high-bandwidth applications is placing enormous demands on networks in terms of capacity, productivity, and efficiency.

These demands can only be met with advanced optical communication technologies including 100G and higher data transmission and advanced ROADM architectures. Hyperscale data center operators are starting major 100G upgrades.

Advanced manufacturing techniques including the cutting and welding of metals, precision, machining of semiconductor wafers, printed circuit boards, and glass and plastic displays are driving further reliance on lasers. Leaders in next-generation consumer electronics, virtual and augmented reality as well as the automobile industry are looking to laser-based 3-D sensing to enhance capabilities and enable new applications. Lumentum is a leader in the photonics technologies that are critical enablers of all these applications. And our investments in new products position us well for these future trends.

On our last call, we highlighted a supplier quality issue that affected our ability to meet customer demand for our 100G Datacom products. During the quarter we resumed volume shipments of these products. Utilizing capacity added over the prior quarters we grew our 100G Datacom revenue 124% sequentially and over 500% year over year to $52 million. Lower speed Datacom revenues continued to decline and now represent only 17% of Datacom revenue.

Due to capacity limitations second-quarter datacom revenue was primarily from network equipment manufacturers. Looking ahead, we expect revenue from hyperscale data center operators to increase as we bring more 100G transceiver manufacturing capacity online.

Telecom revenue declined 3% quarter-on-quarter. This decline had two primary components. First, we had a multi million dollar drop in older lower speed telecom product lines that are end of life. Aggregate quarterly revenue from these end-of-life in product lines are less than $1 million. Second, in the first quarter we added significant capacity for 100G coherent components and were able to satisfy some pent-up customer demand. Second-quarter revenue from these coherent components declined from this level but were still up more than 13% compared to two quarters ago.

Coming off the strong first-quarter, second-quarter pump laser and submarine revenues were at record levels based on continued strong demand worldwide. Pump lasers and the optical amplifiers they pump, are key elements of all network -- new network deployments.

In addition to lighting new fiber, pump demand is also driven by strong global demand for ROADMs which generally require optical amplification when deployed. New submarine cables are being built and lit up around the world. In addition to traditional communication service providers, cloud operators are increasingly driving new deployments of submarine cables.

Demand from ROADMs is strong. Our overall ROADM unit volume increased significantly during the second quarter driven by strong demand for WSS modules worldwide and in particular from our Chinese customers. Blade level ROADM shipments were down. Blades have a higher average selling price as they integrate WSS modules with other optical components including pumps.

The lower mix of blades resulted in a 10% decline of ROADM revenue despite higher overall ROADM unit volume. This mix shift also freed up pump capacity and enabled increased external pump lasers and optical amplifier revenues. Customers buying WSS modules generally need to purchase pump lasers for optical amplifiers to make their own blades. Pump lasers are still on allocation.

We have been and continue to be capacity constrained on pump lasers even with significant capacity additions over the past year. We are still in the early stages of North American metro deployments. We expect we will see a shift back to more blades in our product mix as our customers begin new cities.

Also of note on ROADMs, during the quarter, we received orders from Chinese customers for deployments in China. We are encouraged by these initial orders and expect China ROADM deployments to pick up materially in calendar 2017.

Looking to the third quarter, we expect seasonal factors will be more at play this year than they were last year which was the start of the strong China ramp. Overall demand remains healthy, but sequential growth will likely be insufficient to overcome normal seasonality. Industry capacity remains very tight on ROADMs and pump lasers and demand for these products remains very strong. Continued strong demand for pump lasers is encouraging as pump laser demand is an often a leading indicator of new network deployments.

Recent discussions with customers and network operators in China continue to reinforce our expectation that calendar year 2017 will be a strong growth year again in China. Chinese operators continue to add capacity, light new fiber requiring pump lasers and began large scale deployments of ROADM nodes. We believe there will be a significant growth for Lumentum in China in calendar 2017.

Turning to commercial lasers, as expected, revenue declined in the second quarter. We saw a 29% sequential decline driven by a fiber laser product transition and the second quarter being seasonally weaker in the micro materials processing market. Looking to the third quarter, we expect lasers from micro-machines to rebound to levels similar to a year ago.

We expect modest growth from our second-quarter levels in our kilowatt fiber lasers. Market forecast for semiconductor capital equipment growth are encouraging as this market drives our micro-machining laser business.

Industrial and consumer revenue which consists primarily of revenue from laser diodes we supply to customers building their own fiber lasers and to 3-D sensing customers was approximately flat sequentially. However, we had an exciting development during the second quarter. While not significant to second quarter revenue or our third-quarter guidance, we shipped our first revenue into what we believe to be a high-volume mobile device application. We are very encouraged by the progress and key milestones achieved to date on this application.

We continue to have strong engagement from customers including those in the consumer electronics and automotive markets. We expect 3-D sensing to be a significant growth opportunity over the coming years.

Last month, we were at the consumer electronics show in Las Vegas meeting with the customers, and the level of interest in 3-D sensing was overwhelming. Demand continues for growth -- to grow for bandwidth and speed across the world's data centers and communication networks. Hyperscale data centers are starting to transition to 100G, and our product portfolio and capacity additions position us well for this transition. ROADM based Metro network deployments are just beginning globally with China taking -- notably taking its first step in this direction.

We believe that we have the best products available today as well as new product pipeline that will further our leadership position in the ROADMs market. Manufacturers around the world are increasingly using advanced laser based techniques. Global consumer electronic leaders look to laser based 3-D sensing capabilities for next-generation applications.

We believe we are well positioned with our new products, customer relationships, design win and our ability to execute. It is an exciting time for us. I will now hand the call over to Aaron for more details on our financial results and our guidance for the third quarter of FY17.

Thank you, Alan. The second quarter was $265 million and exceeded the midpoint of guidance. Second-quarter revenue increased 3% sequentially and 21% compared with the same period last year. GAAP gross margin was 32.8% and increased 110 basis points quarter-on-quarter. GAAP operating margin was 5%, and GAAP diluted net income per share was $0.19. Our second-quarter non-GAAP gross margin was 36.9% and increased 270 basis points relative to the prior quarter.

The sequential increase was driven by a 410 basis point improvement in optical communications gross margin. Non-GAAP operating margin for the second quarter was a record 14.7% and exceeded the upper end of our guidance range. Our operating margin expanded 200 basis points sequentially in gross margin improvement. Non-GAAP net income was $35.9 million and up 88% year over year.

Non-GAAP earnings-per-share was $0.57 based on a fully diluted share count of $62.7 million and also exceeded the upper end of our guidance. These earnings include $400,000 and other expense and $2.7 million of tax expense.

Now for some additional details. Optical communications revenue was $236.6 million an increase of 8% over the prior quarter driven by a $23.9 million or 54% increase in Datacom revenue which was partially offset by a $5.5 million or 3% decrease in telecom revenue and a $100,000 or 1% decrease in industrial and consumer revenue. Optical communications gross margin at 36.6% increased 410 basis points sequentially from higher volume and the richer mix of new products including 100G datacom and WSS modules.

Commercial lasers revenue was $28.4 million a decrease of $11.4 million quarter-on-quarter. Going into the second quarter, we did expect a decline in commercial lasers revenue from normal seasonality due to capital equipment spending within the semiconductor industry as well as a major customer product transition.

Commercial lasers gross margin at 39.4% decreased 380 basis points sequentially. Prime gross margin was due to the impact of lower volume. Operating expenses totaled $58.9 million or 22.2% of revenue compared with last quarter of $55.5 million or 21.5% of revenue. R&D expense was $35.4 million, and SG&A expense was $23.5 million.

R&D spending grew sequentially due in part to increasing investments in 3-D sensing. Income tax expense was $2.7 million for the quarter and equated to an effective non-GAAP tax rate of 7%. As we go forward we continue to expect the non-GAAP tax rate to be in the range of 7% to 10%.

Capital equipment additions were approximately $35 million in the second quarter. In addition to expanding capacity for telecom and Datacom products, we are also adding equipment to prepare for emerging 3-D sensing applications. Our cash balance was $155.9 million at the end of the second quarter, a decrease of $10.9 million sequentially, and we remain debt-free. The decline in cash was a result of elevated capacity expansion and the timing of AR collections from customers.

Now on to our guidance for the third quarter, FY17, noting again that all projections are on a non-GAAP basis. We project net revenue for the third quarter to be in the range of $250 million to $265 million with operating margin in the range of 12.5% to 14% and earnings-per-share to be in the range of $0.46 to $0.54.

Now, I will turn the call back over to Chris to begin the Q&A session.

Thank you, Aaron. I would like to ask everyone to limit discussion to one question and one follow-up. Takea, let's begin the question-and-answer session please.

(Operator Instructions)

James Kisner, Jefferies.

Thanks very much. For this, I want to ask a housekeeping question, you spoke about end of life impacting your telecom optical communications. Can you comment or quantify how much that was? And separately, too, Datacom, can you talk about the mix of CFP2, QSFP28 and 40 gig within that as well? And perhaps also maybe parse how those different products drove the nearly 50% increase quarter over quarter. Thanks.

Yes. So the older products that declined were kind of in the life on our 40 gig coherent modules. And we had a 100 gig coherent line cards. Both of those are coming to end-of-life and are a very small revenue going forward.

As far as the mix of 100 gig, datacom the majority of the growth came from CFP2 LR4, but we did see growth in our QSFP28 and saw initial revenue shipments of our LR4 QSFP28. But most of the QSFP28 was CWDM4.

Just to follow up on that. It helped, but can you try to quantify the end of life products in the quarter? It's a pretty big drop sequentially. I'm just trying to understand how big of a factor that was.

Probably a couple million dollars or so on a quarterly basis.

And just last one, this $7 million help in gross margin from other charges, I guess you say related to nonrecurring activities. It's a pretty big number. I'm just wondering if you could elaborate on what that was and whether or not we should to see that -- expect that to hit again in any prior -- any coming quarters. Thanks. I'll pass it.

I'm sorry, can you elaborate? We didn't really say anything about a lot of nonrecurring charges.

I saw it looks to me in non-GAAP gross margin you had about a $7 million help margin, you had a $7 million help. And it says from other charges, related to nonrecurring activities. Maybe I'm reading that wrong, we could take it off-line; but it looks to me you had some help in gross margin there from that.

No, we did have -- so in the past if you go back to last quarter as well as this quarter, we did have some charges related to some supplier component issues. And so it adjusts those out, because we do have the expectation we're going to get recovery from our suppliers as well.

Okay. Does your guidance for gross margin assume any more of that help? Because that was 270 basis points in Q4?

Just to be clear that's not really help. I think the non-GAAP numbers we presented reflect the ongoing business and mix that we've had in the quarter. Going forward, those quality issues are behind us.

And we don't expect to see any of those kind of detriment to our GAAP numbers relative to our non-GAAP numbers, if that make sense.

That does help. Thank you very much.

Michael Genovese, MKM Partners.

Thanks a lot. On the telecom being sequentially down, I understand the end-of-life factor. You said there were two factors, and you explained the second one, but I really didn't follow it. Could you go over that again of why the telecom revenue was sequentially down?

Yes. There were two things beyond the end-of-life stuff. The one I tried to explain in the script was really around coherent component growth, so micro ITLAs, ITLAs, coherent modulators and receivers, that business was down slightly.

As in the Q1 timeframe, we saw a large pent up demand that we were able to satisfy in Q1, and much of the balance of supply and demand became more in balance in Q2. And I'd say the third thing was the mix of ROADMs versus WSS modules as well. Our ROADMs unit grew in the quarter the mix of modules was much higher than the mix of blades.

And so that caused our ROADM revenue to be down 10% even though our number of ROADMs shipped was up.

Okay, so following up on that point, can you just help? It sounds like you were saying the blades are more of a US Metro product versus a WSS product? So when we think about the mix of blades, versus WSS, is there a regional implication or breakout there that makes that -- helps to understand the business?

I'd say that the majority of the blades that we design for our customers are for our US based, or North America based network equipment manufacturers, and a lot of those end up going into the North America Metro builds, but they also get deployed outside of North America. And, frankly, we don't know how much goes to North America versus EMEA or APAC.

But those are for primarily the large North American network equipment manufacturers whereas the WSS customers, the ones of note that we made in the script, were Chinese-based and most of what we had historically shipped into China exited China and ended up in Europe or CALA or other places. But, of note for last quarter, was there was large orders and shipments for WSS modules that will end up staying in China.

Okay. Thanks for the questions. I'll follow the rules and may come back in at the end if there's still time.

Alex Henderson, Needham & Company.

Yes, I was hoping that we could go into the ROADM a little bit more in depth. You are saying that you saw a 10% decline in blade sales. As you look forward into your guide, are you expecting that to reverse, are you expecting that to stay down at that new level and have a mix shift to more WSS and less blades? Can you give us any sense of how you see that progressing over time as we move forward?

Sure, let me just do a clarification first. We saw a 10% reduction in ROADM revenue with ROADM units actually growing more than 10%. So that would mean a larger percent decline in blade shipments that would cause that kind of decline to happen.

So, we expect as more and more North American cities get deployed for the major carriers here that the mix of blades will pick up in the future. I think our expectations are that this quarter it will probably be flattish on the blade level. But we could get surprised as budgets get released and more cities might pick up in North America. But that is our current expectation and what is in our guide.

So have you had any feedback from them on why the number of cities that are deploying or what the cause for the slowdown is? Is that a function for the availability of the parts, is it a function of other fires to fight? Is it M&A activity? What's causing that?

It's hard to say. I'd say though that when people deploy ROADM networks, and several large cities got deployed in the second half of last year, the ROADMs go in and the next thing that happens is the transmission lines come to light up the fiber and light up the different wave lengths. And typically, one goes and then the other goes in a given city, so I would expect to see that as the transmission lines fill up in one city they move onto another city and they start again with the ROADMs and then go to the transmission line.

Can you address whether you think there's any inventory involved with any of the correction there?

I don't think so, Alex. I think that most of the inventory that we have is in the MI hubs for the North America customers, and that's pretty well-controlled. They pull it when they need it.

Okay. I will cede the floor, thank you.

Patrick Newton, Stifel.

Yes, Alan, thank you for taking my questions. I guess just following up on that inventory commentary, you did have a $20 million increase in inventories, and it looks like according to your Q that is almost entirely in finished goods. So what exactly is driving that build? Is that you restocking deplenshed inventories at the hubs? Or are there other products perhaps that you are building some inventory for?

Hey, Patrick, this is Aaron. So in terms of the inventory build, it's a mixture of different products. It's not one specific product family. And it's really to support the growth that we see here over the next couple of quarters.

And then, I guess on the data center side, you did talk about strengths in QSFP28 and also CFP2. I was wondering if you could just give us a broader breakdown of what exactly all the product lines that are embedded into that data center business and if there's any approximate mix that you could give us at this juncture?

I would say, of the $60 million some odd Datacom that 90% of it today is probably in the CFP2 CFP4 form factor. And the balance is in the QSFP28, and as I said, most of the stuff we are shipping to the hyperscale data center today are CWDM4s, and whether they are inside the data center or connecting data centers that are relatively close together, it's not clear to me. But I do think that we are now at the stage where, with inside the data center, the types of products like CWM4 and PSM4 are taking off.

And I guess, Aaron, I just need one more -- just a little bit of help on the gross margin upside. You clearly had higher volume, I think you talked about 100G Datacom mix and also the WSS module all helping that. But you also spoke to this nonrecurring charge; and I'm sorry I jumped on the call late. Did that non-recurring charge aid gross margin in the quarter and we should back it out for an apples to apples? Or is there anything else that I'm missing that drove that really impressive number?

No, there was no aid from any of the adjustments or the extraordinary charges. The gross margin accretion quarter to quarter was really driven by a favorable mix of products, 100 gig, and then the WSS modules. And then we also had a fair amount of submarine business that landed in Q2 as well.

Great. Thank you for taking my questions. Good luck.

Simon Leopold, Raymond James.

Thanks for taking the question. First thing I wanted to see if you can give us a little bit more thought on is, what your assumptions are around the mix in the coming quarter particularly if you could touch on the annual price declines that affect your March quarter. And then, the longer-term trending question I wanted to see if you could talk a little bit more about the 3-D sensing opportunity in autos. I certainly have heard you talk in the past about the mobile device opportunities. In the prepared remarks I heard mention of autos. I'm just wondering how different that is, if this is new or whether I just hadn't heard you talk about that previously. If you could elaborate on that opportunity as well.

Sure, Simon. On the ASPs, I think as we said in the last call, our expectations were that the ASP reduction would be on the low-end of the typical 10% to 15%. And that's where we ended up. I'd say in typical years and this is no different, half of that comes into the March quarter. And we are seeing ASPs impacts our ability to grow and you could just take that number 5%-ish as what we are seeing for ASP reductions or expecting for ASP reductions in the March quarter.

As far as longer-term 3-D sensing, we've been talking about mobile devices for probably three years. And we are looking forward to that actually turning into revenue. I think we're on kind of that same range of automobiles taking that kind of time. We've been working with automobile manufacturers for the better part of a year now. And it's probably a couple years out before anything meaningful contributes to our revenue on that application.

Just to clarify, is the auto opportunity a different type of product or just a different application for the product you are already working on?

They are all very custom, and the requirements of an automobile that protects someone's life on the road is very, very different than something in a mobile device. So, it is different but based on the fundamental based technology for VIXLs or edge emitters. It is different. The ASPs are going to be significantly different because of the complexity. You'll see multiple, multiple of these devices in any automobile as opposed to in the mobile devices where you'll see one or two.

Thanks for the clarification.

Doug Clark, Goldman Sachs.

Great, following up on the 3-D sensing kind of opportunity it sounds like you got a little bit of a more visibility into one customer in particular. Can you talk about, besides initial orders, what type of visibility that's giving you into cadence throughout the rest of the year in terms of revenues and volumes?

Not really, Doug. I mean our customers are very secretive and don't want us to disclose any more than we all ready have. I'd say that it's not just one mobile device manufacturer that we're working with and sampling. It's multiple.

I would hate to give away any of their secrets, and as we start including meaningful revenue in our guidance we will talk more and more about it. But suffice it to say that the milestones that we achieved over the last six months increase my confidence in our ability to make 3-D sensing a meaningful part of our business as we look forward.

Okay, great. And then other one is on relative mix of telecom versus Datacom, expectations for the March quarter, can you talk about sequential growth or declines in each of those segments or perhaps kind of relative sequential declines in each of them? And a bit of a follow-up, last quarter you talked about the $10 million revenue slip in the Datacom business because some of the supplier constraint issues. How much of that was fulfilled in the March quarter, meaning did you get all of that $10 million back in the March quarter? Excuse me, December quarter.

Doug, this is Aaron. In terms of the mix for the March quarter, so just looking at two big buckets that we categorize, [opcon] and lasers. Directionally, lasers will be up sequentially into the March quarter.

And as Alan had mentioned in the prepared remarks, Q3 is typically our seasonal quarter where we have the most of the price declines that show up. So, most of the price decline is heavier in the opcon segment. So directionally opcon would be down a little bit because of the seasonal factors. And then also, submarine is a little bit lumpy, and I had mentioned that submarine was up in the December quarter and down a little bit in the March quarter.

And your question on the $10 million of Datacom. As I said in the prepared remarks, while we grew nearly 100% in 100 gig datacom from Q1 to Q2, we still didn't satisfied all of the demand out there. So whether we satisfied that $10 million or not, the demand is still -- was still more than we could supply. And as we bring on more and more capacity we will be able to move some of that capacity to satisfy more of the hyperscale guys where the ASPs are significantly different than a 10 kilometer LR4 type of device. So that's what we see going forward on the Datacom business.

All right got it. Thanks a lot.

Tim Savageaux, Northland Capital.

Hello, good afternoon. A couple of questions. First, a quick one on, if you have any comments on 10% customers or customer concentration anything changing or notable there.

No, in terms of 10% customers, we will be talking about that or we will disclose it in our annual 10K.

Okay. No comments on any top five in the aggregate or meaningful changes of what we've seen in the past from previous Ks?

No, nothing notable from a change standpoint.

Okay. Great. And then, follow up on the 3-D sensing side and maybe try to approach this from a different angle. That is to understanding a lot of differences in the technology relative to what you did with the connect, back in the day. Sort of checking the way back machine.

It looks like that opportunity for you guys was something on the order of $100 million plus lifetime perspective and got up to $20 million a quarter or more. I wonder if you have any comments on sizing the current opportunities that you are pursuing relative to your previous experience in consumer 3-D sensing or gesture recognition. Thanks.

Yes, I think, putting aside the timeframe for when this happens I would say that the market is multiple times bigger than the connect business and could imagine quarters of $100 million plus type of marketplace growing to over $1 billion, I would expect, as we get into multiple mobile devices and multiple customers with mobile devices.

So, I'd say that every indication is that it's a huge growth driver for us. Timing for initial ramp, I think we're still going to remain quiet on that until it actually starts happening. So one, the tidbit that we wanted to leave you with this time was we're actually shipping revenue units and are very comfortable with the progress that we've made and the milestones that we've achieved.

Well, just to follow up very briefly on that. You mentioned you were seeing shipments, does that indicate that the ramp is beginning, or are we still kind of sampling or qualification type situation?

This is more completion of the qualification and getting to the point where all of the bugs are worked out. But we are very comfortable with where we are, and we still need to have a few more success points along the road to get to the meaningful revenue.

Sounds fairly meaningful, indeed. Thanks.

Thank you.

Rod Hall, JPMorgan.

Yes, hey guys, thanks for taking the question. I wanted to come back to the data center supply situation and to see if you guys could walk us through where the supply constraints still exist, how much longer you expect them to go, that sort of thing. We continue to hear the short range optics in particular, I guess the P28s are in short supply.

So I'd just like to confirm that is the case and when do you guys think that you can meet the supply constraints. And if you could just maybe broaden that out and talk a little bit more about where else you are supply constrained. And then I also wanted to come back to this ROADM question.

What I guess I don't fully -- and you are saying that you expect the blade ROADMs to ramp back up. Can you give us any idea on visibility there? Do you have visibility on timing? Do you expect meaningful ramp in fiscal Q3, or you just don't know? Any color that you can give us on what the disability looks like for those blade runs would be helpful.

Sure. The data center supply as I said in the prepared remarks, we focused our capacity on satisfying the 10 kilometer products mostly for the manufacturers and didn't meet the demands of the hyperscale customers that we had orders for but did not satisfy.

So I'd say that as we continue to bring on more and more capacity, we will start shifting that capacity to the hyperscale guys, and that's going to start really in a meaningful way this quarter and next. Where else do we see supply constraints? As I indicated 980 pumps are on serious constraint.

And the point I tried to make and maybe didn't come across in the prepared remarks was, that the first thing that people need to do to light up new fiber is to buy pumps or amplifiers, and those things go in as a leading indicator that new networks are being deployed. So as long as 980 pumps continue to be constrained, I am very encouraged with our opportunity to grow. Visibility on WSS ROADMs, I think it's hit and miss. As far as the blades are concerned, I think that's a matter of when do the large North America carriers release their budgets and when do they take on more cities; and so, right now we're seeing that a couple of new cities are being deployed and we're being expedited for some of these ROADM blades.

But I will say, that my confidence in visibility in WSS modules in China is pretty clear. I'm very confident that we will see continued growth in China on the individual WSS modules.

On your hyperscale comment could you just clarify, do you expect to be able to supply what they are demanding by, let's say, the end of fiscal Q3? Or do you think -- can you give us any idea when hyperscale can get what they want from an optics point of view?

Yes. Well, we have orders today that we are not satisfying this quarter on hyperscale.

When do you expect to be able to meet demand for hyperscale? Is that next quarter, or is it two or three quarters from now?

It could depend upon how many new orders come in and this quarter as well, Rod. And also, a couple of months ago we did launch a significant capacity in the form of assembly and test equipment. That's not online just yet.

Typically takes about six months to get capacity online. So we're hopeful that maybe by the June quarter it could be a little bit better, but it depends upon what new business comes in as well.

Yes, and I think the other point is that's important is a lot of hyperscale data centers are being deployed with 40 gig. Our exposure to that market is very, very small. So as they transition to 100 gig I think we're going to continue to be in a constrained environment through this calendar year assuming that transition happens as I project going forward.

Okay. Thank you very much.

Meta Marshall, Morgan Stanley.

Hello. Thanks for the question. A couple. I think you just addressed it in the answer to the last question. But, an update on ACO timing, because I know that you have been testing coming out of last year and that you were hoping to start production this year.

Is that still kind of a Q2 event? And then the second question I had is just back to the ROADM question. Mentioning that, you know, deployments you don't know what cities and some of the reason for it potentially being kind of down next quarter.

But I just wanted to make sure, is that is due to any kind of share shift between a competitor getting qualified and some new cities going to a competitor, or is there something we feel like all cities are going to you? Thanks.

Okay let me answer that ROADM question first. I don't think that ROADM blades will be down this quarter. I think we are projecting them to be flat with last quarter. But last quarter they were down from Q1. As far as share shifting, I don't see any share shifting going on.

I think we still have 99% if not 100% of those blade deployments going on in cities. And so, I'm pretty confident that we put the inventory in the BMI hubs and it's there when the customers need it, they are going to continue to pull from us. And so far so good in the deployments and the quality aspects of turning up those new cities.

So very happy with that; it will be there for when our customers deploy more and more cities. And as far as the CFE2 ACO timing is concerned, I guess just an update on that, we made continued progress. We are now to the point where we believe we have our final configuration of product that we are going to take into production.

We are shipping samples of that product -- final qualification samples of that product and expect as we get through our internal qualification testing that takes thousands of hours, then we will release that product that we have today.

And so we have made a tremendous amount of progress on that. I would say that there is not meaningful revenue in this quarter and hoping to have some revenue in the fourth quarter but really taking off more in the second half of the calendar year.

Great, thanks for the clarification.

Joseph Wolf, Barclays.

Thanks, I wanted to go back to a couple of questions from the competitive angle. Just on a hyperscale comments you made two comments. One is that 100G you can't fulfill, because you are fulfilling telecom. And then you mentioned a little bit about 40G.

And I'm just wondering if there are contractual issues? You mentioned ASPs. But I'm just trying to get a better sense on how the customers are reacting to not getting their product. Or is that comment on 40G basically saying they are ordering but they don't need to deploy just yet? And what does the competitive landscape look like? And then I have a follow up.

Yes, so, I would say that if you look back in time, we had a pretty big customer for our 40 gig, 2 kilometer product in the hyperscale space but became uncompetitive because we weren't totally vertically integrated with that. So that's around my comment on the 40 gig. You don't really have much 40 gig, 2 kilometer business any longer.

And my point is as those hyperscale data centers transition from 40 gig to 100 gig, it's going to be a loss for the guys that are providing a lot of the 40 gig, and it's going to be 100% gain for us for anything we can supply at 100 gig. And just to be clear, that the 100 gig products that we shipped last quarter or the primary part of our growth was in the network equipment manufacturers, and it is really the client side of the telecom network, but really it's a Datacom product that's 10 kilometres. So, on the competitive landscape, on those 10 kilometer products there's fewer competitors. It's us. It's Finesar. It's Oclaro. Pricing' s better. ASPs are significantly higher than within the hyperscale data center.

Costs are much lower in the hyperscale data center, but its still uses that same capacity. So, there are more competitors in the hyperscale. Not all of them are delivering, but a lot of them are quoting. And that creates an environment where the ASPs are significantly below the 10 kilometer part.

Okay. Thanks for that. And then, just back on the [wind] for the gesture, the 3-D sensing opportunity, it sounds like there's a couple of those out there. You mentioned a couple of handset vendors where you could see opportunities. But a bunch of other companies are saying the same thing.

And I'm just wondering the competitive landscape, is it for the application? Are you running into people-- are you running into competitors head to head? With everybody spending on this end market, what's the Lumentum competitive advantage? And do you have a specific application where you think you are ahead versus a couple, or is everybody going after the same application?

Well, I'm not going to talk about handset or handset suppliers. What I said with mobile device manufacturers, and you can imply what you can from that. I would say that Lumentum's competitive advantage is that we have been in the consumer electronics space shipping 3-D sensing products for the last eight years.

We have figured out how to make sure we design a product and test it accordingly to make sure we don't have any defective parts. So, I would say that we are the only one in the world that has a track record of understanding 3-D sensing and the reliability requirements associated with that.

So, on the other side, there's enough demand for more than one supplier per application. And I would say, in fact there's probably a need for more than one supplier per application just because of the sheer volume of these devices. And so I'm not disappointed that we're competing.

We think we're in a good position with our products, our technology, and our infrastructure to be able to support our customers now and in the future.

Okay. Thank you.

Sure.

Jorge Rivas, Craig Hallum.

Thank you for taking my question. First, just a housekeeping question. I'm not sure if you mentioned how much revenues from fiber lasers were in the quarter.

Fiber lasers were about $10.6 million or so, about $11 million.

And then, I hear in the commentary that you are confident that calendar 2017 is going to be a strong year in China. I wonder if you can provide some color as to what gives you that confidence. I understand that you are seeing strong orders from pump lasers. But any additional color that you can provide us to what's giving you that confidence and at the same time, do you expect that in China specifically to be a backend loaded calendar year? Or are you expecting more consistent demand throughout the quarters in calendar 2017?

Yes, I think my confidence in China is really based on two things. One is, the discussions we have with our customers and with the carriers and what their plans are. But more importantly, their commitment to deploy ROADMs puts us in a unique position compared to our competitors.

I think as they deploy ROADMs, there will be a lot of them. And they are buying a lot of them from us. So I think, different and apart from some of our other competitors who don't have ROADMs, I think we are going to grow from zero ROADMs in China to a lot of ROADMs in China.

That's one of my reasons for the belief. And I do think not to underestimate that we can't seem to satisfy the pump lasers in China, you don't light up fiber with amplifiers unless you're going to put stuff on the ends of them without putting ROADMs and other 100 gig transponders and modems into the network.

So, this quarter or next quarter, it's still not clear to me. But the last weeks have been a little bit quiet period given Chinese New Year. I'll be going back to China in a couple of weeks and getting more G2. And I think we've incorporated what we know into our Q3 guidance, and I'll learn more in a couple of weeks when I come back from my visit.

Thank you. And just one more follow up, if I can. So the [plumbing] in ROADMs in China, do you have the space to be the majority of these ROADMs of your next generation [thruflakes] or any idea what you're looking at right now?

Yes, I think that we're extremely well-positioned not only with this generation of twin 1 x 20, twin 1 x 9, but we are also coming out with next-generation edge ROADMs that are very, very competitive as well, is even higher port count ROADMs that we are working with our customers with. So I'm really confident and pleased with our progress and the share that we expect to get, and I think the share that we are getting today on those ROADMs. So, pretty happy with that.

Thank you very much. That's all for me.

Thank you.

Troy Jenson, Piper Jaffray.

Thanks for sneaking me in here. Just a quick follow-up on China, and then I've got another one. On the ROADMs into China, Alan, can you confirm that it's all going to China telco right now? When do you think China mobile will start?

I think that there's China telecom is probably furthest along, but I would say that the ROADMs we are shipping today, are for more than that, whether that would be in additional trials or field deployments.

It's not just totally clear to me, and I will get more clarity when I'm there next time. But I think that it's a broad deployment strategy, and I'm pretty confident that it will be more than just China telecom this calendar year.

And one last question, just on the sensing market. Is Heptagon a customer or partner of yours for the 3-D sensing in that smart phone market?

Troy, we like to not comment on our customers in the 3-D sensing market.

Are they a partner? I just I think the end customer would be somewhat different, but this would be a module maker.

We are very familiar with them and have done business with them in the past.

Okay. Understood. Thank you, guys. Keep up the good work.

Thank you, Troy.

Michael Genovese, MKM Partners

Thanks a lot. So, it sounds like sequentially we're expecting in the current quarter, optical to be down, both telecom and Datacom. And I just wanted to ask, do you think that units, are we having seasonality in units and would that be on both telecom and Datacom? Or is that more a function of pricing with the annual price declines for the reasons for the sequentially down revenue?

So, I would say in Datacom, 100 gig datacom, we're going to see sequential unit growth. And, that will probably be offset by continued declines in slower speed stuff. And the ASPs will be lower as a result of more of our units and more of our capacity being shipped into the hyperscale data center. I would say the telecom business, 5% ASP reduction, we are probably going to get less than that from a unit growth. But a lot of it has to do with mix as well. As Aaron indicated, we are expecting to see a little bit down in submarines. We are going to continue to see increases in pump lasers, and then, ROADMs I would say our expectations are pretty much flat quarter-to-quarter.

Okay. And just last follow-up here. You know, you mentioned that a year ago there wasn't as much seasonality. Was that comment primarily directed at Chinese demand saying that there would be more seasonality this year or is that a more across the board comment versus a year ago timeframe?

Yes, so, two things. One, it was probably November of 2015 when China turned on. So, anything that you could shift or anything that you could put in place to satisfy demand, even through the Chinese New Year, was being consumed.

The other thing, and when you do a comparison of our Q3 to Q3, last Q3 was a 14 week quarter. But I'd say that the seasonality portion of it was just the fact that it was the front end of China going crazy with deployments, and it's more balanced between supply and demand.

Okay. Thanks a lot.

Dave Kang, B Riley.

Thank you. Good afternoon. First, on 3-D sensing, could you just talk about the capacity situation, what is it now and where you plan to be late this year, late calendar 2017?

The simple answer is no. But, maybe some color around that. We are partnering with some foundries that are making some of the investment. We're making some of the investment, and we're working with our customers to ensure that we bring that capacity online when they need it.

So it's the dynamic -- it's a dynamic decision-making process that really we would prefer to stay away from. As Aaron talked about it in the script, some of the capacity adds that we had last quarter are going specifically to 3-D sensing. So we are seeing more meaningful deployments of CapEx for us internally as well.

Right. But then I guess your challenge is some of your equipment, front end equipment, has very long lead times so that will be sort of a challenge as far as that time the turn up, right?

Yes, we have ample capacity allocated to us for all of the growing [FE]. So that to me right now is already installed. It's not an issue for hitting the peak levels. So, those super long lead time items are all ready taken care.

Got it. That's helpful.

We're talking more about backend testers and the ability to test what we need to test at the backend. So those lead times for those tools are much shorter.

Sure. And then have you -- or maybe your customers, I don't know who's going to decide. But regarding you will be supplying [bear dyes or orthosis]? Any color on that situation? And of course, the gross margins with each particular product.

Yes, it really depends upon the customer and what they want to do. I would say, that probably the main driver for the first generation of stuff we are working on the mobile applications is at the bear tested dye level.

So you won't be needing a package or anything like that?

No. And then from a gross margin perspective, one would expect that at the bear dye level you would see higher margins than you would see at a packaged level or at an optical component level.

Sure. And then just, I guess to ask questions on the China ROADM situation, do you know whether it's a CD or a CDC, and what is the dollar content difference between CD and CDC? Is it just MCS? What's the ASP of MCS? And then just follow up for Aaron, what is your CapEx budget for this fiscal year? That's it for me.

CapEx budgets we have been spending 10% of revenue on CapEx. And as we continue to spend money and prepare for 3-D sensing ramp, I think 10% is probably where we would be at for the foreseeable future.

And then as far CD versus CDC, they're both getting deployed. And we think we're very well positioned for both network architectures. And then we have a multicast switch that meets the needs of the CDC networks and depending on where you buy if you buy at a module level or blade level, the MCS can be similar in price to a ROADM or ROADM blade.

And that's the main difference between CD and CDC whether MCS is included or not?

Yes. Pretty much. I mean, there are some architectural issues but from our perspective it means we sell MCSs and probably more ROADMs.

Got it. Thank you.

Thanks, Dave.

This concludes the question-and-answer session. I would like to turn the conference back over to Alan Lowe, President and Chief Executive Officer for closing remarks.

Thank you, operator. I want to thank our customers for their business and our employees for all of their hard work in growing our business, putting us in an excellent position in the market. I believe we are in a world wide bandwidth expansion, and photonics are increasingly becoming critical to manufacturing and next-generation high-volume 3-D sensing applications making the future bright at Lumentum. We regularly discuss our business at investor relations events. These events are listed on our website in the investor relations section and are regularly updated. This concludes our call for today. We would like to thank everyone for attending.

We look forward to speaking with you again in another three months. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.