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

For its fiscal second-quarter (to 29 December 2018), optical and photonic optical component and subsystem maker Lumentum Holdings Inc of Milpitas, CA, USA has reported revenue of $373.7m, down 7.6% on $404.6m a year ago but up 5.5% on $354.1m last quarter. However, results include $29.6m from 20 days of revenue from Oclaro Inc of San Jose, CA, USA (which provides components, modules and subsystems for optical communications) since the closing of its acquisition on 10 December (after receiving anti-trust approval from China, and nearly nine months after announcing the acquisition). Excluding Oclaro, revenue was within the revised guidance range of $335-355m given on 12 November (albeit below the original guidance of $405-430m given on 1 November).

Optical Communications segment revenue was $325.4m (87.1% of total revenue), up 4.9% on $310.1m last quarter but down 9.6% on $360.1m a year ago. Of this:

Telecom revenue was $172.5m, up 21% on $142.9m last quarter and 57% on $110.2m a year ago, driven primarily by strong growth in ROADMs (up 29% quarter-on-quarter and 110% year-on-year) plus the 20 days of contribution from Oclaro’s telecom product lines. “Strength in demand and manufacturing capacity expansions drove ROADM and fiber lasers to new record levels,” notes president & CEO Alan Lowe. “Our investments in new and differentiated products continue to drive growth in our telecom and lasers product lines.”
Datacom revenue was $33.4m, down 2% on $34.2m last quarter (it had been expected to be down 20-30%, but that was offset by the acquired Oclaro datacom revenue). “We continue to be selective in our sales of transceivers in this margin-challenged product area while we develop our lower-cost 100G and next-generation 400G products,” says Lowe.
Industrial & Consumer revenue was $119.5m, down 9.8% on $133m last quarter and 45% on $215.5m a year ago, driven by softer demand for 3D sensing lasers. On 12 November, Lumentum had announced “a request from one of our largest Industrial & Consumer customers for laser diodes for 3D sensing to materially reduce shipments to them” (Apple contributed 30% of Lumentum’s total revenue in fiscal full-year 2018).

Commercial Laser segment revenue was $48.3m (12.9% of total revenue), up 9.8% on $44m last quarter (whereas it had been expected to be flat), driven by growth in fiber-laser sales. “We benefited from capacity expansion and further ramped volumes of our newest fiber-laser products to meet strong customer demand,” says Lowe. “We again achieved record revenue from our kilowatt-class fiber lasers, which grew 12% sequentially and 133% relative to the prior year.”

On a non-GAAP basis, gross margin has fallen further, from 44.9% a year ago and 40.3% last quarter to 40.1%, due mainly to the product mix (as well as some dilution from Oclaro, which had been running below 40%). Specifically, Optical Communications gross margin has fallen from 45% a year ago and 40.3% last quarter to 39.7%, due to the lower Industrial & Consumer revenue (3D sensing lasers) in the mix. Commercial Lasers gross margin was 42.7%, down from 44.7% a year ago but up from 40.2% last quarter due to higher volumes and product cost reductions.

Operating expenses have risen from $57.9m (16.4% of revenue) last quarter to $67.5m (18.1% of revenue). However, the R&D expenses of $39.3m included not only increased investment in new product development but also the added R&D expense from Oclaro.

Operating margin has fallen further, from 28.3% a year ago and 23.9% last quarter to 22% (well below the expected 28-30%), again due to the faltering 3D sensing laser sales.

Likewise, net income has fallen further, from $107.8m ($1.67 per diluted share) and $85.8m ($1.31 per diluted share) last quarter to $78.3m ($1.15 per diluted share, below the expected $1.60-1.75).

The cash portion of the Oclaro acquisition was $964.8m, funded by a new term loan of $500m plus the combined company’s balance sheets, which at the end of the December quarter totaled about $1.1bn. After paying the $964.8m plus more than $50m in acquisition-related fees, Lumentum’s cash and short-term investments fell by only $50.2m during the quarter, from $734.3m to $684.1m, due to its strong cash generation.

“The closing of the Oclaro acquisition in December gives us a first-mover advantage in a consolidating industry and establishes leadership positions based on fundamental photonic chip capabilities across a broad range of products and technologies to address the growing communications, industrial and consumer markets,” reckons Lowe. “With the closing of the acquisition, we now have chip sales in the datacom and 5G markets, which we expect we will continue to grow,” he adds.

“Demand from our customers for our telecom products is very strong and is spread across a broad customer and geographical base,” says Lowe. “Strength in Telecom demand is expected to continue in the third quarter, counter to historical seasonality,” he adds. “We continue to add ROADM capacity, but demand will outstrip our ability to supply throughout the third quarter.”

For fiscal third-quarter 2019 (including Oclaro for the full quarter), Lumentum expects revenue to rebound to $420-440m. However, operating margin will fall to 16-18% and diluted earnings per share to $0.76-0.94.

Specifically, Commercial Lasers segment revenue will rise, due mainly to new product growth. In the Optical Communications segment, Telecom revenue will rise, driven by continued market growth plus a full quarter of the Oclaro acquisition. Datacom revenue will also rise (significantly, to $50-55m), but this will only be due to the full quarter of the acquisition – compared to combined company historic levels, Datacom revenue will decline. Industrial & Consumer revenue will fall due to consumer electronics customer seasonality (meanwhile, the firm is still taking a conservative approach to 3D sensing laser revenue).

“The market for laser-based sensing is still in its infancy,” notes Lowe. “We continue to make excellent progress with additional Android customers and additional new design wins. During the second half of calendar 2018, additional customers announced or started shipping high-end 3D sensing enabled devices. During calendar 2019, based on customer engagements we have today, we expect new and existing customers will announce and release additional new 3D sensing enabled products. Several of these opportunities are expected to bring new functionality that could expand our content per device, including world-facing capabilities. We believe these new customer products are the first step to broad incorporation of 3D sensing in lower-priced, higher-volume devices in the years to come,” he adds. “The market opportunity over the long run is tremendous, as the applications that use our lasers enhance security, safety and new functionality in the billions of electronic devices that people rely on every day. The seeds for this long-term market opportunity continue to be planted.”

“We are making healthy investments in new laser product development and production capacity, targeting higher-growth material processing applications in calendar 2019, and over the long run we have good opportunities for growth, driven by new product design wins in addition to market growth,” reckons Lowe.

Synergies from the Oclaro acquisition should be in excess of $60m per year, within 12-24 months from the close of the transaction. “To date, we estimate that we have achieved more than $10m in annual expense synergies,” says interim chief financial officer Chris Coldren. “We expect modest level of new synergies to be obtained in the third quarter and then we expect synergy attainment will accelerate in the fourth quarter and into fiscal year 2020. Work done since the closing of the transaction gives us confidence in our ability to meet or exceed our expense reduction target,” he adds. “We are going through the product rationalization as well as fab utilization optimization and we'll be talking to our customers later this quarter and putting in place the actions to drive to the lowest-cost product or the highest-margin product, where appropriate, where there is overlap. But the overlap is pretty minimal and we expect to drive those to conclusion throughout this calendar year.”

Such product rationalization could eliminate over $50m of revenue through paring of product lines, concedes Coldren. However, “Expense synergies did not include any increased revenue or profit due to new product differentiation or product roadmap acceleration resulting from the combined company’s innovation engine [aiming for this to more than offset the loss of revenue to product paring]. However, we believe over the long run, it is these types of synergies that will create the most long-term value and underpins our strategic rationale for the transaction.”

See related items:

Lumentum completes Oclaro acquisition

Lumentum reduces December-quarter revenue, operating margin and earnings guidance

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

Lumentum’s seasonal decline in 3D sensing revenue offset by growth in Telecom, Datacom and Commercial Laser products

Lumentum’s record quarterly revenue driven by VCSEL array ramp for 3D sensing in consumer mobile applications

Tags: Optical communications

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