18 May 2020
Lumentum’s quarterly revenue falls 12% as COVID-19 exacerbates supply constraints
For fiscal third-quarter 2020 (ended 28 March), Lumentum Holdings Inc of San Jose, CA, USA (which designs and makes photonics products for optical networks and lasers for industrial and consumer markets) has reported revenue of $402.8m, down 12% on $457.8m last quarter and 7% on $432.9m a year ago.
“Results were impacted by the COVID-19 pandemic due to limitations on our ability to supply products to our customers,” notes president & CEO Alan Lowe. Initial guidance (given in early February) assumed that COVID-19 would impact revenue by $15–20m, reducing it to $400–425m, revenue came in at the lower end of this guidance. “We had a larger impact [by more than $10m] than we assumed, due to the spread of the virus beyond China late in the third quarter,” he adds.
“In China, because we had a large number of employees working through the Lunar New Year holiday due to strong demand for our products, we were able to quickly ramp up production from our Shenzhen factory after the extended Lunar New Year holiday. However, our Shenzhen factory was impacted in the third quarter by challenges in obtaining components from third-party suppliers inside and outside of China,” says Lowe.
“In nearly all of our locations around the world, local governments have mandated social distancing measures including shelter-in-place orders. We are deemed an essential business by these local governments due to the key role we play in the global supply chains of critical communications and healthcare systems. As such, we have been encouraged and permitted to continue operations regarding our factories in Asia which perform assembly & test operations,” continues Lowe.
“In Thailand, we rapidly implemented employee protective measures in the third quarter. These measures have not limited output so far, but production in Thailand has been impacted by the same challenges that our Shenzhen factory is experiencing with sourcing components,” notes Lowe.
In Malaysia, Lumentum uses a contract-manufacturing partner for most of its telecom transmission revenue. Output was significantly impacted late in fiscal Q3 due to the government’s movement control order issued on 16 March. “We had no production for several weeks after this,” says Lowe. “As we provide an essential service under the order, we have been able to slowly increase production in Malaysia from zero when the movement control order was issued and expect to reach near 100% production levels in the coming weeks.”
Optical Communications segment revenue already supply constrained before COVID-19
Commercial Laser segment revenue was $43.5m (10.8% of total revenue) in fiscal Q3, down 10.8% on $48.4m last quarter and 20.9% on $55m a year ago due primarily to lower fiber-laser sales.
Optical Communications segment revenue was $359.3m (89.2% of total revenue), down 12.2% on $409.2m last quarter (due primarily to 3D sensing seasonality and COVID-19-related supply limitations) and down 4.9% on $377.9m a year ago (from exiting the datacom transceiver module business, and the COVID-19 supply limitations more than offsetting higher 3D sensing revenue). Revenue from the remaining discontinued datacom transceiver module products was about $5m (and will decline to zero in the next quarter or two, as planned). In April 2019, Lumentum completed the divestiture of several datacom transceiver product lines (manufactured by subsidiary Oclaro Japan Inc) to Shanghai-based Cambridge Industries Group (CIG) in exchange for a long-term strategic supply agreement for Lumentum’s photonic chips.
“On our telecom and datacom product lines, before COVID-19 demand was very strong and accelerating, driven by global telecom infrastructure upgrades, the start of 5G deployments and significant cloud data-center expansion. We were already supply-constrained on most key product lines,” notes Lowe. Despite COVID-19, demand was strong throughout the quarter across telecom transmission, transport and datacom chips. Bookings for these products grew more than 10% sequentially, driving book-to-bill to over 1.3 (up from 1.1 last quarter). However, the COVID-19 outbreak exacerbated existing supply challenges.
Telecom transmission product supply from China and Malaysia was significantly negatively impacted late in fiscal Q3. Telecom and datacom revenue hence fell 6% sequentially. “Despite these supply challenges, we continue to grow our DCO [digital coherent optics] module revenue and our next-generation indium phosphide (InP) high-bandwidth components for 600G and 800G systems,” says Lowe.
Telecom transport revenue was roughly flat quarter-on-quarter. “These product lines are more reliant on Thailand than China for manufacturing operations, but growth was limited by the supply of key components from third parties in China and elsewhere within Asia,” notes Lowe.
Datacom chip revenue continues to grow strongly, rising more than 20% sequentially as data-center and 5G demand was robust.
Industrial & Consumer product revenue was down seasonally by 24% sequentially, but up 40% year-on-year driven by customers incorporating 3D sensing in a higher percentage of their products plus increased consumer demand for 3D-sensing-enabled products. “We steeply ramped volume production of lasers for world-facing cameras or LiDAR for consumer applications,” says Lowe.
Lumentum’s top two customers comprised about 37% of total revenue, with the largest contributing more than $90m per quarter. Huawei contributed $60m. “That’s a supply-constrained number, given the constraints we’re having on ability to provide telecom transport, for that matter, as well as transmission,” notes Lowe. “The demand is higher than that.”
About $100m of targeted $110m annual expense synergies completed during quarter
On a non-GAAP basis, gross margin was 45.5%, down from 47.4% last quarter but up from 39% a year ago. By segment, Optical Communications gross margin was 45%, down from 48% last quarter due to the lower revenue (particularly in Industrial & Consumer) and a less favorable product mix, but up from 38% a year ago aided by improved telecom and datacom margins as well as acquisition synergies. Commercial Lasers gross margin was 49.7%, up from 42.1% last quarter due to a better product mix and lower manufacturing costs.
Operating expenses have been cut further, from $91.8m a year ago and $84.8m last quarter to $82.7m (falling from 21.2% to 20.5% of revenue). Selling, general & administrative (SG&A) expenses were steady at $38.4m. R&D expenses have been cut from $52.8m a year ago and $46.8m last quarter to $44.3m, driven by reduced tradeshow and travel expenses and the realization of additional acquisition synergies (and cutting investment in underperforming product lines). During the quarter, Lumentum completed actions that will result in annual expense synergies of about $100m (of its targeted $110m, with the remaining $10m to be attained over the next few quarters.)
Operating income was $100.7m (operating margin of 25% of revenue), down from $132m (28.8% margin) last quarter but up from $77m (17.8% margin) a year ago (and above the expected margin of 21–23%).
Despite falling from $119.4m ($1.53 per diluted share) last quarter, net income is still up on $70.9m ($0.92 per diluted share) a year ago at $98m ($1.26 per diluted share, above the expected $1.00–1.17).
During fiscal Q3, Lumentum closed the sale of its lithium niobate (LiNbO3)-based optical component wafer fab in San Donato, Italy to China-based Advanced Fiber Resources (Zhuhai) Ltd (AFR) – in fiscal Q3 Lumentum recorded a gain of $13.8m on the sale of product lines – and it continues to ramp down its US-based lithium niobate production. Lithium niobate revenue was about $10m in fiscal Q3 and is expected to fall to almost zero over the next two quarters.
Total cash and short-term investments rose by $135.8m during the quarter, from $1315.6 to $1451.4m. Lumentum has $1.5bn in aggregate principal convertible notes and no term debt. Of these convertible notes, $450m is due in 2024 and $1.05bn is due in 2026. The total cash interest expense associated with these notes is about $6m per year.
Also during fiscal Q3, Lumentum introduced key new telecom datacom products. “These new products leveraged our highly differentiated indium phosphide and gallium arsenide capabilities and included 50G PAM4 vertical-cavity surface-emitting lasers [VCSELs] and directly modulated lasers (DMLs) to enable higher bandwidths, uncooled 100G PAM 4 externally modulated lasers (EMLs) to reduce data-center power consumption, and a wide set of new pump laser products that increase efficiency and power while lowering cost. These address the full range of optical amplifier applications,” says Lowe.
COVID-19 to suppress June-quarter revenue by more than 29% (over $90m)
For fiscal fourth-quarter 2020, Lumentum expects revenue to fall to $325–365m (down 14.7% year-on-year). “We are providing a wider-than-normal revenue range to incorporate uncertainty around our assumptions on the impact of COVID-19. This includes on-going component supply challenges and limited production in Malaysia in the first half of the quarter,” says Lowe. “COVID-19 will impact fourth-quarter revenue by more than $90m at the midpoint of our guidance. This is more than 20% below what we were anticipating for the fourth-quarter before the brunt of our challenges from COVID-19 began,” he adds. “A little more than half of this $90m [$50m] is a result of our inability to supply communication products due to both component sourcing and production limitations, and the balance is from reduced Industrial & Consumer market demand.”
Industrial & Consumer revenue (3D sensing) is expected to fall by more than 40% due to expectations around consumer spending trends in a macro slowdown, the potential for smartphone supply-chain challenges impacting demand for the firm’s products, and potential risk around the timing of new customer programs. “We have a range of new products we are readying to ramp in the second half of the calendar year, including additional world-facing designs that we expect will increase the penetration of world-facing 3D sensing or LiDAR-enabled cameras,” says Lowe. “It is too early to quantify with confidence any impact to consumer volumes or the timing of new programs due to COVID-19... We believe the 3D sensing market will continue to grow over the long term,” he adds. “Mobile device manufacturers continue to make progress on their plans to incorporate front-facing and world-facing capabilities into a wider range of models. We are engaged with a broad range of customers focused on the consumer, industrial and automotive end-markets looking to add 3D sensing or LiDAR capabilities to enable their applications,” Lowe continues. “Our focus is making sure we’re there for our customer when they need us, especially on the new products.”
Telecom and datacom demand remains robust and strong bookings continue, but revenue is expected to be roughly flat due to declines from discontinued products of $6–8m and limitations from the continuing COVID-19-related supply constraints.
Telecom transport revenue is expected to rise sequentially due to progress on relieving supply challenges and new product momentum in the market. “Supply constraints in telecom transmission in Malaysia are improving, but we are not at 100% output yet. We won’t be able to satisfy more than $100m of current backlog we have for these products until the second half of the calendar year,” says Lowe. “Historic transmission business is usually $100–120m per quarter and growing. We’re continuing to get bookings. So, we’re going to end the fiscal year with a very strong backlog.”
Datacom chip revenue is expected to grow, again due to continued strong cloud and 5G market demand, but is still gated by capacity in the firm’s wafer fab.
Commercial Lasers segment revenue should fall by about 20% due to end-market demand, caused by the slowdown in industrial production globally, with declines for fiber lasers exceeding growth in solid-state lasers. “Our solid-state laser revenue expanded nicely quarter-on-quarter and attained levels not seen in nearly two years. This was due to strength in certain semiconductor manufacturing end-markets, including 5G antenna fabrication,” says Lowe. “We expect over the next several quarters that our fiber-lasers business will soften further, as it is tied to growth in global manufacturing,” he adds. “We think it’s several quarters until the global manufacturing infrastructure comes back to normal. We’re at a new lower level for lasers, probably through the calendar year.”
Operating expenses should be reduced by $2–3m. “There will be some travel that starts up again as June rolls around,” notes chief financial officer Wajid Ali. “There certainly is an itch from our sales team as well as our operations team to get back into normal, especially with the number of capital deployments that we’ve got going on specifically at our UK facility as well as Caswell.”
Operating margin is expected to fall to 18–21%, but this is still up on 17.8% a year previously. “Our model improvement is seen in the improving margins in our guidance for the fourth quarter, even with a substantially lower top line and a less rich revenue mix, relative to the prior year,” notes Ali.
“The COVID-19-related revenue reduction lowers projected fourth-quarter earnings by more than $0.50 per share [by more than 35%, from $1.26 in fiscal Q3 to $0.70–0.90 in fiscal Q4],” says Lowe.
Adding staff and capital equipment to restore fab capacity post-COVID-19
Lumentum has received the go-ahead to re-engage its employees in Malaysia, but social distancing limitations prevent it from getting all the way back to 100% with the current headcount. “So, we’re hiring, we’re adding capital equipment,” says Lowe. By the end of May, it should be close to where it was in February.
Lumentum’s wafer fabs in the USA (chips for telecom transport and commercial lasers products), Japan (datacom chips) and the UK (chips for telecom transmission products) are all operating, with some at lower efficiencies than before due to implementing social distancing and other protocols to protect the health of employees. “The lower efficiency in our Japan and UK fabs is limiting our ability to grow to meet strong and increasing customer demand. We need to be able to get more wafers out and improve the yields and drive the cost and things like that,” says Lowe. “We are hiring and adding capital equipment to increase our capacity, but this takes time. As we enter into July and August, we should be back to near-normal,” he reckons.
“We use third-party fabs in Taiwan, the USA and the UK for 3D sensing and have not seen any impact in our ability to meet customer demand for these products,” notes Lowe.
“While the COVID-19 pandemic is currently impacting our ability to satisfy strong customer demand for our communications products, we believe the world’s experience with COVID-19 will accelerate the shift to increasingly digital and virtual approaches to work, education, healthcare, entertainment, social interaction and commerce around the world,” says Lowe. “This accelerating shift will stress the world’s communications and cloud networks and should, therefore, drive the need for higher volumes of high-performance optical devices. This will favorably impact our communication business, as well as our laser and 3D sensing lines of business over the long run, as more secure devices and other hardware that are easier to interact with and more autonomous will be needed to consume, produce and communicate digital and virtual content.