Q2 2025 Earnings Call Transcript

Good day, everyone, and welcome to Lumentum Holdings Second Quarter Fiscal Year 2025 Earnings Call. All participants will be in a listen-only mode. Please also note today's event is being recorded for replay purposes. At this time, I would like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, go ahead.

Thank you and welcome to Lumentum's fiscal second quarter 2025 earnings call. This is Kathy Ta, Lumentum's Vice President of Investor Relations. Joining me today are Alan Lowe, President and Chief Executive Officer; Wajid Ali, Executive Vice President and Chief Financial Officer; and Chris Coldren, Senior Vice President and Chief Strategy and Corporate Development Officer. Today's call will include forward-looking statements, including statements regarding our strategies, trends, and expectations for our products and technologies, including demand, our customers, our end markets, end market opportunities, our expectations and beliefs regarding recent acquisitions, including Cloud Light, macroeconomic trends and our expected financial and operating performance, including our guidance, as well as statements regarding our future revenues, financial model, and margin targets.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risk factors described in our SEC filings. We encourage you to review our most recent filings with the SEC, particularly the risk factors described in our most recent 10-K and in our 10-Q that will be filed soon. 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 that unless otherwise stated, all financial 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 fiscal second quarter results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. With that, I'll turn the call over to Alan.

Thank you, Kathy, and good afternoon, everyone. Before reviewing our second quarter results, I want to address the leadership transition announced earlier this week. After a decade as Lumentum's CEO, I am retiring from my role effective tomorrow and Michael Hurlston is succeeding me and joining our Board of Directors. Leading Lumentum over the past 18 years, first at our predecessor company and then as a standalone public company, has been a privilege.

I am proud of our market leading innovations, strong customer relationships and best-in-class manufacturing. We have transformed Lumentum and the photonics industry, positioning the company for continued growth. The Board and I believe that this is the right time for a leadership transition and that Michael is the right leader for the next chapter at Lumentum. His global experience, semiconductor and optical communications background and track record of driving sustained profitable growth make him uniquely qualified to lead Lumentum forward.

He steps in at a time of financial and operational strength and I am confident in his ability to build upon our momentum. Serving as Lumentum's CEO has been the highlight of my career and I am deeply grateful to our talented team who has positioned us for sustained growth. I look forward to continuing my role on Lumentum's Board and to serving as an advisor to the company to ensure a smooth transition. With that, I'd like to turn to the second quarter.

In the second quarter, we exceeded the high end of our guidance range for both revenue and earnings per share. This level of performance was driven by robust demand from cloud customers, both inside the data centers as well as interconnecting data centers along with an overall improving networking market. And we're just getting started. This is an exciting time for Lumentum as we position ourselves to capitalize on the rapidly expanding cloud market, where our photonics technologies play a vital role.

Our photonics innovations are clearly essential to scaling compute capacity within data centers for the AI era today and into the future. Optical links enable ultra-high speed, low latency, and energy efficient data transmission in today's scale out networks. In the coming years, we believe transitioning to optical links will be essential to meeting the rapidly growing needs of scale up networks where data bandwidths are significantly larger than scale out networks. The rapid growth of compute capacity inside data centers will also drive rapid growth in data center interconnects or DCI.

Cloud operators are increasingly building and planning many more and geographically dispersed interconnected data centers to address space and power availability. These require high capacity, long distance optical links, which leverage the same core technologies we have developed over several decades for telecom networks. As we indicated on our last call, demand for our components and subsystems for data center interconnect is strengthening, and we have been ramping production to fill this strong demand. We are making significant progress in advancing our cloud business through our three-pronged strategy.

First, we are successfully expanding our customer base in the cloud and AI markets. Second, we are scaling capacity for our highly differentiated laser transmitter chips in our indium phosphide wafer fabs and optical circuit switch and transceiver production capacity in our proven factories outside of China to meet the rising demand. And third, we are partnering with our cloud operator and AI infrastructure customers to develop game changing optical solutions that shape their long-term technology roadmaps. With this focused approach, we are uniquely positioned to drive growth and deliver sustained value in the rapidly accelerating AI cloud era.

Before discussing the second quarter details, I want to address the recent news related to DeepSeek. Discussions with cloud customers reinforce that advancements in software efficiency are key to the long-term viability of the AI business model, just as efficiency gains in optical data transmission are essential for enabling AI in data centers. These reports on improved efficiencies highlight a positive trend that strengthens the AI market for both our customers and our business. Now, let me move to additional fiscal second quarter revenue and product highlights, starting with Cloud and Networking.

Our second quarter Cloud and Networking segment revenue grew 20% sequentially and 18% year-over-year, primarily driven by strong end market demand from cloud hyperscale customers. We saw sequential increases in nearly all of our Cloud and Networking product lines. In Q2, Datacom transceiver revenue grew sequentially as expected, driven by an increase in shipments to our largest cloud hyperscale customer and the start of volume production shipments to one of our new customers we highlighted on prior calls. We continue qualification work with the other new customer and expect to start initial volume production during the fourth quarter continuing to ramp through the first half of fiscal '26. Transceiver manufacturing capacity expansion is also progressing as planned.

Complementing our existing production lines in Thailand, construction of our large new three-storey facility and cleanroom on the same campus is well underway, with the first floor completed and ready for tool installation. We achieved another record for EML unit shipments in Q2 and began delivering 200G lane speed EMLs to multiple customers. Based on the breadth of our 200G EML design wins, we expect to gain additional laser transmitter market share in the upcoming wave of 800G and 1.6T transceivers, utilizing the more efficient 200G EMLs for AI applications. Complementing our EMLs are our new 200G lens integrated photodetector arrays, which adds to our content opportunity in next generation 800G and 1.6T transceivers as well as strengthens our vertical integration strategy for our own cloud modules.

Our wafer fab expansion plans to enable higher volumes of EMLs and other indium phosphide lasers and photodetectors continues to be on track. We still anticipate that demand for our EML chips will continue to exceed supply at least into calendar year 2026. We are experiencing strengthening demand for our DCI products as well as long haul transmission and transport solutions. These product lines, historically classified as telecom products, are increasingly utilized by cloud customers, often indirectly through our network equipment manufacturing customers. Engagement with cloud customers and AI infrastructure providers on their long-term technology and product roadmap has reached an all-time high.

As part of one collaboration, we began shipping preproduction volumes of our unique ultra-high power lasers to an AI infrastructure customer for a proprietary interconnect solution in Q2 and have received follow-on orders as well as excellent feedback on the product's performance. This is a very exciting opportunity. Looking ahead to Q3, we anticipate strong sequential growth in our Cloud and Networking revenue, primarily driven by capacity additions, ramping up new customer programs and improving demand from network equipment manufacturers. Now let me move to our Industrial Tech segment.

Industrial Tech segment revenue increased 15% sequentially, while being down 21% from the same quarter last year. The sequential increase was driven by higher industrial laser shipments, partially offset by seasonally lower 3D sensing shipments. The year-over-year revenue trend reflects that demand continues to be challenged due to the weak industrial end market. In Industrial Tech, we remain committed to developing innovative laser solutions that address customers' growing demand for high precision and speed.

Our latest generation of 26 kilowatt fiber lasers, our most powerful yet, delivers cutting speeds up to three times faster than its predecessor. We have shipped sample units to a key customer and are receiving very positive feedback. In Q2, ultrafast laser shipments reached a new record, driven primarily by growing demand from a leading tool supplier for high volume solar cell manufacturing. We are also actively engaged with customers on new ultrafast laser opportunities as this technology gains traction in advanced packaging, displays and emerging semiconductor processes.

Looking ahead to fiscal Q3, we anticipate a sequential decline in Industrial Tech revenue due to the challenging macroeconomic environment affecting industrial laser demand as well as a seasonal decline in 3D sensing revenue. In summary, we have made significant progress in executing our strategy to grow our cloud business. In Q2, we began to ramp our cloud transceiver volumes to our largest customer and one of our new customers and we set another new record for EML shipments, including new 200G lane speed variance. We are working diligently to further expand capacity for many of our products over the next several quarters and to complete qualifications on key new customer programs.

Our robust pipeline of cloud customer engagements, coupled with improving trends with our network equipment manufacturing customers, strengthens our confidence in achieving our previously stated goal of reaching $500 million in quarterly revenue by the end of calendar 2025. Looking beyond, we expect significant growth in the years ahead as we capitalize on emerging opportunities in cloud and AI. Before I hand the call over to Wajid, I want to take a moment to express my sincere gratitude to all of our employees for their unwavering focus and dedication and to our customers worldwide for their trust, partnership and collaboration.

With that, Wajid?

Thank you, Alan. Second quarter revenue of $402.2 million and non-GAAP EPS of $0.42 were above the high end of our guidance ranges. GAAP gross margin for the second quarter was 24.8%, GAAP operating loss was 12.8% and GAAP net loss per share was $0.88. Turning to our non-GAAP results. Second quarter non-GAAP gross margin was 32.3%, which was slightly down sequentially, but up year-on-year due to product mix.

In future quarters, we anticipate company gross margins will sequentially increase as manufacturing utilization improves as well as an increase in Datacom laser shipments. Second quarter non-GAAP operating margin was 7.9%, which was up 490 basis points sequentially and up 600 basis points year-on-year, primarily driven by improved Cloud and Networking profitability and lower SG&A expenses. Second quarter non-GAAP operating profit was $31.7 million and adjusted EBITDA was $57.6 million. Second quarter non-GAAP operating expenses totaled $98.3 million or 24.4% of revenue, a decrease of $2.1 million from the first quarter and a decrease of $9.9 million from the year ago quarter.

This substantial reduction in operating expenses was achieved driven by the restructuring actions that were taken during fiscal 2024 as well as overall stringent cost controls across the company and despite increased investment in our expanding cloud opportunities. Q2 non-GAAP SG&A expense was $35.9 million. Non-GAAP R&D expense was $62.4 million. Interest and other income was $4.2 million on a non-GAAP basis.

Second quarter non-GAAP net income was $30 million and non-GAAP diluted net income per share was $0.42. Our fully diluted share count for the second quarter was 71.6 million shares on a non-GAAP basis. During the second quarter, our cash and short-term investments decreased by $19 million to $897 million. Our inventory levels were approximately flat sequentially despite the expected growth in our Cloud and Networking revenue. In Q2, we invested $65 million in CapEx, primarily focused on expanding cleanroom capacity at our Thailand manufacturing site and increasing equipment capacity for indium phosphide wafer production to support EML chip manufacturing.

Nearly all of our CapEx investment was directed toward our Cloud and Networking business. Turning to segment details. Second quarter Cloud and Networking segment revenue at $339.2 million increased 20% sequentially and 18% year-on-year. Cloud and Networking segment profit at 16.2% increased 330 basis points sequentially and increased 610 basis points year-on-year on higher revenue.

Our second quarter Industrial Tech segment revenue at $63 million was up 15% sequentially and down 21% year-on-year. Second quarter Industrial Tech segment profit of 6.2% increased sequentially on higher revenue and decreased year-on-year on lower revenue. Now let me move to our guidance for the third quarter of fiscal '25, which is on a non-GAAP basis and is based on our assumptions as of today. We expect net revenue for the third quarter of fiscal '25 to be in the range of $410 million to $425 million.

This Q3 revenue forecast includes the following assumptions. Cloud and Networking to be up sequentially with strong growth in products addressing cloud applications and improving network customer demand and Industrial Tech to be down sequentially by approximately $10 million with declines in both commercial lasers and 3D sensing. In Q3, operating expenses are expected to increase sequentially based on our typical annual fringe rate increase. Based on this, we project third quarter non-GAAP operating margin to be in the range of 9.5% to 10.5% and diluted net income per share to be in the range of $0.47 to $0.53. Our non-GAAP EPS guidance for the third quarter is based on a non-GAAP annual effective tax rate of 16.5%.

These projections also assume an approximate share count of 73 million shares. With that, I'll turn the call back to Kathy to start the Q&A session. Kathy?

Thank you, Wajid. To allow everyone an opportunity to ask questions, we ask that you please keep to one question and one follow-up. Sierra, let's begin the Q&A session.

Absolutely. We will now begin the Q&A session. [Operator Instructions] Our first question today comes from Samik Chatterjee with JPMorgan. Your line is now open.

Hi. Thank you for taking my question. Maybe for the first one and Wajid you did mention this in your prepared remarks, but maybe I need to sort of clarification on this. In terms of the sequential revenue increase from December to March, Cloud and Networking is the segment that's driving that by about $25 million or so quarter-over-quarter at the midpoint.

Can you just outline the drivers there between Cloud Light or transceivers versus Datacom chips versus Telecom? Just wanted to get a relatively sort of ballpark in terms of how should we rank out of those three in relation to contribution to the sequential increase they're expecting? I know you mentioned this in the remarks, maybe I missed it. Thank you.

And I have a follow-up.

Yes, sure, Samik. So, yes, so your math is correct. We are increasing or expected to increase by $25 million in our Cloud and Networking business. And actually we have demand that far surpasses that.

We're actually having some supply chain shortages on some critical components that's keeping that a little bit lower. We could have probably seen a double-digit increase sequentially quarter-over-quarter had we not had some of those supply chain shortages. In terms of rank ordering, the Datacom business is really what's driving the growth quarter-over-quarter, both Datacom chips and Transceivers. We've got some new products, both on the chips side as well as the Transceiver side that are going to be ramping through the quarter.

So it's difficult to kind of split out which one will do more or less, but both of them are growing sequentially. We are seeing some inventory drawdowns as well in our overall Telecom business, so that's aiding a little bit of growth as well. And then on the Industrial Tech segment like we prepared in our like we mentioned in our prepared remarks, we're expecting to come down by about $10 million driven by both 3D sensing as well as Industrial Lasers.

Got it.

Samik, did you have a follow-up?

Maybe for my follow-up. Yes, please. For my follow-up, you mentioned the 200 gig EML, you can see sort of demand being ahead of capacity or supply by even by end of calendar '26. Just wondering if you can I know you're doing capacity expansion on that front? Can you give us a reference point of where you expect your capacity to be by the end of calendar '26, maybe in reference to either end of 2024 calendar year or like the June '24 fiscal '24 end like how should we think about the pace of capacity increase that you're planning and demand sort of still outstripping that?

And what do you expect to sort of see in 100 gig EMLs and demand for 100 gigs as you ramp to 100 gig at that point? Thank you.

Yes, sure, Samik. This is Alan. We're still on track to what we've been saying, which was 40% or higher growth from the June quarter of calendar '24 to the June quarter of calendar '25 and then another 40% by the end of calendar '25. So, that's for all 100 gig and 200 gig. I think we were in our prepared remarks, we talked about being overall supply constrained, not 200 gig because we can start a 200 gig wafer or a 100 gig wafer just the same.

So, we're just overall the demand is outstripping even that 40% compounded twice in an 18 month period of time. We do have additional capacity expansion beyond the end of calendar '25 obviously and those are investments that we've made over the past several quarters that come online in calendar '25, which will give us increased capacity as well. So not going to get into the details of that because we're going to monitor the demand outlook. But suffice it to say, we're expediting tool deliveries so that we can bring up tools as well as move to larger wafer sizes.

So everything is on track and going very well.

Thank you, Samik.

Got it. Got it. And Alan congrats on the retirement. Thank you.

Thanks, Samik.

Our next question comes from Tom O'Malley with Barclays. Your line is now open.

Hey, guys. Thanks for taking my question. I wanted to echo the congrats to Alan. Go Raiders, hopefully, you have a little more time in retirement to watch hopefully some better football than you did for the last ten years.

So with that, I'll kick off on the business side. I wanted to start with your comments on Q2. So you talked about shipping to a proprietary interconnect customer and an exciting opportunity. I think you hinted at this a little bit in the past, but maybe could you just explore that a bit more? Is that on the laser side?

Is that on the module side? Any additional color there would be helpful.

Yes. I'm not going to give too much color on it, Tom, just because it is proprietary as we said in the prepared remarks. But suffice it to say, it's a ultra-high power laser. So you can imagine a larger indium phosphide chip and placed on a carrier.

So it's between a chip and a module and that it's today the product that we're shipping is a chip on carrier with very high power and a unique technology that we've had developed over the years and are now shipping. I would say preproduction volume with forecasts for more meaningful volume throughout calendar '25 and then real extremely high volume in calendar '26. So, feedback is very positive. The performance is very unique and the line width that we produce with the laser is superior to anything in the market. So, we're very excited to be working with a very leading edge customer.

And I think I'll just leave it at that.

Helpful. And then you talked about so you have one customer that's ramping already in December. You have another customer that's coming online closer to the end of the fiscal year. This opportunity sounds like there's some goodness in '25, but really more of a '26 story.

You guys kept the commentary around the $500 million at some point in the calendar year '25. Was that just you regurgitating that statement? Does it mean Q4 or could you possibly get there earlier? I was just surprised you kind of kept the same language as you did before. Thank you.

Well, we don't want to get you guys ahead of our expectations. And so we've been consistent. So I don't know about regurgitating it, but we've been repeating it. And so I think as we've shown in the December quarter, we exceeded our guidance range.

And I think with the pipeline of new products and the capacity that's coming online, absent what Wajid talked about, which is supply constraints from our suppliers. We just wanted to reiterate that we're well on track to be able to achieve $500 million by the end of the calendar year. And if Michael comes in and does better than that, good for Michael.

Appreciate it. Thanks a lot, guys.

Thanks, Tom.

Thanks, Tom.

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

Great. Thank you very much for taking the question. I've got two. First one is, I wanted to see if you could speak a little bit to your thoughts and comments on the prospects for Co-Package Optics or CPO, thinking about really an intermediate and long-term because obviously it's not going to affect momentum in the near-term. And then I've got a follow-up.

Sure, Simon. I'll take a stab at it and Alan can come in as well. Co-Packaged Optics, I think maybe important to highlight is, it's really a solution to scaling short distance, frankly, electrical links to speeds beyond 200 gig per lane. That's really where the value comes in that being able to drive the switch silicon or even GPU, TPU out from where it is on the circuit board out to the edge of the circuit board where pluggable transceivers would typically be is very challenging at those speeds.

So if you can move the optics in close proximity, that enables overcoming electrical speed scaling. In that process, obviously, you're still not going to need lasers, you're still going to need optics. So, we don't see the optical content going down. And as to the prior question that Alan addressed, our unique capabilities in high power lasers to enable CPO, we believe this is actually an opportunity for us.

I know folks are concerned, hey, does that reduce or cannibalize transceiver volumes over time. I think the reality is enabling scaling from power consumption and speed standpoint ultimately just like the comment on DeepSeek just like similar questions on optical circuits, which is, if we can make data centers more efficient, we can live within power envelopes, data centers can get bigger and then there are more optics overall. So I think it's a good thing. But I'd also highlight for Lumentum a little bit of a unique situation where we're more modest share on transceivers today and share gaining, if you will, over time.

So even if there is some cannibalization in the mid to long-term, we don't think it impacts our transceiver opportunity and creates an expanded opportunity for high power lasers.

Great. Thanks. And then just as a follow-up. We've had a number of data points recently that the telco demand is recovering and you mentioned inventory draw downs.

It sounds to us like that business was probably over $200 million for you in the December quarter. And I guess I'm just looking for maybe a little bit more of a drill down in that I interpreted your comment on your outlook to be more about inventory normalizing, whereas some of the others in the supply chain have sounded a little bit more upbeat. Maybe that's nuance, but how are you thinking about that and maybe any quantification you can offer on telco? Thank you.

Yes. I'd say that the past two years of talking about inventory in the channel and at our customers and at their customers, I think that discussion is over. So I'd say we're shipping in what they're shipping out today. That said, I'd say what we have typically called telecom is also interconnecting data centers.

And so the data center interconnect and the networks that are interconnecting these data centers is showing very, very strong demand. And so DCIs and the components as well as ROADMs amplifiers and longer haul coherent transmission connecting further apart data centers is very strong. So I would say that we did see an uptick, obviously, in telecom or to what we traditionally have called telecom and see strong demand going forward. It's just not getting back to the peak levels that we had early in the pandemic when I think we were over shipping at the time.

So we're excited. We think it's a good opportunity for us. And as more and more data centers get built, more and more submarine cables are being laid and more and more data center interconnects and longer haul terrestrial networks are being deployed to connect those.

Thanks, Simon.

Thank you. And Alan congratulations. We'll miss you.

Thanks, Simon.

Our next question comes from George Notter with Jefferies. Your line is now open.

Hi. Thanks a lot guys. Alan, congratulations, well deserved. Looking forward to working with Michael here also. All right. So on the question I have is just on the Transceiver business. Your largest transceiver customer, are you now fully through that product transition? And was that fully in the quarter?

No, I'd say that there's a pipeline of new products. So some are coming up in the December quarter, some are coming up this quarter and next. And so I wouldn't say we're done with it. We're making progress.

And as new products get introduced into the factory and we start ramping them, we'll see the revenue continue to grow at our largest transceiver customers. So still a lot of work to do on new products and new developments, but we're encouraged by the progress to-date.

Got it. And then could you just give us a sense on the milestones for the additional cloud provider customers you guys have won? I heard what you said certainly about shipping to one of those new customers. But is there what's gating your ability to ship to that customer?

And then the third customer win, again, what do the milestones look like in terms of going from here to more significant volumes? Thanks.

Yes, I'd say we started shipping in the December quarter, as we talked about in the earlier scripts, and are working on additional products with that customer and are in qualification efforts there. So we expect to grow that business with that first customer that we started shipping in December, over the calendar year. I'd say the other customers that we haven't started shipping that we talked about beginning to ship production in the fourth fiscal quarter is just time. I mean you do a set of qualification builds and you start testing them and you put them in chambers and really stress them for several hundreds, if not thousands of hours, and that's what we're waiting through to get through.

So just nothing off track there. Customers still pulling hard and hoping the clock goes faster than normal, but you can't make the clock go faster. So I think from our perspective, exciting times, additional opportunities at those customers, but as well working with other customers that we really haven't talked about at this phase. But I think over the calendar year, we'll talk about fourth customer, hopefully, a fifth customer.

Great. Thank you.

Thanks, George.

Next question comes from Meta Marshall with Morgan Stanley. Your line is now open.

Great. Thanks. Maybe just a question on gross margins. Wajid, you gave some detail, but just should we consider kind of the sequential downtick more mix or just kind of working through yields as you expand capacity?

And then just maybe as a second question, building on what George just asked. Just how should we think about kind of the relative size of customer in two and three as they ramp maybe in comparison to one? Thank you.

Sure. So, Meta, so gross margins actually were favorable from a product mix standpoint because of the incremental EMLs that we shipped in fiscal Q2. And actually, as part of our guide into Q3, the increased shipments of EMLs are certainly helping us. In contrast to that, we were ramping up new products both in Thailand and in Dongguan related to current customers and future customers for the transceiver part of our business. And we had initial ramp-up yield issues that occurred there that we're working through.

And so that was a headwind to us during the quarter. We think we're behind that. And so we should see a sequential increase in gross margins moving into Q3. And then as capacity improves, again, in our June quarter, we should see a tailwind related to increased EML shipments on our gross margins as well. So generally, we should be moving up.

But during the quarter, initial yield issues related to new products was a headwind for us.

Yes, I'd say just to add to that, I'd say that the start-up costs in Thailand, where we have large infrastructure and production lines going in are highly underutilized. And so there's a headwind with respect to that. And as that utilization rate of those equipment and production lines increases, that should help dramatically there. And so we're actually getting ready for the new products and new customers, but also putting in place infrastructure in Thailand to actually move production out of China into Thailand.

So once that happens, we'll be in a much, much better position to increase gross margins as Wajid said.

And just on the thinking about -- customer.

Sorry, second question.

Yes.

Yes, relative sorry, sorry. Yes. So I would say that certainly the opportunity at customer two and three are large. They certainly could be as big, if not larger than our opportunity that we have with our first customer.

So I'd say these are very, very large customers that are deploying very large and many, many data centers. And so I'm not so concerned about overall demand. We need to get through the qualifications and ramp them up throughout the calendar year.

Great. Thanks.

Thanks, Meta.

Our next question comes from Ruben Roy with Stifel. Your line is now open.

Thank you. Congrats, Alan. First question for Alan or Wajid on the supply chain commentary. What's your line of sight on that? Could you give us any more details on what it is that's short? Is it related to transceiver specifically, the ingredients at short or is it more widespread? And you see that kind of constraint extending further into the year beyond the March quarter?

Yes. So it doesn't have to do with transceivers. It has to do with some telecom products. And the situation is over the last two plus years as we've been throttling back our production, our suppliers throttle back their production and shuttered factories.

And so a couple of quarters ago as the demand started picking up, they try to add capacity and try to meet the demand, but it far outstripped their ability in their smaller footprint. So we're working with our suppliers to help them get up the curve as well as qualify other alternative suppliers. But the worldwide shortage of things like hermetic packages is creating a challenge for the kinds of volumes that our customers are looking for especially in coherent components and narrow line with lasers. And so if we have those packages and we could get them more readily, we could grow, as Wajid said, double-digits quarter-on-quarter.

It is going to hamper us in both the March quarter as well as the June quarter and we're working diligently to minimize that impact in the June quarter, but the March quarter is what it is because we need those deliveries now in order to turn products for the quarter and we have a limited supply and ability to get that for example. Does that answer your question, Ruben?

Thank you. Yes, absolutely. Thanks, Alan. Just a quick follow-up.

Just thinking through the ramp of 200 gig per lane EML lasers for this year and maybe beyond this year. I would assume there's demand for those lasers in 800 gig transceivers as well as obviously 1.6. Is that the right way to think about it or is that going to be sort of more of a production ramp for you as we get to 1.6T transceivers?

Yes. There's designs that we're working on that have 200 gig lane speeds at 800 gig as well as 1.6T as well as working with our module customers to provide that technology to them for the first generation of 200 gig lane speeds. And so I'd say that's step one and those products are in the qualification phase today and should ramp up in the second half more meaningfully of the calendar year. Right behind that we're working on and sampling customers with our differential 200 gig EMLs and the feedback has been very positive as that's another avenue for our customers and the data centers to drive down power consumption.

And so that is really a winning product and that I think we're in a leadership position there to really take advantage of the years and years of technology development that we have in our EML business in Japan.

Perfect. Great. Thank you, Alan.

Yes. Sorry, just one thing to add, Ruben. We're also in the works to create high power CW lasers to address the silicon photonics market and our internal consumption which most all of our transceivers we build today are silicon photonics and need those high power CW lasers. And so we're working on that as well.

And as we grow our wafer fabs, in Japan, we'll be able to continue with the 200 gig EMLs, the CW lasers. And as I talked about, the photodetector arrays that will really give us a lot of content for our customers, but also for our internal vertical integration.

I guess if you added that, Alan, maybe I'll sneak in. What's your expectations for mix as we progress through this year on EML versus SiPho?

From a chip standpoint, very little CW lasers for Sipho because of the strong demand in EMLs. From a consumption standpoint in our transceivers, vast majority is CW lasers for silicon photonics, but we are designing EML based transceivers there will probably be more late calendar year than anything before that. So the vast majority of our designs that are in production and about to enter production are silicon photonic based.

Got it. Thanks for all that detail, Alan. Thanks.

Thanks, Ruben.

All right. Thanks, Ruben.

Thank you.

Our next question comes from David Vogt with UBS. Your line is now open.

Great. Thanks, guys, for taking my question. And Alan we wish you well in your next endeavor. Wajid, can I go back to gross margin for a second.

So it sounds like, obviously, Industrial is much stronger, which carries a stronger gross margin. I guess I'm trying to understand the mix comment on why gross margins were down sequentially. Does that mean are you referring that the Transceiver business grew significantly faster than Datacom in the quarter? Just trying to figure out kind of the stack ranking of how that played out.

And I'll give you my second question, because it's more thematic. We haven't heard anything about tariffs recently from a lot of companies. I know things are paused. We just love to kind of get your perspective, maybe not so much from the China, Thailand dynamic, but other markets that may be affected like Mexico.

So just kind of what your thoughts are there and how you guys are thinking about that as we move through the early part of '25. Thanks.

Sure. I'll get started and then Alan is welcome to chip in. So, yes, so during the quarter, we had some yield issues related to new product ramps within our Transceiver business. That probably was a headwind of anywhere from 100 to 150 basis points.

In addition to that, as Alan mentioned, we had quite a bit of infrastructure that we're putting in inside of Thailand that also negatively impacted us because the utilization is not there and we're expecting that utilization to improve in the back half of the fiscal year. So that's really what happened in Q2. And had that not happened, we would have actually seen gross margins improve in Q2 sequentially versus Q1. Moving into Q3, as some of those ramp issues are behind us, we expect that gross margins will improve into Q3, primarily because of the increased supply we have of EMLs. We won't be actually able to even meet all the allocation of demand throughout the calendar year.

So really it's all about what our Sagamihara facility in Japan can actually produce from a supply standpoint as much as they can produce. That's as much as our gross margins will improve quarter-over-quarter and we expect that to happen both in March and in June. As far as your questions on tariffs are concerned. So we've taken a look at the impact of tariffs, both from a supply chain standpoint as well as the impact to our customers, we've incorporated a very nominal impact in our operating margin guidance that we provided for Q3. And the primary reason for that is because our footprint in China is quite minimal, right?

We have some production that happens in China and then those components are integrated into bigger components, bigger products at our Thailand facility. And then most of the shipments happen from Thailand, even if they are to the US or to Mexico as well. And then much of the growth that we're seeing is shipments that are coming from Japan as well as from Caswell for the transmission products that we have. So because of that, at least in the short to mid-term, unless policy changes, happen at a government level, we're not expecting much of an impact.

Obviously, our customers that are importers of records will see some impact and that may have some longer-term consequences for the industry worldwide, but at least for this fiscal year, given what we know, we don't expect much impact from tariffs.

Yes. I think that's great, Wajid.

Great. Thanks, Wajid.

Thanks, David.

Thanks, David.

Alan, good luck.

Thanks, David.

Our next question comes from Ryan Koontz with Needham & Company. Your line is now open.

Great. Thanks for the question. I wanted to follow back up on your comments around DCI. We heard some pretty frothy numbers from others reporting over the last couple of months about volumes picking up there and it seems like we're well on our way to kind of see some substitution from traditional systems over to pluggables.

I wonder if you can comment on your CapEx exposure, your BOM exposure as it relates to systems versus pluggables. And do you feel like that can provide a tailwind to revenue growth even if CapEx numbers aren't going up as fast? Thank you.

Yes. I actually don't think it's cannibalizing as much as it is adding to the coherent transmission in the market. And you're right, I think, the boom of today, 400 gig and soon to be 800 gig ZRs is phenomenal. And we're adding, in our factory, capital to be able to meet the demand from our customers who make the ZR modules.

So a lot of our components are critically enabling the ZR market and we just don't have enough capacity and we're being impacted by the supplier shortages that I talked about earlier. So I'd say, from our perspective, it's additive. We have -- we do have a strong position with what you call traditional coherent in the very, very high speed stuff that we're seeing actually strengthening of the very high gigabaud both modulators and tunable lasers to address that market. So I'd say across the board, new products are doing well.

ZRs are doing very well. We're having to add capital to our factories to be able to meet the needs of both markets that are growing.

That's great. Thanks. And a quick follow-up if I could around the space industry. Are you seeing much interest in these kind of space satellite to satellite communications for free space optics?

We do have some business with the satellite customers. It's relatively small, but growing. And I think we have an opportunity to expand our footprint there. I think it's relatively small though based relative to data centers and in fact data center interconnect or any of the other product lines that we have.

Sure. All right. Great, Alan. Thanks and congrats on the retirement.

Great. Thanks, Ryan.

Thanks, Ryan.

Our next question comes from Karl Ackerman with BNP. Your line is now open.

Yes. Thank you. And Alan congrats on the next opportunity in front of you.

Thanks, Karl.

I was hoping you kind of remind us whether the. Sure. I was hoping you could remind us whether the new Datacom transceiver wins you have from two additional hyperscalers are only 800G or could they be early samples of 1.6T? And I was hoping as you addressed that question whether your Datacom opportunity is inhibited just in the March quarter from EML bottlenecks, like you noted, Wajid, or if it's an issue that could persist through the first half of the year?

Thank you.

Yes, Karl, I'll take the first part. The new customers that we're talking about are slower speeds than 1.6T. So I'd say 1.6T for most of the hyperscalers is really late this year, if not calendar 2026. We are working on 1.6T with multiple customers, but that's really not what we're talking about when we talk about customer number two and customer number three. To your second question, we're gating our module customers ability to grow their Transceiver business by the lack of worldwide indium phosphide for EMLs and CW lasers, quite frankly, we're having challenges actually getting enough CW lasers for our own transceivers.

So that is actually impacting us on the short-term this quarter, hope to have that resolved in the June quarter. So we're feeling the impact and that's why we're now working more diligently to get CW lasers up in our factory so we can control that supply chain more effectively. So did that answer your question or was it a different question around EMLs.

It did. If I may speak within then that's tangential to that. Just I guess how to think about CapEx. On one hand, the first half of this year, you've spent the same amount of CapEx you spent all of last year. And so as you contemplate building out the remaining area of Thailand, how should we think about the CapEx trajectory from here? Thank you.

Yes. So great question. So probably in the back half of our fiscal year, we will spend about the same amount in CapEx that we did in the first part of the fiscal year. In terms of our ordering patterns, the cash out might be a little bit later.

Most of those investments will be around expanding our capacity for Datacom chips. So for EML shipments. We're well on our way to the infrastructure builds that we need for our transceiver production. We have some equipment that we need to order against that.

But most of that CapEx that we're going to buy in the back half of this fiscal year will be related to EML capacity expansion. Because as you asked earlier, we're expecting to be in allocation to our customers all the way through this calendar year. And so in order to mitigate that as we move into calendar '26, we're starting the purchases of CapEx to expand that capacity further.

Thank you.

Thanks, Karl.

Our next question comes from Ananda Baruah with Loop Capital. Your line is now open.

Thanks, guys, for taking the questions. And, Alan, we'll miss working with you. Congrats on retirement.

Thanks, Ananda.

Two, I guess real quick and I can ask them both at the same time. Yes, you're welcome, Alan. I'll ask those at the same time. On the new ramping customer, can you give us some sense of time frame when you think that it hits run rate and or any context around what run rate I know this is probably kind of somewhat project based, but when you think it hits run rate, what time frame?

And then the second one is sounds like this year, calendar year '25, you're not going to run into sort of congestion between your EML chips and your own transceivers since they're largely SiPho based right now. But how do you think maybe in '26 calendar about balancing out EML sort of like third-party EML selling and your own transceiver like Lumentum Cloud Light branded transceiver shipments? Some context there would be great. Thanks.

Sure. As far as the new customer reaching run rate, I'd say that's going to take some time. So don't be raising your projections for that customer. But as I said earlier, we're qualifying a second product there that should come on by the end of the calendar year.

So I'd say around the end of the calendar year, we should be in full motion with that customer. And then as we talked about in the script, the third customer start production in fiscal Q4 and really hit run rate, I'd say, by the fall time. So September, October. That product is scheduled to ramp significantly faster.

So that's the ramp color. As far as, yes, we don't have any conflict of interest with respect to where do we allocate EMLs, although between our customers, there's a challenge for sure. But I'd say as we add additional capacity and we're doing that aggressively, we should be able to, number one, get CW lasers internally produced for our new products as well as the photodetectors, which are critically enabling and in shortage today at 200 gig. And so that should become easier for us.

I would say that we won't go backwards with respect to what we're supplying externally. We'll continue to grow that as we bring on more capacity and that incremental capacity we can use internally. So we've mapped it out. I think we have a good plan and we're probably not going to use too much of our own indium phosphide, frankly, in calendar '25 at all and we'll start using it more meaningful in '26 as the 200 gig per lane really start taking off.

That's super helpful context on both. Yes. Thanks a lot. Really appreciate it.

Yes. Thanks, Ananda. And unfortunately that is all the time we have for questions. So with that, I'd like to thank you for joining us today, and we look forward to connecting with you at upcoming investor conferences and meetings this quarter. You may now disconnect.