19 August 2020
Lumentum’s revenue falls a less-than-expected 9% in June quarter
For full-year fiscal 2020 (ended 27 June), Lumentum Holdings Inc of San Jose, CA, USA (which designs and makes photonics products for optical networks and lasers for industrial and consumer markets) has reported record revenue of $1678.6m, up 7.2% on fiscal 2019’s $1565.3m (including revenue from the acquisition of San Jose-based optical communications component and module maker Oclaro Inc from 10 December 2018). The growth is despite the impact of product-line exits and divestitures and, more recently, COVID-19 and geopolitical headwinds, namely:
- China’s Huawei Technologies falling from $238m (15.2% of revenue) to $221m (13.2% of revenue) after the US Department of Commerce’s Bureau of Industry and Security (BIS) on 16 May added Huawei to its ‘Entity List’, requiring a license for products covered by the Export Administration Regulations (EAR);
- a $100m impact in second-half fiscal 2020 from the COVID-19 pandemic;
- a drop of $90m (to $62m) in revenue from discontinuing low-margin product lines, including:
- in April 2019 divesting the datacom transceiver module business (manufactured by subsidiary Oclaro Japan Inc) to Shanghai-based Cambridge Industries Group (CIG) in exchange for a long-term strategic supply agreement for Lumentum’s photonic chips;
- in December 2019 divesting the lithium niobate (LiNbO3)-based optical component wafer fab in San Donato, Italy to China-based passive optical component provider Advanced Fiber Resources (Zhuhai) Ltd (AFR).
“Fiscal 2020 was a record year for revenue, margins and earnings… driven by a product mix rich in differentiated high-margin products and the attainment of significant acquisition synergies,” says president & CEO Alan Lowe.
Optical Communications segment revenue grew by 10.6% from $1370m to $1515m, driven by growth in vertical-cavity surface-emitting lasers (VCSELs) for 3D sensing, plus Datacom chips and Telecom transmission, and the contribution of the Oclaro acquisition.
Commercial Laser segment revenue fell by 16.2% from $195.1m to $163.5m, with the impact of COVID-19 strongly exacerbating an already slow lasers market.
Fiscal fourth-quarter 2020 revenue was $368.1m, down 8.6% on $402.8m last quarter and 9% on $404.6m a year ago (with sales to China’s Huawei declining further, by 6% sequentially to about $45m, following a 20% decline to $48m in fiscal Q3 from fiscal Q2’s $60m, having been $80m a year ago). However, Lumentum’s fiscal Q4 revenue was above the $325–365m guidance after the impact of COVID-19 was less than the $90m expected due to strengthening in 3D sensing and lasers.
Commercial Lasers segment revenue was $37.8m (10.3% of total revenue), down 13.1% on $43.5m last quarter and 20.9% on $47.8m a year ago, due to lower fiber-laser sales (driven by the macro-economic slowdown). However, this was a smaller decline than expected due to strong sales of solid-state lasers into the semiconductor processing end-market.
Optical Communications segment revenue was $330.3m (89.7% of total revenue), down 8.1% on $359.3m last quarter (due primarily to 3D sensing seasonality) and down 7.4% on $356.8m a year ago (due to lower Telecom & Datacom revenue through exiting the Datacom module business). Of this:
- Telecom & Datacom revenue was $256.4m, down 4.8% on $269.2m a year ago after being impacted by COVID-19. However, this was a 2% rebound from $251m last quarter, as production exited fiscal Q4 above pre-pandemic levels. Demand was very strong especially in datacom chips, coherent components and modules, and high-end reconfigurable optical add/drop multiplexer (ROADMs), but supply constraints for these products limited revenue. Specifically:
- Telecom transmission was the most impacted by COVID-19 supply challenges and, as a result, declined a few million dollars sequentially, however new high-baud-rate components and DCO (digital coherent optics) modules are ramping up;
- Telecom transport grew sequentially due to strong pump-laser sales and increased sales of wavelength-management and ROADM products, with next-generation contentionless MxN and high-port-count ROADMs ramping up;
- Datacom revenue growth continued, driven by strong sales of chips ($50m, surpassing 95% of Datacom revenue) although growth is still limited by wafer fab capacity (with Datacom chip backlog rising to nearly $150m).
- Industrial & Consumer revenue was $73.9m, down 31.8% on $108.3m last quarter and 15.6% on $87.6m a year ago due to normal seasonality plus the timing of new customer programs. However, this exceeded the guidance (of a sequential decline of more than 40%) due to stronger-than-expected demand. The firm is also ramping shipments of next-generation chips for contactless biometric authentication, computation photography, and light detection & ranging (LiDAR).
“Through the quarter, we saw some of the supply limitations free up. For instance, our contract manufacturer in Malaysia is now back to full speed,” says Lowe. “We've added capacity. They've added people. So we're running at full speed there,” he adds.
“Strong market demand and solid execution drove better-than-projected results across all financial metrics in our fourth quarter, especially gross margin and EPS,” notes Lowe.
Despite COVID-19 impacting revenue, quarterly non-GAAP gross margin has risen further, from 38.9% a year ago and 45.5% last quarter to 47.2% (only just below the record 47.4% of fiscal Q2/2020). By segment, Commercial Lasers gross margin rose further, from 43.5% a year ago and 49.7% last quarter to 52.9%, due to a better product mix and lower manufacturing costs. Optical Communications gross margin was 46.6%, up from 45% last quarter and 38.3% a year ago (due to higher acquisition synergies and a better product mix within Telecom & Datacom sectors). Specifically, data-center chip product mix is improving through higher speeds, PAM4 (4-level pulse amplitude modulation) and 5G designs.
Full-year fiscal 2020 gross margin hence rose from 2019’s 39.5% to 2020’s 46.5% (with each quarter above 45%).
Full-year operating expenses increased from $297.9m (19% of revenue) in fiscal 2019 to $333.4m (20% of revenue) in fiscal 2020, reflecting the full year of incremental acquisition expenses and an increase in R&D investments in new technology and customer programs. Quarterly operating expenses were $82.5m (22.4% of revenue) in fiscal Q4, roughly level with $82.7m (20.5% of revenue) in fiscal Q3, a little lower than normal run rates due to COVID-19 reducing travel to trade shows etc. Specifically, selling, general & administrative (SG&A) expense was $36.6m (down from $38.4m last quarter). In contrast, R&D expense was $45.9m (up from $44.3m last quarter).
“We have been simultaneously attaining R&D-related acquisition synergies and cutting investments in under-performing product lines, while ramping investments in areas with stronger outlooks and returns,” notes chief financial officer Wajid Ali.
Quarterly operating income was $91.4m (operating margin of 24.8% of revenue), down from $100.7m (25% margin) last quarter but up from $76.7m (19% margin) a year ago (and above the expected 18-21%), driven by gross margin improvement. Full-year operating income rose from $320.6m (20.5% margin) in fiscal 2019 to $446.8m (26.6% margin) in fiscal 2020.
Likewise, net income for fiscal Q4/2020 was $91.7m ($1.18 per diluted share), down from $98m ($1.26 per diluted share) in fiscal Q3 but up on $70.4m ($0.91 per diluted share) a year ago (and much better than the projected $0.70–0.90 per diluted share). Full-year net income rose from fiscal 2019’s $305.4m ($4.25 per diluted share) to $420.5m ($5.42 per diluted share) for fiscal 2020.
During fiscal Q4, total cash, cash equivalents and short-term investments rose by $102.4m, from $1451.4m to $1553.8m. The firm has $1.5bn in aggregate principal convertible notes and no term debt. Of these convertible notes, $450m is due in 2024 and $1.05bn is due in 2026. The associated total cash interest expense is about $6m per year. “We are well-positioned financially with a strong margin model, high levels of cash with low interest expense, and long maturity financing,” reckons Ali.
“We head into fiscal 2021 with demand increasingly driven by new products and technologies, strengthened market positions, and an improving financial model with accruing benefits from acquisition synergies,” says Lowe.
For fiscal first-quarter 2021 (to end-September), Lumentum expects revenue to rise to $430-455m, despite sales to Huawei declining further. “For products that they can get from other non-US suppliers, I think they have generally moved away from us. What remains in our revenue are products where we are the only guy or the other supplier is another US-based supplier,” says senior VP, strategy & corporate development Chris Coldren. “While most of the products we supply are indispensable to Huawei and we don’t have visibility to any sharp demand reduction, given the current geopolitical uncertainty, we are taking a cautious approach to Huawei in our outlook,” says Lowe. “We have lots of other customers for those products and we’re capacity constrained on most of them,” continues Coldren. “Therefore, even if we were to see a limitation coming from Huawei from a demand standpoint, we should be able to redirect that to other customers.”
Commercial Lasers segment revenue is expected to fall by 25% due to end-market demand being impacted by the global slowdown in industrial production). Lasers revenue is expected to decline further over the next two quarters, since the second half of the calendar year is seasonally softer for the firm’s solid-state lasers.
In the Optical Communications segment, Telecom & Datacom sales should be the highest in more than a year due to strong demand and recovery from COVID-19 supply constraints (despite revenue from a discontinued product line falling by $4-5m from fiscal Q4/2020’s $7m). “We are increasing production capacity in our fabs and our back-end assembly & test facilities,” says Lowe. “As additional capacity and new production staff have been coming online, we have been increasing our wafer starts to satisfy our very strong company backlog.”
Industrial & Consumer sales should be up strongly due to the seasonal consumer electronics product cycle, and because Lumentum is already shipping high volumes of new products for future customer product launches. The new product shipments include Lumentum’s latest chips for user-facing and world-facing 3D sensing applications. This seasonal ramp started only late last year, so fiscal Q2 shipments should be higher than fiscal Q1’s shipments (unlike last year). “While we continue to make very good progress on new Android opportunities, we are taking a conservative approach to Android revenue in our first-quarter projections due to COVID-19 and geopolitical factors,” notes Lowe.
Fiscal Q1/2021 operating margin is expected to rise to 28-30%. Diluted earnings per share should increase to $1.40-1.55.
“Based on our view of the long-term opportunities ahead of us, we are strongly investing in R&D to further accelerate our leadership positions and enter new markets that benefit from our capabilities,” says Lowe. “Additionally, notable manufacturing capacity increases include the following major three investments: (1) doubling of our indium phosphide wafer fab capacity over the next 18 months, as we believe the performance and capabilities provided by our InP laser chips and photonic integrated circuits (PICs) will be central to every telecom and datacom communication network, and, perhaps over time, increasingly in 3D sensing and LiDAR applications; (2) expanding gallium arsenide device production capacity for our 3D sensing, automotive, industrial laser and telecom & datacom products as applications for these products are expanding rapidly; and (3) expanding capacity for next-generation, high-port-count and MxN ROADMs as customers globally are designing their new networks based on these technologies,” continues Lowe.
“We’d like to keep CapEx at a rate that hovers around depreciation [which was $113.3m in fiscal 2021],” says Ali. “In fiscal 2020 [for which depreciation was $102.9m], we were a little bit lower than that.” For full-year fiscal 2021, Lumentum is therefore aiming for CapEx to rise by 20-25% year-on-year to $100-110m. “We’re putting that CapEx investment around products that have higher gross margins, and where we see a lot of backlog and a lot of customer demand [i.e. Datacom chips and telecom transmission],” says Ali. “We are either the major supplier or the number one and only supplier for those products.”
At Lumentum’s existing production capacity run rate of $50m per quarter for Datacom chips, the firm’s $150m order backlog equates to three quarters. But the plans to double InP production capacity over the next 18 months mean that, six quarters from now, it could be shipping $100m of Datacom chips per quarter. “We’re working to try to overcome and increase yields, increase productivity and get more out of the assets we have, while at the same time increasing our capabilities in our fab,” says Lowe.
“Our balance sheet is healthy with ample cash to fund further organic and inorganic growth,” he concludes.
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