Lumentum quarterly revenue hit by Huawei ban, but telecom growth driven by ROADMs and coherent transmission modules

For its full-year fiscal 2019 (to 29 June), optical and photonic optical component and subsystem maker Lumentum Holdings Inc of Milpitas, CA, USA has reported record revenue of $1565.3m, up 25.5% on fiscal 2018’s $1247.7m.

By segment, Commercial Laser revenue grew by 3.5% from $188.5m to a record $195.1m, driven by fiber-laser sales almost doubling (aided by “unique” new products), counteracting the down market.

Optical Communications revenue grew by 29.4% from $1059.2m to $1370.2m, driven by 65% growth for Telecom products (including transport revenue rising by nearly 50%) and output more than doubling for reconfigurable optical add/drop multiplexers (ROADMs), boosted by the acquisition on 10 December 2018 of optical communications component and module maker Oclaro Inc of San Jose, CA, USA.

However, after the US Department of Commerce’s Bureau of Industry and Security (BIS) added Huawei Technologies Co Ltd and 68 of its affiliates to its ‘Entity List’ prohibiting the sale to Huawei of products covered by the Export Administration Regulations (EAR) without obtaining an appropriate export license, on 20 May Lumentum ceased shipping to Huawei. “Subsequently, we completed a detailed analysis of the products we supply to Huawei and determined that certain products were not subject to Export Administration Regulations,” notes president & CEO Alan Lowe.

Fiscal fourth-quarter 2019 revenue was correspondingly up year-on-year by 34.4% from $301.1m to $404.6m but down 6.5% on $432.9m last quarter due to an expected decline for Commercial Lasers as well as sales to Huawei falling by 25%, i.e. about $20m (primarily impacting telecoms) although that was better than the $30m+ drop initially feared (before resuming non-EAR shipments to Huawei late in the quarter after applying new business processes to ensure compliance with government requirements on an ongoing basis). Revenue was also better than mid-May’s reduced guidance of $375-390m (and almost reaching the original guidance of $405-425m).

Commercial Laser segment revenue was $47.8m (11.8% of total revenue), down 13.1% on $55m last quarter and 14.9% on $56.2m a year ago, as expected due to customer inventory levels.

Optical Communications segment revenue was $356.8m (88.2% of total revenue), up 45.7% on $244.9m a year ago but down 5.6% on $377.9m last quarter. Of this:

Telecom revenue was $227.7m, up 71% on $133.1m a year ago but down 6% on $243.4m last quarter due to the lower Huawei sales, despite revenue from coherent transmission modules rising by 10% (with sales of both ACO and DCO products growing). ROADM sales were again a record, exceeding $100m (despite geopolitical disruption), although growth was less than originally expected prior to the Huawei export ban in mid-May. Lost Huawei ROADM revenue was partially offset by redirecting manufacturing capacity to two other customers (albeit too late in the quarter – a month or so before the end – to have much impact).
Datacom revenue was $41.5m, up 20.3% on $34.5m a year ago but down 28% on $57.3m last quarter. This was driven by the divestiture (early in fiscal Q4) of the firm’s “challenged” Oclaro Japan-based datacom transceiver business. “This was a key milestone in our strategic pivot to focus exclusively on photonic chip sales in the datacom market,” says Lowe. “We have seen strong engagement from customers for datacom photonic chips, including in 5G wireless applications. In many cases, new customer interest is from leading competitors who previously would not purchase from us due to us competing in the transceiver business.” Datacom chip sales hence rose by 11% to a new record level.
Industrial & Consumer revenue has risen by 13% from $77.2m last quarter to $87.6m, due to higher-than-expected revenues for both industrial diode lasers and 3D sensing VCSEL lasers. “In the case of 3D sensing, in the fourth quarter, we started ramping deliveries to support customers’ product cycles expected to start this fall,” notes Lowe.

“The fourth quarter was eventful to say the least, but it capped off a fiscal year during which we made significant progress toward our long-term strategic and financial goals,” says Lowe.

On a non-GAAP basis, full-year fiscal 2019 gross margin rose from 2018’s 38.9% to 2019’s 39.5%, driven by more higher-margin products in the revenue mix, as well as increased leverage over fixed manufacturing costs.

Fourth-quarter gross margin was 38.9%, up from 37.2% a year ago but down slightly from 39% last quarter due to the lower revenue level. By segment, Optical Communications gross margin rose further, from 34.8% a year ago and 38% last quarter to 38.3%, due to the divestiture of the lower-margin datacom transceiver product lines, plus greater Industrial & Consumer sales in the revenue mix. Commercial Lasers gross margin has fallen further, from 47.9% a year ago and 46% last quarter to 43.5%.

Full-year operating expenses have grown from $238.9m in fiscal 2018 to $297.9m in fiscal 2019 (although falling slightly as a proportion of revenue from 19.1% to 19%). However, despite rising from $58.5m (19.4% of revenue) a year ago, quarterly OpEx has been cut from $91.8m (21.2% of revenue) last quarter to $80.7m (19.9% of revenue).

Full-year operating income has grown from $246.2m (19.7% of revenue) in fiscal 2018 to $320.6m (20.5% of revenue) in fiscal 2019 (exceeding 20% for the first time). Quarterly operating income of $76.7m was down slightly from $77m last quarter but up from $53.6m a year ago, while operating margin has risen from 17.8% both a year ago and last quarter to 19% (exceeding mid-May’s reduced guidance of 15.5-17% and within the original guidance range of 18-20%, despite the 7% sequential decline in revenue). From the close of the Oclaro transaction through to the end of fiscal Q4/2019, Lumentum has achieved more than the targeted $60m in (annualized) synergies. “We achieved these synergy levels earlier than we estimated when we announced the transaction by strong execution after the close of the transaction,” says chief financial officer Wajid Ali.

Full-year net income has risen from $247.8m ($3.82 per diluted share) for fiscal 2018 to $304.8m ($4.25 per diluted share) for fiscal 2019. Quarterly net income has risen further, from $61.6m ($0.95 per diluted share) a year ago and $69.9m ($0.91 per diluted share) last quarter to for fiscal Q4/2019’s $70.8m ($0.92 per diluted share, well above mid-May’s reduced guidance of $0.65-0.77, and within the original guidance range of $0.85-1.00). During the quarter, cash and short-term investments hence rose by $71m, from $697.5m to $768.5m.

“With market-leading positions in the growing telecom and 3D sensing markets, a datacom strategy that profitably benefits from growth in cloud and 5G wireless network deployments, a Commercial Lasers business that bucked market trends and grew to record levels, and a more profitable business model driven by the increased scale and synergies from the Oclaro acquisition, we are well positioned for revenue growth and margin expansion in fiscal 2020 and beyond,” believes Lowe.

For fiscal first-quarter 2020 (to end-September), Lumentum expects sales to Huawei to be flat to down sequentially. However, Lumentum’s total revenue should still grow to $435-455m, despite Commercial Lasers falling by 20% on entering the seasonally weaker fall-time period. Datacom revenue will decline due to discontinuing all remaining datacom transceivers and certain low-margin telecom product lines (which collectively contributed $31m in fiscal Q4/2019 and should decline to zero over the next few quarters). Telecom revenue is expected to be flat to slightly up sequentially (driven by strong non-Huawei demand), including continuing growth in ROADMs (mostly from the very high-end ROADMs and ROADM blades, with demand outstripping capacity) and coherent modules (ACOs and DCOs). Industrial & Consumer revenue should rise as the firm enters the seasonally strong time period for 3D sensing.

“We expect unit growth to exceed price declines as 3D sensing is expected to be incorporated in a higher percentage of end-customer models, and supply chain inventory levels appear to be more normalized when compared to last year,” says Lowe. “Taking into account the accelerated fourth-quarter shipments and expectations around global smartphone volumes and our market share, we expect 3D sensing revenue in the first half of fiscal 2020 be slightly up from the first half of fiscal 2019,” he adds.

Due to the stronger mix of 3D sensing, gross margin will rise. OpEx will probably stay within the range of fiscal Q4 (plus or minus a couple of million dollars). Operating margin should hence rise to 22.5-24.5%. Diluted earnings per share is expected to grow to $1.12-1.26.

Telecom customer demand outside of Huawei is strong. “However, this [non-Huawei] demand is for a different mix of products than Huawei purchases from us and for which our supply chain had been driving material. Challenges in obtaining supply of long-lead-time materials is currently the limitation,” says Lowe. “Additionally impacting Telecom is an expected temporary dip in our submarine business, which has historically been a lumpy project-based business,” he adds.

“We now estimate that synergies will be approximately $100m in total, or $40m higher [$10m per quarter] than our original target,” notes Ali. “Additional synergies will primarily benefit cost of goods sold [COGS], as further operating expense synergies are likely to be reinvested in new capabilities and R&D programs to fuel growth and extend our market-leadership positions,” he adds. “We expect to complete the additional synergy actions over the next five quarters, although the bulk of these positive financial impacts will be realized toward the tail end of this time line... These additional COGS synergies should drive average gross margins [up by 2-2.5% alone] to the upper half of the 40-45% gross-margin range of the target model,” concludes Ali.

“During the past year, we believe we have added to or extended our market and technology leadership positions in telecom and 3D sensing. We introduced many highly differentiated new products and one new design win with market-leading customers in all of our markets,” says Lowe.

“Favorable consumer and media reviews for initial world-facing-enabled smartphones has caused customers’ product road maps to more broadly incorporate 3D depth sensing for photography and augmented and virtual reality [AR and VR] applications,” notes Lowe. “Based on customer activity, we expect major smartphone manufacturers to introduce products with new world-facing capabilities in calendar 2020. This, combined with increased customer demand for smartphones driven by future 5G availability, should drive a significant increase in 3D sensing market in calendar 2020 and 2021.”

“The Oclaro acquisition has given us a first-mover advantage in a transforming industry. First, we attained a leading position in telecom transmission based on fundamental indium phosphide (InP) photonic integrated circuit (PIC) technology. This technology will be critical to our customers' ability to scale to higher network bandwidth in the future, including 800Gb/s and, eventually, higher speeds. Second, we re-vectored our datacom business to a significantly more profitable model that is based on a highly differentiated photonic chip capability,” he adds.

“We expanded our datacom market focus to include 5G wireless and other high-volume applications. Finally, we improved our business model by achieving cost synergies on a more accelerated time line than originally estimated and are now increasing our annual synergy target to $100m from our initial $60m target, which we have exceeded. These additional savings will be attained over the next five quarters,” says Lowe.

“Looking further out, based on expected continued strong growth and global network bandwidth and data-center traffic, the needed optical infrastructure for 5G wireless, we believe that telecom market should be strong on a multi-year basis… The strength we have seen in telecom transport over the past year is a leading indicator of future strength and demand for transmission products. We are well-positioned to capitalize on these market trends with our industry-leading telecom transmission and transport products and deep customer relationships,” Lowe believes.

See related items:

Lumentum’s growth in ROADM and fiber-laser capacity outweighs drop in 3D sensing laser revenue

Lumentum selling Oclaro Japan optical transceiver product lines to CIG

Lumentum’s revenue suppressed by faltering 3D sensing laser demand, but telecoms demand outstripping capacity expansion

Lumentum completes Oclaro acquisition

Lumentum’s quarterly revenue rises 45.6% year-on-year to $354.1m, driven by telecom and fiber-laser demand

Lumentum’s annual revenue grows 25% to record $1.25bn, yielding record profit

Tags: Optical communications

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