Lumentum Holdings Inc. (LITE) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Lumentum Fiscal Second Quarter 2017 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [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 of Strategy and Corporate Development. Sir, you may begin.

Thank you, Takkiya [ph]. Welcome to Lumentum’s second quarter fiscal 2017 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 call 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 positions 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 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 fiscal 2017 results is available on our website, www.lumentum.com, under the Investor section and includes additional details about our non-GAAP financial measures and 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 relating 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 product in technology and foster the closest relationship with market leading customers is succeeding. I'm pleased to announce that we have achieved both record revenue and margin once again. Strength in 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. Optical communications revenue grew 8% sequentially and 27% year on year based on continued strength in telecom and datacom markets. Datacom grown was notably strong increasing 54% sequentially and 95% year on year. Despite the increased output for 100G datacom product, our customers wanted more. Both gross 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 photonic technologies to accelerate the speed and scale of cloud, networking, advanced manufacturing and next generation 3D sensing application. The rapid growth in cloud computing, streaming video, mobile and other high bandwidth applications is placing enormous demand on networks in terms of capacity, connectivity 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 3D sensing to enhance capabilities and enable new applications. Lumentum is a leader in the photonic technologies that are critical enablers of all of 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 product. 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 centers operators to increase as we bring more 100G transceiver manufacturing 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 product lines are now less than a million dollars. Second, in the first quarter we added significant capacity for 100G coherent component and we are able to satisfy some pent up customer demand. Second quarter revenue from these coherent components declined from this levels, but we're still up more than 13% compared to two quarters ago. Coming of a strong first quarter, second quarter pump laser and submarine revenues were at record levels based on continued strong demand worldwide. Pump lasers and optical amplifiers they pump are key elements of all network - new network deployment. In addition to lighting new fiber, pump demand is also driven by strong global demand for ROADM, 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 deployment of submarine cables. Demand for ROADN 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 in ROADM despite higher overall ROADM unit volume. This mix shift also freed up pump capacity and it enhanced increased external pump lasers and optical amplifier revenues. Customers buying WSS modules generally need to purchase pump lasers or optical amplifiers to make their own blade. 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 remained 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 often a leading indicator of new network deployment. 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 like new fiber requiring pump lasers and begin large scale deployments of ROADM nose. 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 third quarter, we expect lasers for micro machine to rebound to levels similar to a year ago. We expect modest growth from our second quarter level in our kilowatt fiber lasers. Market forecast for semiconductor capital equipment grow are encouraging as this market drives our micromachining 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 3D sensing customers was approximately flat sequentially. However, we had an exciting development during the second quarter. Well not significant to second quarter revenue or our third quarter guidance, we shipped our first revenue into what we believe could be a high volume mobile device application. We are very encouraged by the progress and key milestones achieved today on this application. We continue to have strong engagement from customers including those in the consumer electronics and automotive markets. We expect 3D 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 customers and the level of interest in 3D sensing was overwhelming. Demand continues to grow for bandwidth and speed across the world’s data centers, communication networks. Hyperscale data centers are starting to transition to 100G and our product portfolio and capacity additions position as well for this transition. Firm-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 3D sensing capabilities for next generation applications. We believe we are well positioned with our new products, customer relationship, design wins 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 result and our guidance for third quarter of fiscal 2017.

Thank you, Allan. 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 from 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 included $400,000 of other expense and 2.7 million of tax expense. Now for some additional detail. 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 $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 laser revenues from normal seasonality, muted 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. Decline in 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 investment in 3D 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 3D sensing application. Our cash balance was $155.9 million at the end of second quarter, a decrease of 10.9 million sequentially and we remained debt free. The decline in cash was a result of elevated capacity expansion and the timing of the AR collections from customers. Now onto our guidance for the third quarter of fiscal 2017. 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. Takkiya [ph] let's begin the question-and-answer session please.

[Operator Instructions] And our first question comes from James Kisner with Jefferies. Your line is now open.

Firstly I just 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 just in datacom, can you talk about the mix of CFP2, QSFP28 and 40-gig within that as well and perhaps also maybe parse out how those different products drove the nearly 50% increase quarter over quarter. Thanks.

The older products are that declined. We're kind of end of life on our 40-gig coherent modules and 100-gig coherent line card. Both of those are coming to end of life and are 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 a growth in our QSFP28 and saw initial revenue shipment of our LR4 QSFP28 but most of the QSFP28 was CWDM4.

I mean just a follow-up on that. Can you try to quantify the impact of the end of life products on a quarter, is a pretty big drop sequentially, I’m just trying to understand how big a factor that was.

So James, probably a couple of million dollars or so on a quarterly basis.

And just last one, this [indiscernible] gross margin from other charges. I guess you say [indiscernible] activates. It’s a pretty big number, I’m just wondering you to elaborate on what was and whether or not we should see that hit again in coming quarters. Thanks, I’ll pass it.

I'm sorry, can you elaborate, we didn’t really say anything about a lot of non-recurring charges.

I saw, so it looks to me like non-GAAP gross margin you had about $7 million help, and it says from other charges related to non-recurring activities, maybe I’m reading that wrong, we can take it offline but looks to me like you got some help in gross margin there from that.

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 there we had to adjust those out because we do have that the expectation that we're going to get recovery from our suppliers as well.

Does your guidance for gross margin assume any more of that help, I mean that's almost 270 [ph] basis points in Q4.

So just be clear that's not really help. I think the non-GAAP numbers we presented reflect the ongoing business and mix that we 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.

Thank you. And our next question comes from Michael Genovese with MKM Partners. Your line is now open.

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 why the telecom revenue was sequentially down.

So there were two things beyond the end of life stuff. I one I tried to explain in the script was really around coherent component growth. So micro-ITLA, ITLAs coherent modulators and receivers that business was down slightly. As in the Q1 time frame 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 then I say the third thing was the mix of ROADMs versus WSS module 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 a ROADM revenue to be down 10% even though our number of ROADM shipped was up.

So following up on that point. Can you help, I mean it sounds like you were saying the blades are more of a US metro product versus WSS product. So, when we think about the mix of blades versus WSS is there a regional implication or breakout there that helps understand the business?

I’d say 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 in-depth going into the North America metro bills but they also get deployed outside of North America and frankly we don't know exactly how much goes to North America versus EMEA or APAC but those are for primarily the large North America 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 [indiscernible] or other places. But of note, for last quarter there was large orders in and shipments for WSS modules that will end up staying in China.

Thank you. Our next question comes from Alex Henderson with Needham and Company. Your line is now open.

I was opening we can got into the ROADM a little bit more in depth. So you're saying that you saw a 10% decline in blade sales. As you look forward into your guide, are you expecting that to reverse, you’re 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 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’s our current expectation and what's 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 that slowdown is. I mean is that a function of availability of parts, is it a function of other fires to fight, is it an M&A activity. What's causing that?

It's hard to say, I say though that when people deploy ROADM network and several large cities got deployed in the second half of last year. The ROADMs go in and then the next thing that happens is transmission lines come to light up the fiber and light up the different wavelengths 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 on to 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 most of the inventory that we have is in VMI hubs for the North America customers and that’s pretty well controlled, they pull it when they need it.

Thank you. Our next question comes from Patrick Newton with Stifel. Your line is now open.

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 replenished inventories at the hubs or is there other products perhaps that you're 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 orders.

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 some odd million 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're shipping to the hyperscale data center today are CWDM4s and whether they're 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 this stage where within the inside of data center the types of products like CWDM4 and PSM4 are taken off.

And I guess, Aaron, I just need one more just a little bit help on the gross margin upside, you clearly had higher volume I think you talked 100G datacom mix and then also the WSS module all helping that. But you also spoke to this non-recurring charge and I'm sorry I jumped on the call late, but did that nonrecurring 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 product. 100-gig and then the WSS models and we also has a fair amount of submarine businesses that landed in Q2 as well.

Thank you. Our next question comes from Simon Leopold with Raymond James. Your line is now open.

First thing I want to see if you can give us a little bit more thought on is what you're assumptions are around the mix in the in the coming quarter particularly if you could touch on the annual price decline that affect your March quarter. And then in terms of the longer term trending question I wanted to see if you could talk a little bit more about the 3D 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, you could elaborate on that particular opportunity as well. Thank you.

Sure Simon. On the ASPs I think you know as he said in the last call our expectations were that the ASPs reduction would be on the low-end of the typical 10% to 15% and that's where we ended up, I’d say that in typical years and this is no different half of that comes in the March quarter. So we are seeing ASPs impact our ability to grow and you can just take that number of 5% ish is what we're seeing for ASP reductions or expecting an ASP reductions in the March quarter. As far as longer term 3D sensing, we've been talking about mobile devices for probably three years and we're looking to that actually turning into revenue. I think we're on kind that same range of automobiles taking that kind of time we've been working with automobile manufacturers for 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're already working on?

They're all very custom and the requirements of an automobile that protects someone life on the road is very, very different than something in a mobile device. So it is different but based on the fundamental base technology for either VCSELs or [indiscernible] So it is different, the ASPs are going to be significantly different because of the complexity and you'll see multiple of these devices in the automobile as opposed to in the mobile devices where you’ll see one or two.

Thank you. Our next question comes from Doug Clark of Goldman Sachs. Your line is now open.

Great. Following up on the 3D 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 the initial orders for the product, what type of visibility that's given you into kind of 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 already have and I’d say that it's not just one mobile device manufacturer that we're working with in sampling, it’s multiple. So I would have to give away any of their secrets and as we start including meaningful revenue in our guidance, we’ll talk more and more about it, but suffice it to say that the milestones that we achieved over the last six months increased my confidence in our ability to make 3D sensing a meaningful part of our business as we look forward.

Okay, great. And then the other one is on relative mix of telecom versus datacom or expectations for the March quarter, can you talk about the 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 fall-off. Last quarter, you talked about $10 million revenue slip in the datacom business because of some of those supplier constraint issues. How much of that was fulfilled in the March quarter, meaning did you get all that 10 million back in the March quarter? Or in December quarter?

Hi, Doug. This is Aaron. So in terms of the mix for the March quarter, so just looking at two big buckets that we categorized, opcom and lasers, so directionally, lasers will be up sequentially in to the March quarter. And as Alan had mentioned in the prepared remarks, Q3 is typically our seasonal quarter where we have most of the price declines that show up. So most of the price decline is heavier in the opcom segment. So directionally, opcom would be down a little bit because of the seasonal factors and then also some - a little bit lumpy and I mentioned that sovereign was up in the December quarter, hence down a little bit in the March quarter.

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

Thank you. Our next question comes from Tim Savageaux with Northland Capital. Your line is now open.

Hi. Good afternoon. A couple of questions. First, a quick one on, if you had any comments on 10% customers or customer concentration and anything changing or notable there?

So in terms of the 10% customers, Tim, we’ll be talking about that or we’ll disclose it in our annual 10-K.

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

Nothing notable from a change standpoint.

Okay, great. And wanted to also follow up on the 3D sensing side and maybe try to approach this from a different angle and that is to understanding, a lot of this is in new 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 from a 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're pursuing relative to your previous kind of experience in consumer 3D sensing or just your recognition. Thanks.

Yeah, I mean 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 plus million dollars 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 and 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 we've made and the milestones we’ve achieved.

Well, just to follow-up very briefly on that, you mentioned you were seeing initial shipments, does that not indicate that the ramp is beginning or are we kind of still some sort of sampling or qualification type situation.

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

Thank you. Our next question comes from Rod Hall with JP Morgan. Your line is now open.

Hey, guys. Thanks for taking the question. I want to just come back to the data center, the supply situation and just 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 things. We continue to hear the short range optics in particular that gets at between short supply. So I just like to confirm that is the case and when do you guys think you can meet the supply constraints and if you could just maybe broaden that out and talk a little bit more about where else your supply constrained. And then I also wanted to come back to this ROADM question. What I guess I don't fully - you're saying that you expect the blade ROADMs to ramp back up, but can you give us any idea on visibility there, I mean do you have visibility on planning, do you expect meaningful ramp in fiscal Q3 or you just don't know, just any color you can give us on what the visibility looks like for those blade ROADMs would be helpful. Thanks.

Sure. Datacenter supply, as I said in the prepared remarks, we focused our capacity on satisfying the ten kilometer products, mostly for the network equipment 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'll 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 try to make and maybe didn't come across in the prepared remarks was that the first thing people need to do is light up to light up new fibers, 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'm very encouraged with our opportunity to grow. Visibility on WSS ROADMs, I think as far as the blades are concerned, I think that’s a matter of when did the large North America carriers release their budgets and when did 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 and visibility in WSS modules in China is pretty clear. I’m very confident that we'll see continued growth in China on the individual WSS modules.

Alan, on your hyperscale comment, could you just clarify do you expect to be able to supply what they're 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 OpEx point of view?

Yeah. Well we have orders today that were not satisfying this quarter on hyperscale.

So 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?

Well, it could depend upon how many new orders come in this quarter as well, Rod. And also a couple of months ago, we did launch a significant amount of capacity in the form of assembly and test equipment. That's not online just yet. So typically it takes up to 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 on what new business comes in as well.

And I think the other point that’s important is that a lot of hyperscale datacenters are being deployed with 40-gig, our exposure to that market is very, very small. And 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.

Thank you. Our next question comes from Meta Marshall with Morgan Stanley. Your line is now open.

Hi. Thanks for the question. A couple I think you kind of just addressed it in the answer to the last question, but an update on ACO timing because I know that you were kind of in 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 kind of back to the ROADM question. Mentioning that the deployment you don't know what cities and not that’s some of the reason for potentially being kind of down next quarter, but I just wanted to make sure is that due to any kind of share shift between kind of a competitor getting qualified and some new cities going to a competitor or is that something where you still feel like all cities are going to you. Thanks.

Okay. Yes. Let me answer that ROADM question first. I don't think that ROADM blades will be down this quarter. I think we're 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 there when the customers need it, they're going to continue to pull from us and so far so good in the deployments and the quality aspects of turning up to new cities. So very happy with that. It will be there for when our customers deploy more and more cities. As far as the CFP2-ACO timing is concerned, I guess just an update on that. We’ve made continued progress. We are now to the point where we believe we have our final configuration of product that we're going to take into production. We’re shipping samples of that product, final qualification samples of that product and expect that as we get through our internal qualification testing that takes thousands of hours that then we’ll release that product that we have today and so we've made tremendous amount of progress on that. I would say that not meaningful revenue in this quarter and hoping to have some revenue in the fourth quarter, but really taken off more in the second half of the calendar year.

Thank you. Our next question comes from Joseph Wolf with Barclays. Your line is now open.

Thanks. I wanted to go back to a couple of questions from the competitive angle. Just on the hyperscale comments, you made two comments, one is that 100-G, you can’t fulfill, because you're fulfilling telecom and you mentioned a little bit about 40-G. And I'm just wondering are there contractual issues, you mentioned ASP, but I'm just trying to get a better sense of how the customers are reacting to not getting their product or there's that comment on 40-G basically saying they're ordering but they don't need to deploy just yet. And then 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 pretty big customer for our 40-gig two kilometer product in the hyperscale space, but became uncompetitive because we were totally vertically integrated with that. So that's around my comment on the 40-gig. We don't really have much 40-gig 2 kilometer business any longer. And so 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. Just to be clear the 100-gig product that we shipped last quarter are the primary part of our growth was in the network equipment manufactures and it's really the client side of a telecom network but really it's a datacom product that’s 10 kilometers. And so on the competitive landscape, on those 10 kilometer products, there's fewer competitors. To k now, it’s pricing better. ASPs are significantly higher than within the hyperscale data center. Costs are much lower in the hyperscale data center, but 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 ten kilometer for that.

Okay. Thanks for that. And then just back also to the, on the wind for the gesture, the 3D sensing opportunity, it sounds like there is 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 same 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're 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 3D sensing products for the last eight years. We've 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're the only one in the world that has a track record of understanding 3D sensing and the reliability requirements associated with that. So the other - 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 the sheer volume of these devices and so I'm not disappointed that we're competing where 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.

Thank you. Our next question comes from Jorge Rivas with Craig-Hallum. Your line is now open.

Thanks 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. $11 million.

Okay. And then I hear in the commentary that you're confident that calendar 17, it’s going to be strong year in China. I wonder if you can provide some color as to what gives you the confidence. I understand that you're seeing strong orders from opcom lasers, but any additional color you can provide as to, what gives you that confidence and at the same time, do you expect that in China specifically to be a back end loaded calendar year or do you expect more consistent demand throughout the quarters in calendar ‘17?

Well, yeah, I mean 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 an unique position compared to our competitors. And so I think as they deploy ROADMs, they're going to deploy a lot of them and they’re 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’re going to see growth from zero ROADMs in China to a lot of ROADMs in China. So that's one of my reasons for the belief. And I do think not to underestimate the fact that we can't seem to satisfy enough pump lasers in China. You don't light up fiber with amplifiers unless you're going to put stuff on the ends of them and without putting ROADMs and other 100-gig transponders and modems into the networks and so this quarter or next quarter, it’s still not clear to me that the last couple of weeks have been a little bit quiet, given Chinese New Year. I’ll be going back there. We have been a little bit quiet given Chinese New Year I'll be going back to China in a couple of weeks and getting more G2, but 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 deploying enrollments in China, do you anticipate to be the majority of these ROADMs of your next generation through flakes or any idea of what you are looking at right now?

Yeah. I think we're extremely well positioned, not only with this generation of Twin 1x20, Twin 1x9, but we're also coming out with next generation Edge ROADMs that are very, very competitive as well as even higher work count ROADMs that we're working with our customers with. And so I’m really confident and pleased with our progress and share that we expect to get and I think the share we’re getting today on those ROADMs. So pretty happy with that.

Thank you. Our next question comes from Troy Jensen with Piper Jaffray. Your line is now open.

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

I think there is - China Telecom is probably the furthest along, but I would say the ROADMs we’re shipping today are for more than that, whether that be in additional trials or field deployments. It's not totally clear to me and I’ll give more clarity when I'm there next time, but I think it's a broad deployment strategy and pretty confident that it will be more than just China Telecom this calendar year.

And then one last question, just on the sensing market, is Heptagon a customer or partner of yours for the 3D sensing in the smartphone market.

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

Area partner. I mean, I think beyond customer, there would be someone different, but this would be a module maker.

We're very familiar with them and done business with them in the past.

Thank you. Our next question comes from Michael Genovese with MKM Partners. Your line is now open.

Great. 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 going to see seasonality in units and would that be on both telecom and datacom or is it more a function of pricing with the annual price declines for the reason, for that sequentially down revenues?

So I would say in datacom, 100-git 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’d say that the telecom business five 5% ASP reduction, we’re probably going to get less than that from a unit growth, but it all - a lot of it has to do with mix as well as Aaron indicated, we're expecting to see a little bit down in submarine. We're 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 then just last follow up here. You mentioned that a year ago, there wasn't as much seasonality, would I comment primarily directed at Chinese demand saying that there'd be more seasonality this year or is that a more across the board comment versus a year ago timeframe?

So two things. One it was probably no member of 15 when China turned on. And so anything you could ship or anything you could put in place to satisfy demand, even though the Chinese New Year was being consumed. The other thing and when you do a comparison of our Q3 to Q3, last Q# was a fourteen week quarter, but I would 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, more balanced between supply and demand.

Thank you. Our next question comes from Dave Kang with B. Riley. Your line is now open.

Thank you. Good afternoon. First on 3D sensing, can you just talk about the capacity situation, what is it now and where you plan to be in the - maybe late this year, late calendar ‘17?

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 prefer to stay away from. I mean as Aaron talked about in the script, some of the capacity ads that we had last quarter are going specifically to 3D sensing. So we’re seeing more meaningful deployments of CapEx for us internally as well.

Right. But then I guess your challenge is that since some of your equipment, front end equipment has very long lead times, so I guess that will be a sort of challenge as far as trying to time that turnout right.

Yeah. We have ample capacity allocated to us for all of LIFE growing F.P. 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 already taken care of. We're talking more about back end testers and the ability to test what we need to test at the back end. So those lead times for those tools are much shorter.

Sure. And have you or maybe your customers, yes, I don't know who's going to decide, but regarding whether you'll be supplying [indiscernible], any color on that situation and the gross margins would reach with particular products?

Yeah. 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’re working on in mobile application is that they’re tested at high level.

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

And then I’ll say that from a gross margin perspective, one would expect that at the fair die level, you would see higher margins than you would see at a packaged level or optical component level.

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

CapEx budget, so we've been spending about 10% of revenue in CapEx and as we continue to spend money and prepare for 3D sensing ramp, I think 10% is probably where we'd be at for the foreseeable future.

And that as far as 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 a blade level, the MCS can be similar in price to a ROADM or a ROADM blade.

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

Yeah. Pretty much. I mean, this is fundamental architecture issues, but that’s from our perspective, it means we fell into, probably more ROADMs.

Thank you. 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 a next generation high volume 3D 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.

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.