Lumentum Holdings Inc. (LITE) Q4 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the Lumentum Fourth Quarter and Fiscal Year 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jim Fanucchi, of Darrow Associates. Please go ahead.

Thank you, operator. Welcome to Lumentum's fourth quarter and fiscal year 2020 earnings call. This is Jim Fanucchi from Darrow Associates, assisting Lumentum with its Investor Relations. Joining the call today from the company’s management team, we have Alan Lowe, President and Chief Executive Officer; Wajid Ali, Chief Financial Officer; and Chris Coldren, Senior Vice President of Strategy and Corporate Development. Today’s call will include forward-looking statements, including statements regarding the markets, in which we operate, and our position in such markets, the impact of COVID-19 and responsive actions thereto on our business and continuing uncertainty in this regard, trends and expectations for our products and technology, our expected financial performance, including our guidance, as well as statements regarding our business initiatives and the achievement of synergies following our acquisition of Oclaro. These statements are subject to risk and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings, including the company's quarterly report on Form 10-Q for the fiscal quarter ended March 28, 2020, and in Lumentum's 10-K for fiscal year 2020 ended June 27, 2020, which the company expects to file within 60 days of the fiscal year-end. The forward-looking statements provided during this call are based on Lumentum's 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 discussed in this call are non-GAAP. Non-GAAP financials are not to be considered as a substitute for or superior to financials prepared in accordance with GAAP. Lumentum's press release with the fourth quarter and full year fiscal 2020 results is available on its website at www.lumentum.com, under the Investors section and includes additional details about non-GAAP financial measures and the reconciliation between our historical GAAP and non-GAAP results. Now, I will turn the call over to Alan for his comments.

Thank you, Jim. Good morning, everyone. The fourth quarter capped off another record fiscal year. Earlier this month, we celebrated our fifth anniversary of being a stand-alone public company. And, wow, what a five years it's been. We have accomplished a lot. Execution of our strategy has positioned us as a clear technology and market leader and enabled us to strongly grow revenue, margins and earnings per share every year since we became a stand-alone public company. This was accomplished despite the significant impact of product line exits and divestitures and more recently, COVID-19 and geopolitical headwinds. From fiscal year 2015 through fiscal year 2020, our earnings per share grew at a compound annual growth rate of 47%. This includes additional shares related to M&A consideration and convertible debt. Over this period, our gross margin expanded from 33% to nearly 47%, and our operating margins expanded from 5% to nearly 27%. Our balance sheet is healthy with ample cash to fund further organic and inorganic growth. This has all been accomplished by focusing on markets with long-term growth trends, repeatedly introducing highly innovative market-leading products, continuously improving, establishing a clear leadership position in the new and rapidly expanding 3D sensing market, executing highly accretive M&A and wisely managing our capital structure and allocation. Fiscal 2020 was a record year for revenue, margins and earnings. A record results were driven by a product mix rich and differentiated high-margin products and the attainment of significant acquisition synergies. Illustrating the improvements we've made in our financial model is our fourth quarter gross margin performance, which was only 20 basis points below the record level attained in our second quarter despite the fourth quarter revenue being impacted by COVID-19. As pleased as I am with our accomplishments today, I am as excited as ever about the opportunities ahead. I believe the future is truly bright at Lumentum. Long-term market trends and industry dynamics are more favorable now than when we became a public company five years ago. The world is accelerating its shift to increasingly digital and virtual approaches to work, entertainment, education, health care, social interaction and commerce. This is stressing the world's communication and cloud networks and driving the need for higher volumes of higher performance optical devices. In order to produce, communicate and consume increasingly digital content and participate in virtual and augmented experiences, the world needs more capable and secure devices that benefit from our 3D sensing and laser technologies. We are well positioned to capitalized on these trends. We are armed with a product portfolio, rich and differentiated new products that are indispensable both to customers and end markets globally. These include: optical communication products, such as high port count and MxN ROADMs and high bandwidth coherent components and DCO modules. These are all essential to enabling the world's communication networks to scale to the bandwidths needed for our increasing digital and virtual way of life and work. , : 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. Additionally, notable manufacturing capacity increases include the following major three investments: one, doubling of our indium phosphide wafer fab capacity over the next 18 months, as we believe the performance and capabilities provided by our indium phosphide laser chips and photonic-integrated circuits will be central to every telecom and datacom communication network, and perhaps over time, increasingly in 3D sensing and LIDAR applications; two, expanding gallium arsenide device production capacity for our 3D sensing, automotive, industrial laser and telecom and datacom products as application for these products are expanding rapidly; and three, expanding capacity for next generation, high port count and MxN ROADMs as customers globally are designing their new networks based on these technologies. Now on to the fourth quarter comments and trends, fourth quarter results exceeded our guidance range across all metrics. We executed well in our in our recovery from the COVID-19 related shutdowns and supply challenges and returned to pre-pandemic output exiting the quarter. Our manufacturing operations have implemented worker protective measures, including enhanced use of PPE and social distancing and at many of our sites our workforce that can perform their job functions while working from home, continue to do so. Telecom and Datacom demand is very strong, especially in our datacom chips, coherent components and modules and high-end ROADMs, supply of these products limited fourth quarter revenue. Telecom transmission was the most impacted by COVID-19 supply challenges and as a result declined a few million dollars sequentially. Telecom transport grew sequentially due to strong pump laser sales and increase sales of wavelength management and ROADM products. Prior quarter trends continued in Datacom with strong chip demand, driving revenue growth. Chip sales became more than 95% of our Datacom revenue, but growth is still limited by wafer fab capacity. Current Datacom chip backlog is nearly $150 million. Looking to the first quarter, we expect Telecom and Datacom revenue to be higher than anytime from more than a year. As I stated earlier, we are increasing production capacity in our fabs and our back-end assembly and test facilities. 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. As expected, industrial and consumer revenue declined due to customer seasonality and the timing of new customer programs. Revenue was higher than in our guidance assumption due to stronger-than-projected demand. We expect first quarter industrial and consumer revenue to be up strongly quarter-on-quarter as we are already supplying high volumes of our new products for future customer product launches. These new product shipments include our latest chips for user and world-facing applications. This seasonal ramp started later than last year. And as a result, we expect our second quarter shipments to be higher than our first quarter shipments, which is different than 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. Commercial lasers revenue was down approximately 13% quarter-on-quarter. This is a smaller decline than we had assumed in our guidance. Strength in lasers supporting the semiconductor end market partially offset the anticipated softness in fiber lasers. Lasers book-to-bill was substantially below 1, we expect lasers revenue to decline further over the next 2 quarters. Our first quarter guidance assumes an approximate 25% sequential decline for lasers. These expected declines are related to the economy outside of China, which given our customer mix is mainly where our products ultimately end up. Additionally, the second half of the calendar year is seasonally softer for our solid-state lasers. Before handing it over to Wajid to review the numbers, I have a few more comments. Given the current geopolitical situation, I want to provide some color on our business with Huawei. Sales to Huawei declined 6% sequentially in the fourth quarter to the mid-$40 million range. We expect sales to Huawei to decline further in the first quarter. 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. Wajid will provide more details on this. Lumentum is a global company with sales and operations across a wide range of geographies. We are committed to the highest standard of social, ethical and environmental conduct and responsibility. These include promoting safe, diverse and inclusive workplaces, free from discrimination and harassment. In addition to our goals around product leadership, providing a great customer experience, and executing to our financial commitments, our goal around corporate social responsibility and making contribution to society and our local communities are important to Lumentum and its employees. I want to thank our employees around the world. They are the ones who have put us in such a great position, both financially as well as with our technology and product leadership. They have been incredible over the past five years and more recently through the pandemic, despite each having their own personal challenges, living and working in these times. They have gone above and beyond in their jobs, while also helping the communities in which we operate. Our employees are absolutely the company's greatest asset. I'd also like to thank the rest of our stakeholders, including customers, suppliers and shareholders for their support and partnership over the past five years. They've all played a role in getting us to this point. With that, I'll hand it over to Wajid.

Thank you, Alan. Good morning, everyone. I, too, would like to thank our employees for their dedication and perseverance. I am absolutely amazed at their strong execution under such challenging circumstances. Before diving into the fourth quarter results, some high-level comments and our full year fiscal '20 results. Net revenue for fiscal 2020 was $1.68 billion, up 7% compared with fiscal 2019, despite the significant top line impact of COVID-19 in the second half of the year and several product line wind-downs and divestitures. Fiscal 2020 optical communications segment revenue was up 11%, driven by growth in 3D sensing, Datacom chips and telecom transmission and the contribution of the Oclaro acquisition. Our laser segment revenue was down 16% compared to the prior year, driven by the impact of COVID-19 strongly exasperating an already slower lasers market compared with the prior year. For the full year, GAAP gross margin was 38.7%, GAAP operating margin was 12.2% and GAAP diluted net income per share was $1.75. Full year fiscal 2020 non-GAAP gross margin expanded 700 basis points to 46.5%, driven by improvements in product mix and acquisition synergies. Non-GAAP operating margin expanded 610 basis points to 26.6% for the full year and non-GAAP net income increased by more than 38% relative to the prior year. Non-GAAP diluted net income per share expanded 27% to $5.42. Operating expenses for the full year were 20% of revenue, up from 19% in the prior year, reflecting the full year of incremental acquisition expenses and an increase in R&D investments in new technology and customer programs. We have been simultaneously attaining R&D-related acquisition synergies and cutting investments in underperforming product lines, while ramping investments in areas with stronger outlooks and returns. On the balance sheet, we ended the year with $1.55 billion in cash and short-term investments. We have $1.5 billion in aggregate principal convertible notes and no term debt. Of these convertible notes, $450 million is due in 2024 and $1.05 billion is due in 2026. The total cash interest expense associated with these notes is approximately $6 million per year. We are well-positioned financially with a strong margin model, high levels of cash with low interest expense, and long maturity financing. Now, turning to the fourth quarter's numbers. Net revenue for the fourth quarter was $368.1 million, which was down both 9% sequentially and year-on-year. GAAP gross margin for the fourth quarter was 36.9%, GAAP operating margin was 7.3%, and GAAP diluted net loss per share was $0.06. Fourth quarter non-GAAP gross margin was 47.2%, which was up 170 basis points sequentially and up 830 basis points year-on-year. The sequential growth was driven by higher synergies in the quarter and an improvement in product mix, including an increase in laser's gross margins. As Alan highlighted, this gross margin performance demonstrates the improvements we have made in our financial model. Non-GAAP operating margin for the fourth quarter was 24.8%, which was down 20 basis points sequentially, but up 580 basis points year-on-year. Improvements year-on-year were driven by gross margin improvements. Non-GAAP operating expenses totaled $82.5 million or 22.4% of revenue. SG&A expense was $36.6 million; R&D expense was $45.9 million. Operating expenses continue to be a little lower than normal run rates due to COVID-19 reducing travel trade show and other expenses. Fourth quarter non-GAAP net income was $91.7 million. This includes $2.3 million of net interest and other income and $2 million of tax expense. Other income is down sequentially as interest rates on our cash and short-term investments are lower overall, and we are being more conservative in our investment portfolio. Non-GAAP diluted net income per share was $1.18 based on a fully diluted share count of 77.5 million. Turning to segment details, fourth quarter Optical Communications segment revenue at $330.3 million decreased 8% sequentially due primarily to 3D sensing seasonality and COVID-19 related supply limitations. Year-on-year, Optical Communications segment revenue decreased 7% due to lower Telecom & Datacom revenue with the exit of Datacom modules and COVID-19 supply limitations, which more than offset higher 3D sensing revenue. Although the segment revenue declined, Optical Communications segment gross margin at 46.6% increased 160 basis points sequentially due to higher synergies in the quarter and a brighter product mix within Telecom & Datacom and increased 830 basis points year-on-year due to a more favorable mix of products, improved Telecom & Datacom margins and acquisition synergies. Our laser segment revenue at $37.8 million decreased 13% sequentially and 21% year-on-year, due to lower fiber laser sales, offsetting strong solid-state laser sales. Fourth quarter lasers gross margin increased 52.9%, due to a better product mix and lower manufacturing costs. Now on to our guidance for the first quarter of fiscal 2021. Please note, the outlook we are providing is on a non-GAAP basis and is based on our assumptions as of today. We expect net revenue for the first quarter of fiscal 2021 to be in the range of $430 million to $455 million, this revenue projection includes Telecom & Datacom growing sequentially due to strong demand and recovery from COVID-19 supply limitations. Industrial and consumer increasing strongly quarter-on-quarter due to new customer programs, and consumer electronic seasonality. And commercial lasers decreasing by approximately 25% sequentially, due to end market demand caused by the slowdown in industrial production globally. This guidance does not hinge upon material additional shipments to Huawei beyond those made to date. Based on this, we project first quarter operating margin to be in the range of 28% to 30% and diluted net income per share to be in the range of $1.40 to $1.55. These projections incorporate an approximate share count of 79 million and estimated other income of $1.5 million and an estimated tax expense of $13 million. The estimated other income is lower than levels in the recent past due to lower interest rates in general and are taking more conservative positions in our short-term investments. The increase in our relative tax expenses due to increasing profit levels, especially in jurisdictions with higher tax rates. Before wrapping up, I'd like to make a few comments when thinking about the coming fiscal year. In fiscal 2020, we had had approximately $62 million of revenue from low margin product lines that we expect will be immaterial in fiscal 2021. In addition, for fiscal 2020, we had $221 million of Huawei revenue, which declined through the year, ending in the mid-$40 million range in the fourth quarter. With that, I'll turn the call back to Jim to start the Q&A session. Jim?

Thank you, Wajid. Before we start the question-and-answer session, I would like to ask everyone to keep to one question and one follow-up; this should help us get to everyone before the end of our allotted time. Operator, let's begin with a question-and-answer session.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Tom O'Malley of Barclays. Please go ahead.

Good morning, guys, and thanks for taking my question and congratulations on the really nice results. I just wanted to start broadly with your Telecom & Datacom markets, clearly in the quarter you had some capacity constraints and you overcame those. Can you talk about what trends you're seeing there. ROADM demand seems to be really strong and you mentioned some additional investment there. Can you talk about how big you think that market can be and why it's so important that you need to show us some additional investment there?

Yes, thanks, Tom. We saw strong demand from, as I said, the high end ROADMs across the board, across geographies, datacom chips and a combination of both hyperscale 400 gig transceiver type chips to deployment of 5G backhaul and the like. So, I think you know as we indicated in the script, we have $150 million of datacom chip backlog. And today we're shipping approximately $50 million in growing that, so you can see it's going to take us some time to catch up with the datacom chip business. On the telecom transmission business that it was most impacted by COVID through the March to May timeframe, that's now back to being able to produce actually more than what we were producing before as we've added capacity. And we saw strong demand on our coherent ACOs, DCOs as well as our high end coherent components that are going into 400, 600 and even 800 gig coherent transponder. So it's pretty broad range of strong demand across the board.

Great. And then my follow up was on Huawei. You've seen some of your peers take Huawei out of guidance as well. Can you talk about what you mean by de risking Huawei? It seems like, you've taken orders to date and that's included in your guidance and then you basically assumed no additional revenue. Just some clarity there would be helpful and understanding what the de risk actually means? Thanks, guys.

Hey Tom, this is Chris. Thanks for the question. Yeah, so, our business with Huawei has been declining over the past year or a little more than a year with the U.S. action. And, but underneath that decline in revenue what has been happening at a product level is products that they can get from other non-U.S. suppliers, I think they have generally moved away from us. And what remains in our revenue are products that we’re the only guy or the other supplier is another U.S. based supplier. And they continue to have business globally and therefore, we expect we will continue to have business with them on those indispensable products without any visibility into a cliff, if you will out there. Having said all that, obviously, we're trying to be very conservative and ensure that if there was something out there that that did happen during the quarter that we're not in a challenging position. The other key point on Huawei and those indispensable products is that we have lots of other customers for those products and we're capacity constrained on most of those products. 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. And in a sense that's largely contemplated in our guidance, so I wouldn't in a sense, take up our outlook, just because we removed it and there's, if there wasn't something going wrong for the remainder of the quarter, with Huawei, I wouldn't take up numbers because – we could be shipping that to somebody else, and that's already in our guidance assumption.

Next question comes from Rod Hall of Goldman Sachs. Please go ahead.

Yeah. Hi, guys. Thanks for the question. I wanted to start off with 3D. The indications here are pretty strong both now and as you look forward. I wonder if maybe, Alan, you could comment on your share position, what you think that looks like in the fall? I mean, it feels like it's pretty good. And then the second thing that I wanted to ask about is CapEx. With all the capacity expansion can you guys give us some idea of what the CapEx outlook is going to be maybe going into next year? Thanks.

Yes. Thanks, Rod. I'll take the 3D sensing question and then let Wajid answer the CapEx question. I think we're positioned quite well. I mean, I think, we've been the lead supplier for multiple generations of products and have a pipeline of new products that will be introduced over the coming years -- multiple years. So, I think, we are – we view ourselves as the leader by -- clear leader, both from the standpoint of what we have shipped in the past, as well as what we think we're going to ship in the future. And we're doing quite well on the new products. So I think, as we look at the pie expanding, as more content per device --and more devices and the rollout of 5G, I think, we're positioned quite well to continue to maintain a very good share of that business. And it comes down to execution and we've been able to show our customers that we can execute. We can provide them with high-yielding product in their factories and zero defect in the product. So I think from that perspective, we're trying to give our customers every reason to want to continue to buy a high percentage of the share from us. And so I think that's where we are today on that. Wajid, do you want to take the CapEx question?

Sure. Okay. So on CapEx, our general rule of thumb is, is that we'd like to keep CapEx at a rate that hovers around depreciation. Our fiscal 2020, we were a little bit lower than that. And moving into fiscal 2021, we're actually expecting our capital spending to increase somewhere in the 20% to 25% range year-over-year. So you could probably see a CapEx of somewhere between $100 million and $110 million for fiscal year 2021. Now as Alan pointed out in his prepared remarks, we're very laser-focused on where we're putting that money. So we're putting that CapEx investments around products that have higher gross margins, and we see a lot of backlog and a lot of customer demand. And we think that we are either the major supplier or the number one and only supplier for those products. And so that's what's giving us a lot of confidence in the type of returns we'll see on that capital investment.

Okay. Great. Thanks.

Next question comes from Samik Chatterjee of JPMorgan. Please go ahead.

Hi. Good morning. Thanks for taking my question. I just wanted to start off and see if I can dig into the margin expansion here a bit. Looking at 800 basis points of year-on-year margin expansion in optical communications and assuming you couldn't have achieved it without improving telecom margins, where you've mentioned product mix a couple of times already. Just help me think about sustainability of those margins and particularly the opportunity to improve it further? And what role maybe some of these capacity constraints that you have right now are playing in driving those better margins? And I have a follow-up. Thank you.

Yes. Sure. Okay. I'll start off, and then Alan and Chris can also jump in if they think I've missed something. So you're absolutely right. We've seen just a great improvement in our gross margins year-on-year, specifically in that segment of the business. A lot of it has been driven by synergies that we've had happen every single quarter. And now what we're seeing, as we're entering fiscal 2021 is that all of the synergies are accumulating, so we're getting a much better impact of those. Our product mix is improving. You heard Alan say that we've got approximately $150 million worth of Datacom chip backlog. You can appreciate the type of pricing power that allows us to have, as well as just improving our overall product mix within our Optical Communications segment. We've removed $62 million worth of low-margin products that won't be there in fiscal year 2021, that's also having a very strong impact. And I think one of the things that we didn't mention on the call that I'd like to point out now is the new products that are coming out specifically within telecom transmission and telecom transport, the margin profile that we're expecting from those are also better than the older products. And that's one of the reasons we're investing in the type of capital that we are, a 20% to 25% increase in capital spending year-on-year is not a small sum of money, especially given the fact that we're focusing those capital investments in specific areas related to Datacom chips and telecom transmission. So, because of those tailwinds, we certainly see the sustainability of those gross margins. The one thing I also did mention is our world-facing products. We're seeing strong demand for that, moving from our fiscal Q4 into our Q1 and into our Q2. Alan mentioned in his prepared remarks that we're expecting to see stronger demand in the back half of this calendar year. That's all coming from world-facing products and that's expected to have a strengthening improvement on our gross margins as well. So we're feeling quite confident. You saw in fiscal 2020, every single quarter, was above 45% gross margins, and we had not seen that in fiscal 2019. And so, we're looking forward to keeping that up in fiscal 2021 and improving from a very strong baseline that we've got. Okay?

Okay. If I can just follow-up, on just thinking about the restrictions here on Huawei and as they take hold, if Huawei does give up share in Europe to some of the other optical system players that you are a supplier to as well. How should I think about Lumentum's content per system with the likes of Ciena or Nokia relative to Huawei and what kind of impact that would have if market share shifts in the overall landscape?

Yes. I think if you look at our business with Huawei compared to their market share and then look at the western companies and our share of their wallet, clearly, we have a better share of wallet outside of Huawei, which means that over time, if and when carriers decide to move away from Huawei, that will be actually a increase in our available market, should it go to other competitors of theirs, just given the share of the market they have and our share of their wallet. So I think from that perspective -- but keep in mind, the shift from one network equipment manufacturer to another doesn't happen in one quarter, it happens over several quarters. And so that does take time, but when that shift or if that shift does happen, I think it’s a good thing for Lumentum and our products.

Great. Thank you.

The next question comes from Alex Henderson of Needham and Company. Please go ahead.

Thank you very much. I was hoping you could talk a little bit about the 3D sensing market in context of whether you think the various pressures that have developed will impact the amount of demand in the back half or whether the increase in world-facing is sufficient to offset any possible decline in handsets? And to what extent you're looking at some visibility on the Android market? Thanks.

Yes. Let me take a shot at it, Alex, and then let Chris chime in. I'd say that we are not a predictor of how successful product launches that our customers will be. But that said, I think that the signals we're getting from our customers are quite strong with respect to new products and the rollout of 5G. So, again, more content per device, more new chips across the board on new devices which come with higher average selling prices as the chips are somewhat bigger. And then more units that these devices are going into with a growing market for 5G and a refresh cycle that is expected -- at least in my mind, expected to generate demand. So, you pie all those things together, the pie is getting very large relative to where it was last year, and we think we’re maintaining the very, very good share of that business. As for the Android market, we're still engaged with every single one of the Android handset players. That’s said, in corporation of 3D sensing has been only at the very high end and still yet to get into the mid-range where the volumes are substantially larger. And so our outlook contemplates that continuing. And then we'll see what happens in calendar 2021 with the Android market. I think our efforts are to continue to be the partner for everyone and make sure that we're there to support them, and if and when they put those on to more of the mainstream devices, then we'll see that market expand even further. Chris, do you have anything to add on that?

I think the only thing to add is Alex’s question really focused on the second half of the calendar year and I think everything Alan said lines up. There’s also that some of our major customer timelines may have shifted out which can move where our revenue is between September and December quarters and perhaps even some bleed from what normally would think of as the second half of the calendar year into the first part of the next calendar year. That's something that we’re speculating on, don’t have that firm yet, but something to just call out as people should think about as you said the moving headwinds, tailwinds in this industry and it's not just volume, it's also timing.

So, if I could follow-up just to punctuate the point. Does it -- it sounds like you're saying that in TY 3Q, 4Q, the back half of calendar year that you would expect 3D sensing will be up year-over-year given those positive commentary. Is that reasonable to expect?

I think the opportunity is certainly there and we think that the total pie is this year for second half-over-second half substantially larger. Obviously, we guide one quarter time and as we’ve seen in the past this is business, look, can move around pretty quickly, but that's certainly our expectation given as Alan highlighted the increased dollar content per handset is substantially larger, and therefore, the overall opportunity should be significantly up year-over-year.

Thank you, Chris.

Thanks, Alex.

The next question comes from Meta Marshall of Morgan Stanley. Please go ahead.

Great. Thanks. Just clarifying question, kind of, on the remaining $40 million of revenue that is going into Huawei. Is most of that equipment or most of that supply going outside of the country, so into their engagements in other countries? And is any of what you're supplying still servicing within the country? And then maybe the second question, just on the $150 million of wafer backlog or orders that you noted, you noted that you were doubling your capacity, but should we consider that that's a number you could achieve over the next couple of years or just a time line when you think you could achieve those orders? Thanks.

Yeah. Thanks, Meta. So I'd say that it's not perfectly clear where our products are ending up as we ship them to Huawei. I'd say that anecdotally, we know there's large deployments happening today in China that are using for instance, our high end ROADMs. And so I would speculate that the majority of our production shipments are staying within China. Although, I know there are deployments going with our product outside of China. So I'd say, it's a dynamic mix as carriers decide to go with Huawei or not to go with Huawei. And we’re seeing mix shifts and customer shifts as those decisions get made. So -- I’d say that, as we said in the script, our business with Huawei is expected to continue to go down this quarter. I would be surprised if there are even a 10% customers in fiscal 2021, but we're still working with them on new product designs and technology and products that are -- we are the leader on and continue to partner with them on. So I think we’re keeping the door open and we’ll see what happens. As for the Datacom chip backlog of $150 million, again, we’re shifting approximately $50 million a quarter. We're growing that incrementally every quarter and the increments come in chunks. And so as we said, we're going to double the indium phosphide production capacity over the next 18 months, one could imagine that six quarters from now, we could be shipping $100 million of Datacom chips at that point in time. So I'd say at today's run rate, we have three quarters of backlog. We're trying to catch that up as fast as we can. Orders are continuing to come in. So it's a fight that 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.

Great.

Hey, Alan, I’d like to add to the point about domestic sales in China, we’re also significantly increasing our business with other customers in China who are also buying high end ROADMs and other of our for very differentiated products. So our access to the Chinese market domestically that is still strong in some ways increasing in that as metro deployments or the equivalent of metro deployments grow in China based on high-end ROADMs, we are supplying to all of the major network equipment manufacturers in China.

Good point. Thanks, Chris.

Thanks, Meta.

The next question is from John Marchetti of Stifel. Please go.

Thanks very much. Actually, Chris, I just wanted to follow-up on that last point that you made. Some of the other suppliers in China, judging from the comments you guys have made, it sounds like you're still obviously expecting to shift to Huawei this year, although obviously, it's declining year-over-year. But is there a chance, I guess, that you think your China business overall is either on par with what we saw in fiscal 2020 or maybe even a little bit higher, if some of these other suppliers that maybe you didn't do as much with historically start to pick up some of that that slack within the China market?

Yes. I mean, I think that's certainly in the aggregate when you add up all of Chinese customers. I think the one – because the demand is strong and increasing in China and are relevance to customers outside Huawei is also increasing significantly. The only slight modulation I'd point, which is just a subtlety is that of those products we've discontinued, which include datacom transceivers and lithium niobate modulators, a set of customer in China were relatively large percentage of that business but if you were to normalize for that, then absolutely.

Thanks. And then Wahid, if I can just ask a quick follow-up question on the model, I'm just curious as we look out into 2021, if we should expect the higher tax rate that you're assuming in the first quarter to kind of be the new normal as we look out for the full year or that has to do a little bit more with some of the 3D sensing volumes and some things what they were expecting to pick-up here in the first half of the fiscal year? Thank you.

Yes, John. Yes. No, good question. We should probably model somewhere between 10% and 11% for our tax rate for fiscal year 2021. It's being driven by a combination of higher expected profits that are going to be coming out of our datacom chip business as well as, like you mentioned, just generally higher profits on many of our product lines. And so, 10% to 11% is probably the right model for fiscal 2021.

Thanks very much.

The next question comes from Simon Leopold of Raymond James. Please go ahead.

Thank you very much for taking the question. First, on the strength in the chip sales, just wondering if you could help us discern drivers. To what extent is this related to 5G initiatives, front-haul, back-haul, mid-haul, perhaps China versus activity in data centers and hyperscale? Do you have visibility that helps us understand what's driving this?

Hi, Simon, this is Chris. Yes. So I would say it's all of the above that you mentioned, but I would also highlight that within data centers, it's not just volumes, the volumes are certainly very important. It's also that data centers are moving from 100-gig to 200-gig to 400-gig. And in doing so or buying increasingly sophisticated and differentiated chips from us. So that also helps drive revenue growth, where we may be having a content or ASP increase. But certainly, both 5G and data center are heavy contributors to the revenue and the growth.

One more than the other or equal? How do we kind of think about that? I'm trying to get a sense of ability?

Yes. I don't want to get into deep details. I would say they both are material. It's not in 90/10. It's a little more equitable than that.

Great. And then as my follow-up, I wanted to maybe get a little better sense of the materiality of the world-facing element, in the 3D growth. And I certainly can appreciate you don't want to give us breakdown by piece part. But I guess, what we're trying to get a better sense of is -- sort of the organic front-facing contribution versus world-facing, does world-facing have better margins. Is that the growth driver? Or are both elements growing and front-facing is additive, but not at the expense of front-facing? Anything you could help us understand that, would appreciate it.

Sure, Simon. This is Alan. I think as we look at it, the user-facing or front-facing has two chips in it. And there are various sizes. And what you can think of is, on the world facing, there's one chip and it's about an average size. So when -- our expectation is for a handset that has both, front-facing and world-facing compared to one that has just front-facing. We will see a 50% increase in the content per handset. That said again, the new chips are somewhat larger and therefore, carry a higher ASP. So, when you look at old front-facing compared to new front-facing, there is an incremental ASP increase or revenue per handset increase. And I'm not going to get into how much that is or the margin differences between the various products as our customers are listening. And that would not be a wise choice to do. But that said, we continue to drive our costs and supply chain so that we continue to maintain the margins that we've had over the past three years, while at the same time, having the average selling price on existing products, come down over time. So that's our model. And we're going to continue to drive costs. And continue to have margins that we expect on 3D sensing.

Next question comes from George Notter of Jefferies. Please go ahead.

Hi guys. Thanks very much. I guess I wanted to ask about, the supply chain impacts. You mentioned coming into the quarter, you expected more than a $90 million impact in June. I think that was a combo of supply side and end-market impacts, due to COVID. But can you talk about, what you about what you actually saw? And then, -- in the quarter and then, just to confirm, for September, you guys are full speed, full strength in terms of the supply side, from manufacturing perspective?

Yeah. So in the guidance that we provided, the $90 million was a combination of sell of supply and demand. Demand on the side of lasers and 3D sensing and supply across the board, but mainly on transmission. So we did see some strengthening, as we said in the script on 3D sensing and lasers relative to $90 million. And so that's helped with the outperformance to guidance. And then, through the quarter, we saw some of the supply limitations free up, for instance, our contract manufacturer in Malaysia, now is back to full speed. We've added capacity. They've added people. So we're running at full speed there. I will say that, not all the problems are done. I mean we typically have chip shortages or other kind of component shortages from time to time in the normal course. That's kind of where we are today. And there might be a little bit of impact, as demand has been very strong for some of the communication products that are also going into healthcare products. And so, those are the discussions I'm having with senior executives at some of our IC component suppliers. But it's more like the normal chasing of parts and not the factory shutdown kind of thing. So I think from that perspective, you can think of as we went into July and August, we're back to full speed ahead in normal course of business.

The next question comes from Tim Savageaux of Northland Capital Markets. Please go --

Hey, good morning, and congrats on the results, especially once again. Gross margin execution --

Thanks.

My question is strategic in nature. Alan, you mentioned ample cash. You also have a fairly decent share price there. So, I guess, at a high level, I wonder if you could kind of review the company's kind of strategic priorities, given what a success the Oclaro deal has been on the communication side, as you look across industries and areas of focus for Lumentum? And then, I'll ask my follow-up right now since it's potentially related, but only potentially, which is to say, as you look at the emerging market for 400ZR modules. I wonder if you could frame that opportunity for us from a Lumentum perspective. Relative to the module businesses that you exited in Datacom, inside the data center versus the module businesses that you remained in and that have performed well for you on the coherent side, ACO, DCO as people are estimating $1 billion ZR marker over the next few years, I wonder where Lumentum stands relative to that opportunity?

Great, Tim. I'll take the strategic question and ask Chris to cover the ZR market and our perspective on that. I think, obviously, as we said in the script, we have ample cash for continued organic investments as well as inorganic. And we have a process that we are looking at on a regular basis that looks at potential targets in all the industries we participate in, as well as other industries where our technology might mix with something else that could give us a new market to attack. Obviously, nothing to announce here, but I'd say that, to your point, I think the team has done a very, very good job of taking the Oclaro acquisition and really transforming our business into a very high margin, very efficient machine. And I think, that one is 90% behind us. We have a few more things to do there, but I'd say the most of it's behind us, and I think we're ready for more. Again, nothing to announce, but we're looking at everything. And, yes, we have ample cash, and I won't comment on the stock price, but I think there's certainly opportunities there. Chris, do you want to take the ZR question?

Yeah, absolutely. So Tim, the ZR as a product is a sort of a manifestation of trends that we’ve been focused on for several years, it's really in capsule, moving away from discrete components and driving a highly integrated solution based on photonic-integrated circuit to offer high density, which requires small size, low power consumption, et cetera for certain applications, shorter distance, high density, et cetera. That's one of the major reasons why we've decided to get out of the discrete modulator business, as an example and with an underpinning of the Oclaro acquisition getting a leadership position in those photonic-integrated circuits, which we believe our indium phosphide platform offers the best performance possible out there for such types of solutions that customers are looking for. It's definitely a market we are chasing and developing products for and sort of commenting on the market size is I think, it would be a little careful with words of saying $1 billion over few years. I mean $1 billion cumulative, you got to also recognize that these are lower -- relatively on a coherent module, lower ASP product and DCI, which is really the portion of the market that the ZR is focused on has good volume and increasing volume, but it's not the entire market. So, while we are focused on 400-gig ZR, we're also focused on bringing the same kind of capabilities, i.e. low power consumption, small size, but very high-performance to metro applications and other applications using our indium phosphide photonic created circuit capabilities.

The next question is from Christopher Rolland of Susquehanna. Please go ahead.

Thanks guys for the question. If you guys could -- I might have missed it, but if you could give an overall company book-to-bill, I think it was 1.3 exiting March. So, would like to see how that changed. Also if you could talk about lead-times for your products, where have they been traditionally, particularly Telco -- on the Telco side of things? Where have been traditionally and where have they stretched to? And then ultimately, where do you think we can go with that? Thank you.

Sure. Just book-to-bill was over 1 for the quarter even with reduction in bookings for lasers that led us to this guide of down 25% in lasers in Q1. So, I’d say nothing abnormal on book-to-bill, strong demand across the board with the exception of lasers. Lead-times really vary depending on if we're the sole supplier or have $150 million worth of backlog for Datacom. That’s a three quarter lead-time for new products unless they prioritize and shift things around. So, it depends. I'd say that's the extreme and ROADMs vary from the low end ROADM, which is probably more like two months to the high ROADMs which are probably longer than a quarter. Now we’re adding capacity as I said to try to shorten that because I don't think any of our customers have a crystal ball to know what they need four quarters or four months from now let alone four quarters from now. So, we’re trying to provide some additional flexibility, but at the same time, being smart with our investments on capital. So, we're not where we want to be and that's why we're adding capacity and capital.

Great. And then I guess one for Wajid. Where does OpEx go once we normalize here -- once we all, let's say, get our shots next year and travel comes back, where do we ultimately shake out on a run rate? Thank you. Quarterly run rate? Thank you, Wajid.

Yeah. Chris, we're thinking that OpEx will increase a little bit in fiscal year 2021 versus fiscal year 2020, specifically, in R&D from a modeling standpoint, thinking about it in the 20% to 21% of revenue is probably appropriate, but most of the increase will come in R&D.

And the last question today will come from Ryan Koontz of Rosenblatt Securities. Please go ahead.

Thanks for taking the question. I wondered if you could drill down a little bit on the 400-gig cycle in the data center. It sounds like that's a big driver of backlog and some strong statements from the NEMs about optical costs are holding back the cycle. How do you see that playing out with the hyperscale operators? And are you at risk of losing share by -- not by having such a long lead times? Appreciate that. Thanks.

Yes. Thanks, Ryan. So 400-gig is absolutely critical to data center operators to be able to get data center -- I am sorry, compute capacity up, if you will. And we're in a strong leadership position there in that lasers needed for 400-gig are very challenging to make. We certainly get your point about risk of share loss there. That's something that we're certainly managing and ensuring that we're doing the right thing to prioritize customers that we think are the sort of right horse to ride, if you will to ensure that we have the lions share of that opportunity and why we're expanding capacity as aggressively as we are to address those opportunities.

Helpful. Thanks so much. Appreciate it.

This concludes our question-and-answer session. I would like to turn the conference back over to Jim Fanucchi for any closing remarks.

Thank you so much. And that does conclude our call for today. We would like to thank everyone for attending and we do look forward to talking with you again in another few months when we report our first quarter fiscal 2021 results. Thank you, and have a great day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.