Q3 2026 Earnings Call Transcript

Good day, everyone, and welcome to the Lumentum Holdings Third Quarter Fiscal Year 2026 Earnings Call. [Operator Instructions] Please also note, today's event is being recorded for replay purposes. [Operator Instructions] At this time, I would like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please go ahead.

Thank you, Melissa, and welcome to Lumentum's Third Quarter Fiscal Year 2026 Earnings Call. This is Kathy Ta, Lumentum's Vice President of Investor Relations. Joining me today are Michael Hurlston, President and Chief Executive Officer; Wajid Ali, Executive Vice President and Chief Financial Officer; and Wupen Yuen, President, Global Business Units. Today's call will include forward-looking statements, including, without limitation, statements regarding our future operating results, strategies, trends and expectations for our products and technologies that are being made under the safe harbor of the Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risks set forth in our SEC filings under Risk Factors and elsewhere.

We encourage you to review our most recent filings with the SEC, particularly the risk factors described in our 10-Q for the fiscal quarter ended December 27, 2025, and in our most recent 10-Q for the fiscal quarter ended March 28, 2026, to be filed by Lumentum with the SEC. 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 or revise 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 have inherent limitations and are not to be considered in isolation from or as a substitute for or superior to financials prepared in accordance with GAAP. You can find a reconciliation between non-GAAP and GAAP measures and information about our use of non-GAAP measures and factors that could impact our financial results in our press release and our filings with the SEC. Lumentum's press release with the fiscal third quarter results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. We encourage you to review these materials carefully.

With that, I'll turn the call over to Michael.

Thank you, Kathy, and good afternoon, everyone. Lumentum delivered an exceptional third quarter with revenue growing 90% year-over-year to a record $808 million. Top line growth was primarily driven by our transceiver business and laser chips. While revenue growth was impressive, our non-GAAP operating margin was more so, expanding by over 2,100 basis points year-over-year, fueled by a rich product mix and strong operating leverage.

The margin expansion was primarily driven by our industry-leading scale-out portfolio, but another part of the story was our broad array of scale-across products. As hyperscalers exhaust the power and space limits of individual data center buildings, they are shifting to distributed architectures that link compute domains across disparate geographies. These scale-across networks require high-bandwidth synchronization across multiple data centers. To enable this, we provide critical hardware components that provide high-density optical interconnects while meeting aggressive power and performance targets.

Our pump lasers allow scale-across architectures to amplify the light signal over 4, 8 or 16 fiber pairs simultaneously. Complementing this, our narrow linewidth laser assemblies provide the precision required for 1.6T speeds and a higher order modulation, all within highly compact pluggable form factors. To manage all this traffic, our wavelength selectable switches or WSS function as the optical traffic cops. WSS keeps traffic in the optical domain bypassing the latency of electrical buffers while enabling the high port counts essential for massive fiber routing between data center buildings.

Looking forward, our emerging multi-rail technology will be vital for the increased parallelism required by the massive fiber counts and scale-across networks. While we have spent the last few calls detailing our revenue growth drivers, it is important to outline the considerable role the scale-across portfolio will play in our ability to expand gross and operating margins. As we look forward, we expect this part of our business to grow appreciably and the supply-demand imbalance likely improve profitability at the same time. Now let's look closer at the metrics that define our third quarter, starting with the components product category.

Components revenue for the quarter was $533 million, reflecting a 20% sequential increase and 77% year-over-year growth. Shipments of our narrow linewidth laser assemblies grew for the ninth consecutive quarter, rising over 120% year-over-year, while pump laser shipments grew 80% year-over-year. These components remain effectively sold out for the foreseeable future, and we are actively working to secure long-term agreements that will help offset anticipated capital expenditures. Turning to laser chips.

We achieved another quarterly company record in EML shipments, led by 100-gig lane speeds. 200-gig EML revenue more than doubled sequentially. We continue to ship CW lasers to 800-gig transceiver manufacturers, and starting in fiscal Q3, we began supplying CW lasers for internal use in our cloud transceiver business. Our wafer capacity -- wafer fab capacity in Japan remains at a premium and is fully allocated to meet surging customer demand. We shipped twice the number of laser chips as we did in the same quarter last year, and we are on track to achieve more than 50% growth in EML units by the December quarter of 2026 as compared to the December quarter of 2025. Our ultra-high-power laser chip manufacturing ramp for CPO applications is also proceeding according to plan.

We achieved sequential growth this quarter and are on schedule to both deliver meaningful revenue in our December quarter and fulfill the multi-hundred million dollar purchase order slated for the first half of calendar year 2027. In addition, our development work continues with multiple CPO customers through collaborations that leverage our laser chip technologies within a pluggable turnkey ELS module solution. In mid-March, we announced our acquisition of a fifth indium phosphide fab in Greensboro, North Carolina, which provides the capacity needed for years of future growth. At our grand opening ceremony held just days ago, we highlighted our commitment to U.S. manufacturing and the significant job creation we expect to generate in the state.

We onboarded the plant's team and plans to convert the facility from gallium arsenide to indium phosphide are well underway. Another positive note is that we expect to take advantage of a significant number of the tools that already exist in our Greensboro site. Now I'll move to our systems product category. Systems revenue reached $275 million, representing a 24% sequential and 121% year-over-year increase.

Cloud transceivers accounted for the lion's share of this growth, increasing over 40% sequentially as we successfully leverage our expanded manufacturing footprint in Thailand. In addition, we are poised to ramp 1.6T-speed transceiver shipments in fiscal Q4 with a portion of this volume leveraging our own CW lasers. We are improving transceiver profitability through better yields and lower scrap rates. Despite these gains, supply constraints on critical components keep our shipments well below customer demand.

In OCS, the multiyear, multibillion-dollar purchase agreement we recently announced ensures sustained long-term growth. Our OCS ramp is largely on track, although our pace and slope are gated by the supply chain. We are experiencing considerable tightness in this product area due largely to the significant step-up in requested output. On the other hand, the number of new opportunities we are seeing for optical switches is putting tension on our road map, and we are having to make choices across the company in order to service them.

Rounding out our systems business, performance industrial lasers and cable access remains muted. Industrial lasers were approximately flat sequentially, while cable access shipments declined on quarter due to customer and timing factors. Looking ahead to Q4, we expect to set another quarterly revenue record. We anticipate that over half of the sequential growth will stem from our components business.

The remainder will be driven by the continued ramp of our systems portfolio, primarily through high-speed transceivers and additional contributions from OCS. Our current numbers and guidance reflect continued success in EML lasers and our scale-across components. We are seeing improved performance in our cloud modules business, which has grown significantly across the last few quarters. In addition, while we're seeing initial contributions from both scale-out CPO and OCS, they are still relatively modest.

Furthermore, our largest single growth driver, scale-up CPO is still very much in its infancy. Taken together, this gives us confidence that we are very much on track to reach our $2 billion quarterly revenue goal as we articulated at our OFC event. Now I'll hand the call over to Wajid.

Thank you, Michael. Third quarter revenue of $808.4 million was above the midpoint of our guidance range and non-GAAP EPS of $2.37 was above our prior expectation range, demonstrating the leverage of our business model. GAAP gross margin for the third quarter was 44.2%. GAAP operating margin was 21.6%.

GAAP net income was $144.2 million and GAAP net income per share was $1.50. Turning to our non-GAAP results. Third quarter gross margin was 47.9%, which was up 540 basis points sequentially and up 1,270 basis points year-on-year due to better manufacturing utilization across the majority of our product lines, increased pricing on select products and favorable product mix. The improvement in product mix was primarily driven by growth in data center laser chips. Third quarter non-GAAP operating margin was 32.2%, which was up 700 basis points sequentially and up 2,140 basis points year-on-year, primarily driven by revenue growth in components products.

While continuing to invest in critical R&D programs serving cloud and AI customers, we have maintained the rigorous cost controls necessary to optimize our business model. Third quarter non-GAAP operating profit was $260.7 million, and adjusted EBITDA was $293.5 million. Third quarter non-GAAP operating expenses totaled $126.2 million or 15.6% of revenue, an increase of $11.3 million from the second quarter and an increase of $22.8 million from the same quarter last year in support of expanding cloud opportunities. Q3 non-GAAP SG&A expense was $47.8 million.

Non-GAAP R&D expense was $78.4 million. Interest and other income was $9.6 million on a non-GAAP basis. Third quarter non-GAAP net income was $225.7 million and non-GAAP net income per share was $2.37. Our diluted weighted shares for the third quarter was 95.2 million on a non-GAAP basis. Turning to the balance sheet.

During the third quarter, our cash and short-term investments increased by $2.02 billion to $3.17 billion, with the increase primarily driven by NVIDIA's direct investment in Lumentum. Our inventory levels increased by [ $62 million ] sequentially to support the expected growth in our cloud and AI-related revenue. In Q3, we spent $125 million in CapEx, primarily focused on manufacturing capacity to support cloud and AI customers. Turning to revenue details.

Components revenue of $533.3 million increased 20% sequentially in Q3 and 77% year-on-year. Systems revenue of $275.1 million increased 24% sequentially in Q3 and 121% year-on-year. Now let me move to our guidance for the fourth quarter of fiscal '26, which is on a non-GAAP basis and is based on our assumptions as of today. We anticipate net revenue for the fourth quarter of fiscal year '26 to be in the range of $960 million to $1.01 billion.

The $985 million midpoint would represent another new all-time quarterly revenue record for Lumentum. We project fourth quarter non-GAAP operating margin to be in the range of 35% to 36% and diluted net income per share to be in the range of $2.85 to $3.05. Our non-GAAP EPS guidance is based on a non-GAAP annual effective tax rate of 16.5%. These projections also assume shares used for non-GAAP diluted earnings of approximately 102 million shares. With that, I'll turn the call back to Kathy to start the Q&A session.

Kathy?

Thank you, Wajid. [Operator Instructions] Now let's begin the Q&A session.

We will now begin the question and answer session. [Operator Instructions] Your first question comes from the line of Samik Chatterjee with JPMorgan. Our next question comes from the line of Ryan Koontz with Needham & Co.

Can you hear me?

Yes, we can.

Yes.

We do. Great. Maybe let's start with your strength in EMLs and laser supply. Clearly, demand is not a concern here, and you guys have just done an incredible job of executing.

What are the dynamics both on the supply side as well as your ability to ramp production? Maybe give some color on kind of where you are in meeting demand, what the gap looks like as well as what are some of the puts and takes that you're battling with on a quarter-to-quarter basis?

Ryan, thanks for the question. Look, I think we're still chasing behind relative to demand. We are steadily increasing supply. I think we just gave the benchmark that we'd expect our supply line to increase 50% on year, meaning as measured from December quarter to December quarter.

So we're actually stepping up our supply in a pretty significant way. That being said, as we've said kind of over and over again, we continue to lag demand. The supply-demand imbalance is probably even higher than we reported in our last call, somewhere greater than 30%. I think last time we gave a metric of 25% to 30%.

We still seem to be behind significantly. We had conversations today with customers, significant customers looking to really up their demand and get output from us, and we simply can't service that. So we are stepping up. We're doing everything we can to step that up.

I think you know that story pretty well, but we continue to lag demand.

And is that largely in your own control -- sorry, Michael, but largely in your own control in terms of executing against that and getting the equipment you need? Or do you have input that is a big challenge?

Yes. Right now, it's largely within our own control. So some of these, for example, substrate shortages that's been reported out, I think you know our story better than most, and that is that we've executed some long-term agreements that we feel leave us in pretty good shape on substrates. That being said, I mean, the number of lasers that we're going to have to output, for example, in 2027 is really a massive step-up just given the scale-out and scale-up demands that we're seeing in that time frame.

So it's -- certainly, near term, it's mostly on us. I think as we head into 2027, we're going to continue to have to work the substrates. I think we have that mostly under control. But we've got a lot of work to do to sort of catch up to demand at this point.

That's great. And maybe on the scale-across part, you really highlighted that as, I think, something that's a market opportunity that's probably less appreciated with Lumentum. Obviously, you've got the kind of the components there among lasers, and you talked about the multi-rail opportunity. Can you expand on that in terms of where you fit in that supply chain in that value chain?

And then how big you size that opportunity as it moves to multi-rail application densification?

Yes. Look, it's a significant opportunity. I think we chose this call to talk about it because I think it's a significant contributor to our margin enhancement. So we focus very much on sort of the 4 main growth drivers.

I think you know those well, the transceiver business, OCS, optical scale-out, optical scale up. We spent less time, I think, on our scale-across components, and they are actually big, big contributors to the gross margin line. As we look out right now, we are probably more constrained in this area than even EMLs, particularly on things like pump lasers, narrow linewidth lasers for sure. And both of those are going into the coherent subassemblies that drive a lot of this scale-across activity, the synchronization and high bandwidth that we mentioned in the prepared remarks.

Multi-rail increases that content, right, because you've got more pumps that need to go into those. We are focused right now on ramping our pump capacity. We expect to make pretty appreciable step-ups. And at the right time, we'll give you some color around that.

But those numbers are going up from an output perspective, actually to a much greater degree than even our EML output. We would expect to output a lot more of these here in the near term because there's a little bit less constraint on the fab that puts these out. So we have a little more ability to inflect that line. Wupen, any more on the sort of the multi-rail and how you think about it?

Yes. So a couple of things, right? So first of all, the pump lasers actually goes into the optical amplifiers, right, at the -- we call it in-line amplifiers at the sites. And that's where a lot of the traffic and then the density has to really increase, right, to get the traffic through.

So that's one big area of growth. And frankly, the multi-rail opportunities are huge. And then with all the expansion plans that Michael talked about just now, our view actually is that the multi-rail could be even bigger than that. So we don't yet have a full quantification.

We'll share that when we are more ready, but we believe there's a huge opportunity for [ Lumentum ] to grow our business and gross margins.

Our next question comes from the line of Samik Chatterjee with JPMorgan.

Can you hear me now?

We can hear you now.

Sounds like you figured out the mute button, good, good.

Still learning, Michael. So maybe on OCS, I know you mentioned sort of multiple customers that you're still working with and you had the customer announcement at OFC. Can you just talk about sort of where maybe the engagements are in terms of how close you are to finalizing additional sort of award wins on the OCS front? And do you see some of the wins being sizable compared to what you announced at OFC.

How should we think about the additional wins that you can sort of lock in? And how should we size them relative to the win that you announced at OFC? And I have a follow-up.

Yes. I mean I think, look, we continue to work with the 3 customers that we've been talking to. Two of those 3 are making up the majority of the volume, as we've been saying. I think that we are really making progress now on sort of additional wins.

I think it's too early to call when we would be able to talk to those. But I would say that they're quite sizable. We really are, as I said in the remarks, working the road map to add differentiation, different port counts, different configurations to service these multiple opportunities. And these multiple opportunities are substantial.

They're on the order of what we've talked to relative to this backlog that we're seeing for 2027. So it is our biggest area. Wupen and the engineering teams are working aggressively to drive those new designs.

Got it. Okay. Great. And for my follow-up, maybe I can ask you on the revenue guide a bit.

You did deliver when I look quarter-over-quarter, like a $140 million increase, and you're expecting that to accelerate as you get into the June quarter, which is in the backdrop of sort of the supply constraints that you're also dealing with. So maybe if you can just sort of highlight which are the areas you see accelerating compared to the March quarter itself as you go into June? And where are the supply constraints maybe impacting you more than others, if you can sort of highlight that?

Yes. I think in the guide is contemplated, obviously, the sort of the basic business, meaning EMLs, we'd expect to go up. We'd expect the scale-across components to go up. We continue to increment OCS, so that will go up.

But really, the big story is transceivers, right? That is going to be quite strong. And I think it's impressive to note that as you and I have talked about, our margins there are relatively challenged, but we expect to see margin improvement in the face of a growing transceiver business. So I think that's important to highlight.

As we go into the back half of the year, that's when you're going to start seeing much bigger contributions from OCS. In the fourth calendar quarter, you're going to see more contributions from the scale-out CPO. So there's a lot of things that begin to layer in. But specific to your question on the guide, I think the big headline is going to be transceivers.

We appear to be ahead on 1.6T. We seem to be executing relatively well. I think Wupen and the team have done a really, really good job turning around our designs. Our constraint is going to be on transceivers.

So we are -- we could ship quite a bit more in the guide, actually quite a bit more this quarter in the quarter we just completed, certainly quite a bit more in the guide have we not the supply constraints that we see. And as we detailed, there's electrical components are driving that. The laser diodes are in that mix, right, which is necessitating the switch to our internal laser diodes. So there's quite a few things that are contributing there.

But the main headline is we're undershipping demand there quite significantly.

The next question comes from the line of Vijay Rakesh with Mizuho.

Just a question on -- a question back to the pump laser side on scale-across. Just wondering, given that demand pickup, obviously, it looks like those will be pretty high-power lasers as well. Just wondering what is the mix of demand you're seeing going to scale-across? And does that imply given the significant pickup in demand with that and 1.6T that you continue to see this supply-demand imbalance of 30% as you go through into next year as well?

I have a follow-up.

Yes, Vijay, I mean, a couple of things I'd say. One, the constraints on lasers pumps are probably the biggest that we are -- it's somewhat unanticipated. I mean we haven't talked to you about this in the last couple of quarters, but it's somewhat unanticipated. It's hit us relatively suddenly.

And I don't even -- I don't think we've given a number of the supply-demand imbalance, but it's certainly greater than that 30% number. We are significantly undershipping demand. And we're having to make choices as to who we support. We're trying to be as fair and reasonable as possible, but we are having to make choices as to how we allocate our pump demand.

That being said, I think we're trying to ramp capacity here quickly. We have a plan to ramp capacity over the next 4 quarters. That's coming out of our local facility here in the United States, our Rose Orchard facility. And we think we have room there to build some significant capacity.

And we're obviously spending a lot of money on CapEx to try to enable that as Wajid highlighted. So hopefully, that caught the gist of your question, Vijay.

Yes, sure. And just a quick follow-up, too. Back on the OCS side, obviously, it looks like Google is now talking the v8 inference rack with 1152 TPUs and the training rack with like 130,000 TPUs. Does that drive your OCS -- should drive a pretty nice uptick there back to like the 300-radix or the 500-radix OCS racks into next year, right?

And it looks like even Anthropic now announcing a massive potential, not Anthropic, but it looks like there's some information, et cetera, noting Anthropic could do $200 billion with Google, positive for you guys. But just wondering how you're looking at OCS into '27, '28.

Yes. Look, I mean, we're not sort of commenting on specific customers and specific customer architectures. Based on what we know, I would say that Google is obviously doing very, very well in the market. I would say that Google is driving a lot of demand on our business, right?

They're certainly one of our largest customers, and we benefited greatly from that relationship. As we know it, as we understand it, the sort of the difference in v7 and v8 in terms of OCS pull is a little bit. It's incremental. It's not that big, but we would expect, as you are correctly saying, that they are doing [Audio Gap] look, hopefully, we can get engaged.

I think it would drive significant upside for us just given the expansion of our business as they look at v8.

The next question comes from the line of Meta Marshall with Morgan Stanley.

Maybe a couple of questions. Just on -- expecting to supply some of the CW lasers into the transceivers into the next quarter. Just any kind of further commentary there on just the path and progression of kind of the in-sourcing of your own lasers into that piece of the transceiver portfolio? And then maybe just as a follow-up, just any kind of disclosure we could have in terms of, obviously, a great step-up in the gross margins, just on kind of like rough mix of pricing, yield, mix and kind of the contributions there?

Yes. I mean, I would say, Meta, maybe to the second question on mix, it's sort of all of the above. I think the headline has been better factory absorption. I mean that helps I think our mix, and we made some big decisions here throughout the last year to drop certain product lines that are not margin beneficial.

So we really worked on the portfolio to a great degree. And I think that's helped considerably. And then, of course, there is price increases. Obviously, pricing with this kind of supply-demand imbalance is something that we consider.

It's something that where we see biggest area of constraints, we have applied and we continue to think about applying. We think there's continued room, right? Gross margin is something that as a management team, we have focused on tremendously. And look, I think people who followed my history know that gross margin is super, super important.

And although we're trailing what we've done in our previous instantiations, I do think there's a lot of room for improvement on the gross margin line. Relative to the in-sourcing of the lasers, that's something that's driven by margin, right? But we are forced to do that probably faster than -- and that forecast oscillated, as you know. I mean, you followed our story extremely closely.

We had initially forecasted sometime in calendar Q2, we'd be introducing the lasers, and we backed off just seeing so much tension on the EML line. But now we've seen a little bit of tension in our own supply line externally to get lasers from the external market, CW lasers. And as such, now we've allocated more of our fab capacity to CW lasers. I think in our mix, roughly, as we think about it in this -- in the guide, it would be about 20% of our modules would have our own CW lasers.

It's still minority, but we'd expect to step that up through time and see some of the associated margin benefit as a result.

The next question comes from the line of Papa Sylla with Citi.

Congrats on the very strong results. Michael, I guess one a little bit longer-term question kind of on the CPO scale-up opportunity. It seems like even at kind of you mentioned kind of the longer-term target and most of it may be more ultra-high power lasers. But at a high level, it seems like there is also a real opportunity into becoming more kind of vertical and doing some more ELS [Technical Difficulty].

Papa, I don't know -- hopefully, it's not us, but at least your line seems to be cutting out a bit. I didn't catch the last part of your question. Sorry for that.

Sorry about that. Yes, I was just asking on just the opportunity around the kind of CPO kind of market. Most of it, it seems like you are mostly around the ultra-high power lasers looking into maybe the second half of the year in 2027. I'm just curious on the opportunity around kind of being more vertically integrated as well, kind of providing more ELS type of product. I'm curious if you are also getting engagement from the same customers you are providing ultra-high power lasers opportunities.

Yes. Great question, Papa. And of course, I continue to thank you for following the company. Look, I think that on ELS, we definitely have a very significant opportunity.

And it's -- we have not -- we only talked about opportunity there. I think we're getting ever closer to being able to convert and start thinking about that as part of our numbers. As we've outlined on previous calls, what I would say with ELS, in particular, is the non-primary customer engagements are largely driven by ELS. Simply, the engineering teams there are less familiar with optics, although, frankly, everybody is becoming a lot more conversed on optics.

But our currency to engage those customers, at least initially, will be the ELS, and so again, we've not really talked about as yet any significant wins there. I feel that's just around the corner, quite frankly, and it's something that at the right time, we'll be able to articulate more deeply. But in particular, as we expand the CPO horizon, we are going to need that vertical integration strategy that you asked in your question.

Got it. That's very helpful. And for my follow-up, it might be for you, again, Michael, as well. On the kind of supply front kind of EML capacity, it seems like across the board demand continues to be very strong despite kind of the very strong effort you're making on raising supply.

But we are also hearing kind of a lot of competitors also providing very large growth numbers. I'm just curious on the risk of oversupply, if any, I guess, where would you put that risk? Is it still very low at this point?

I mean I feel it's low. We are engaging all sorts of transceiver customers right now. Wupen's team is out doing that actually as we speak. I just got a report in this morning from our sales leader.

And the discussion is very much around extending the long-term agreements that we already have. So if there was an expectation from our customers that they see an oversupply of any kind of laser, whether it be EML or CW laser, I just think there'd be a lot more reticence to engage in the kind of conversations we're having. So yes, we're hearing the same things. I mean we know that all -- everybody is trying to add supply, but the reality on the ground now seems to be quite a bit different.

We definitely have some pricing flexibility, which would indicate that, that supply-demand imbalance isn't going to be solved for a while, and we certainly are engaging and extending some of these long-term agreements that we currently have.

The next question comes from the line of Ruben Roy with Stifel.

This is Sahej Singh on for Ruben Roy. Maybe just, Michael, tagging on to the LTAs that you're mentioning there. Even on the scale-across portfolio, you sort of outlined that pump lasers, narrow linewidth lasers, WSS, these are not only supply constrained, but real margin levers for you guys distinct from the 4 growth levers and 9th consecutive quarter of narrow linewidth at, I think you said 120% year-on-year and pump lasers at 80%. That's impressive and you're still describing this as sort of an unanticipated bump up.

And so you're talking about these LTAs. Maybe we can dive a little deeper there. You mentioned that the long-term agreements being negotiated are helping in some sense to offset CapEx. And I think that was with scale-across, but it sounds like more broadly.

So could you maybe give us a sense of the structure? Are these prepayment style commitments maybe similar in maybe spirit, I would say, to the NVIDIA agreement? Or are they take-or-pay capacity reservations? Or are they volume commitments tied to ASP floors?

How should we be thinking about the CapEx whether build, buy, offshore, these agreements are effectively underwriting? I'll stop there, and I have one other.

Yes. Look, I mean, it's all of the above. We're in active discussions right now on our pump lasers. And again, we have sort of a finite amount of capacity, and we're being asked to put on considerably more.

And so we are talking to the major customers around trying to help, right, and put some skin in the game around the CapEx that we're going to try to lay out, one, that can entail prepayment, that can entail take-or-pay, that can entail price increases. And Wupen's team is in active negotiation with all of the scale-across suppliers on how that looks. And again, as I say, we're -- we have some really big customers and important historical customers of ours involved in that, and we want to treat them, obviously, as fairly as we can. But it's really coming down to how these discussions play out as to how I think Wupen and his team think about the allocation.

Understood. And for the second, as I read through the print, the beat was really a margin beat and system sales, as you mentioned, was a driver and seems to be so. And this is happening all while sort of the capacity story is happening and new programs are ramping. And then as we look to the next quarter, I think the margin story kind of gets a little washed out with the diluted shares jumping up.

So maybe could you help frame the waterfall dynamics on margins right now? I mean you set out the targets that you did during OFC. And I think this sort of ties into, I believe Meta asked a question around this as well. But the waterfall dynamics maybe more across a matrix of product mix and the program ramps within those segments, how CapEx is dragging on that, again, on the build buy offshore sort of dynamic?

And then maybe also on the volume versus ASP conversation that is becoming more and more prevalent amid the supply constraint.

Yes. Look, I mean, as we said, there are many, many contributing factors to our margin improvement. I think we had a big step-up. It's an area of focus for us.

I think we're going to continue to work the margin line. It obviously comes from mix, and we keep making mix decisions every single day allocated to the most margin-rich parts of the portfolio. It comes from factory utilization, right? We've historically been underutilized, and we're just now getting our utilization up to where it needs to be.

As we've outlined, we have some of our fabs that are still underutilized, some of the -- for example, our fab in the United Kingdom that now Wupen has put products in that we expect to see in margin-contributing output from them and fixing some of the underutilization. And then as we said, there is some price dynamics that are working in our favor. So we think there's a lot of room on the margin line. We gave a long-term target.

We feel very comfortable with that. I think there's room from here to continue to really step up margin. We've been surprised to a certain extent by how quickly we've been able to move up that margin line. And again, people that know my history know that we had 30% type moves in my last company.

So it's not a total surprise that you'd be seeing this kind of step-up on the margin line.

The next question comes from the line of Christopher Rolland with Susquehanna.

And Michael, I am familiar with the margin focus you have. My question is actually, I think in your prepared remarks, you might have also mentioned some constraints around OCS. So I guess, first of all, I wanted to dig a little bit more into that, but also at OFC, there were some Chinese competitors showing off some OCS boxes. I was wondering if you could speak to competition there, whether you think it's viable or whether you think the kind of MEMS market might be yours for quite some time.

Yes, Chris. I appreciate that. Look, one, my colleague to the right, Wajid Ali, is personally responsible for getting the supply chain right on OCS. We've assigned that to one of the most important people in the company.

It's a challenge. Look, I mean, it's a big step up, right? We've gone in many instances, really from 0 to a significant number very, very quickly. We think we have things under control.

We've outlined this sort of $400 million that we can ship in the back half of the year. We think we have that under control. As we look at 2027, that number continues to step up. We think we have that under control, but we are definitely on a tight rope on this product line, right?

It's probably our biggest ramp now, honestly, pump lasers, CPO, all of these things are keeping us awake. The big 3 ramps are these pumps, right, OCS and the high-powered lasers. So we've got a lot of work on our hands and the biggest single tight rope that we're watching probably is OCS. I think relative to competition, we feel pretty good about our position.

We really do. I think we feel like we're in a very, very strong position. That's not going to last forever, right? We know that.

But I think certainly, in the next year, it's hard for me to imagine anybody is going to be able to ship one of these very innovative solutions. We are also not standing still. We are working on cost reducing. We are working on some innovative solutions in our OCS, which increases the complexity of the decisions that I was outlining relative to what Wupen is facing, right?

Because we've got a lot of new customer demands coming on. And meanwhile, we are trying to focus on new architectures that would keep us in a leading position with MEMS, right? We do believe that, that's the right technology for us long term, but we do believe that there's cost we can take out simplification we can make to continue to compete with these very innovative solutions.

Excellent. And I do know you have your hands full with those 3 very large opportunities. But are there some more adjacencies for you guys to pursue? I think at OFC, you talked about maybe full module design and assembly.

I don't know if this would involve silicon photonics chips, PICs, EICs, et cetera. Are there any other adjacencies or components that you may be able to absorb or organically create that you can bring into the organization as you look forward?

Look, there's a ton of stuff that goes into these transceivers or into a CPO-based solution that today we don't ship, right, PICs, photodiodes, right, laser drivers. There's a ton of stuff to your point. And we're looking at all of these areas. I mean I think we have road maps that contemplate all sorts of different things around our strength in lasers.

And I think there is quite a bit more that we can do around that. A previous question asked, and I'd say, again, on ELS, which is a vertically integrated module that your question sort of led to, we believe that there's significant opportunity there, right? We think that we can integrate up and take more of the dollars by generating a vertically integrated ELS. And I think as we engage on CPO, we're finding that to be a more convincing and shorter path to market than is just supplying lasers.

The next question comes from the line of Vivek Arya with Bank of America Securities.

This is Michael Mani on for Vivek Arya. My first question is on the transceiver business. Number one, how large would it have been if you had been able to address all the demand that you saw in the quarter? Or if you could peg that number relative to the 30% overall imbalance for the entire company?

And then on 1.6T specifically, you talked about how the margin structure is still a bit challenged and it's a work in progress. But as we move into 1.6T, what we're hearing from many of the suppliers in the ecosystem is that the margins are just significantly better, maybe led by pricing. So to what extent does that transition that's happening in the next quarter or 2 help your margin structure for transceivers?

Yes. I mean on the first one, I don't think that we've given a figure of merit around our own transceiver imbalance. It was significant. I mean we had a lot of demand that was placed on us, and we simply weren't able to ship due to -- largely due to supply constraints.

The 30% number that I gave is on our EMLs, right? So it's a supply imbalance. It's not relative to our whole business, it's on that particular line of business. I would say here, the supply-demand imbalance on our own transceivers was somewhere in that ZIP code, but it was definitely appreciable, although I don't know that we've calculated that.

I think the second part of your question. What was the second part was...

1.6T.

No doubt, right? The margins are definitely better. I would say that, too. When I said the margins are challenging, our transceiver business, as we've outlined over and over again, is definitely a challenge for us on the margin line.

I think we are underperforming peers. We have room to grow. We're getting better. I think we are -- we've certainly gotten the lead in terms of design.

And now in terms of margin, I think we're improving. We still trail. That being said, to your point, 1.6T is definitely better. Structurally from a margin standpoint is definitely better than 800-gig.

So there's definitely -- we will see step-up in our margin line. We have room as a unique Lumentum entity to do better, and we will do better.

And for my follow-up, on OCS specifically, you said you're still constrained, maybe that's more due to your current output right now relative to demand. How do you think about engaging with more contract manufacturers? I know you mentioned that OFC, but where are you in that process, maybe not just for OCS, but for other product areas as well? And then within OCS specifically, how do you think given the demand you're seeing from multiple customers, maybe multiple different applications and multiple types of products between medium radix, high radix products, how do you think about prioritizing all those different sources of demand, right, for applications based on your own competitiveness or share?

Yes. Look, I'm going to answer the first part of it, right, just in the interest of time to get some more questions. I think one of the levers we do have is contract manufacturing. We have historically in-sourced everything.

And we found that working with good contract manufacturers, of which there are several, we can actually improve our margins. So as we have started to shift and we're early in those innings, back to a contract manufacturing base, we would actually expect to see improvement in our margins. The margins that we pay to those contract manufacturers are more than offset by the efficiency and cost benefit that they can drive on common components. So that ends up being a lever for us.

Melissa, I think we have time for one more question.

Our last question comes from the line of Ananda Baruah with Loop Capital.

I guess I have to say, apologies if this has already been asked, hopefully, it hasn't been. But Michael, you announced, I think it was last week, the opening of the Greensboro -- new Greensboro facility that you recently purchased. And I think it was also in the press release that, that capacity was new. And I think it -- as a clarification, is it also incremental to the revenue projections that you gave at OFC, so could you clarify that?

And then also, what's a good way to think about the capacity potential coming out of Greensboro? Appreciate that.

Yes. I mean, look, that is not in our numbers, right? It is very, very significant. I think what we've said is that we are -- we will have a massive supply-demand imbalance on CPO.

It's going to be very, very significant. We've seen multibillion-dollar orders that we've characterized on previous calls come in mostly on scale-out. We expect to scale-up to be significantly more than that in terms of revenue opportunity. I think it's going to be somewhere greater than $5 billion of incremental revenue that we can add if we execute properly.

Now what I would say is the Greensboro fab is not going to come online until 2028. So we sort of set expectation that sort of in the early 2028 line start to be adding that incremental revenue. So we're still 6 or so quarters away from seeing significant contribution from Greensboro.

I will now turn the call back to Kathy for closing remarks.

Thank you, Melissa. That is all the time we have for questions, and we look forward to connecting with you at upcoming investor conferences and meetings throughout this next quarter. And with that, I'd like to thank you for joining us today.

This concludes today's call. Thank you for attending. You may now disconnect.