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Lumentum Holdings Inc
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Good morning. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q1 Fiscal Year '19 Lumentum Earnings Conference Call. [Operator Instructions]. Thank you. Chris Coldren, Interim Chief Financial Officer, Senior Vice President, Strategy and Corporate Development, please begin your conference.
Thank you, Emily. Welcome to Lumentum's First Quarter Fiscal 2019 Earnings Call. This is Chris Coldren, Interim Chief Financial Officer, Senior Vice President of Strategy and Corporate Development. Joining me on today's call is Alan Lowe, President and Chief Executive Officer. This call will include forward-looking statements, including statements regarding the markets in which we operate, including potential market sizes; trends and expectations for products and technology, including product development and projected new product releases; purchasing trends and demand for our products; our expected financial performance, expenses and position in the market; as well as statements regarding our pending acquisition of Oclaro.
These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectation. We encourage you to review our most recent filings with the SEC, particularly the risk factors described in our 10-Q filing for our first quarter fiscal 2019, which we expect will be on file with the SEC later today; our 10-K filing, which was filed with the SEC on August 28, 2018; and the registration statement on Form S-4 relating to our pending acquisition of Oclaro, which was declared effective on May 31, 2018.
Forward-looking statements we provide during this call, including projections for future performance, are based on our reasonable beliefs and expectations as of today. Lumentum undertakes no obligations to update these statements, except as required by applicable law.
Please also note, unless otherwise stated, all results and projections are non-GAAP. Non-GAAP financials should not be considered as a substitute for or superior to financials prepared in accordance with GAAP.
Our press release with our first quarter fiscal 2019 results is available on our website www.lumentum.com under the Investors section and includes additional details about our non-GAAP financial measures and a reconciliation between our GAAP and non-GAAP results. Our website also has our latest SEC filings, which we encourage you to review, and supplementary slides relating to today's earnings release.
A recording of today's call will be available by 11:30 a.m. Pacific Time this morning on our website.
Before turning the call over to Alan, we have some additional comments relating to the pending acquisition of Oclaro. First, today's call is not an offering of securities. The information disclosed today is qualified in its entirety by the S-4 proxy statement/prospectus on file with the SEC in connection with the proposed transaction. We encourage security holders to read the joint proxy statement/prospectus and other documents filed with the SEC carefully as they contain important information about this pending transaction.
Further on the pending Oclaro transaction, we previously mentioned that we have received HSR approval and that Oclaro stockholders approved the transaction at their meeting in July. This merger is subject to certain other closing conditions, including antitrust regulatory approval in China. We continue to work with Oclaro in receiving antitrust approval in China and completing this pending transaction.
Finally, during the Q&A session, please keep in mind that the focus of this call is our earnings report and guidance, and we will not be sharing incremental information relating to the status of our pending acquisition of Oclaro beyond our prepared remarks. None of the trends, uncertainty or guidance discussed today take into account Oclaro.
Now, I would like to turn the call over to Alan for his continents and first quarter market and product highlights.
Thank you, Chris. Good morning, everyone. I'm very pleased to be here discussing our first quarter results. Strong telecom and fiber laser demand along with 3D sensing expansion across multiple customers and their products drove solid first quarter results. Revenue was up 18% quarter-on-quarter and 46% relative to the prior year. We achieved new record revenues in ROADMs and fiber lasers.
During the quarter, we also made great progress on key new product introductions that we believe will help drive continued growth into fiscal 2020 and beyond. These include first shipments of, number one, the highest port count WSS in the industry, our twin 1x35; two, first products based on our new disruptive MxN ROADM platform; three, fiber laser products based on our 4 kilowatt single module that delivers industry leading brightness and enables even higher performance and lower cost per machine to customers; and finally, time-of-flight VCSEL arrays, which enable world-facing consumer mobile applications, including shipments to Android customers.
Increasing customer demand, our differentiated products and design wins and investments in additional production capacity set the stage for our second quarter as well as the years to come.
Our year-over-year improvement in financial performance highlights that our strategy of investing in differentiated products and multiple end markets each critically dependent on photonics and driven by strong long-term trends is succeeding. The world is becoming more reliant on ever increasing amounts of data flowing through optical networks and data centers. Globally, regardless of who is supplying the optical networking equipment or who is deploying the network, the products and technologies Lumentum supplies are essential.
Higher levels of precision, new material and factory and energy efficiency are all increasingly important to manufacturers around the world. To address these trends, suppliers of manufacturing tools globally are turning more and more to laser-based approaches and the types of lasers that we supply.
Laser-based 3D sensing is a rapidly developing market. The technology enables computer vision applications that enhance security, safety and new functionality in the electronic devices that people rely on every day. With our proven high volume manufacturing strategy and learnings from having shipped hundreds of millions of devices, our primary focus is on new customer design wins and our new pipeline of products based on even more advanced laser designs, which are needed in order to meet increasing customer requirements.
We believe we are well positioned to continue to be the partner of choice for 3D sensing customers around the world over the coming years.
Now I'd like to turn to first quarter product highlights. Revenue from our telecom product lines grew 7% sequentially, driven by a 10% or higher sequential growth in each of our ROADMs, pump lasers and optical amplifier product lines. Demand from customers - from our customers for these products is very strong. While we have added significant manufacturing capacity, we are still not meeting our growing customer demand.
In the second quarter, based on investment decisions made quarters ago, we expect additional production capacity to come online, particularly in our ROADM product line. The strong demand for our telecom products is spread across a broad customer base and is driven by an increase in global demand for next generation optical networks. I believe it is important to highlight that in addition to an increase in the number of networks being built globally, we believe our growth in ROADMs is also driven by a fundamental shift in how optical networks are built. There is no practical way to accomplish that needed network capacity and agility, other than incorporating increasing numbers of even more advanced ROADMs.
Speaking of even more advanced ROADMs, as mentioned earlier, during our first quarter, we shipped production volumes of our Twin 1x35 module and blade level product lines, which contained the highest port count WSS in the industry.
Additionally, during the first quarter, we shipped first products based on our new and disruptive and tension-less MxN ROADM platform. We expect volumes of these new products will increase into calendar 2019. Based on customer traction, we are adding even more capacity than we originally planned for these products.
The MxN ROADM platform creates a new class of ROADM products. These products enable network operators to scale their networks with lower costs and higher density, reliability and power efficiency compared with our current state-of-the-art solutions.
Turning to 3D sensing. First quarter 3D sensing shipments ramped slightly ahead of plan and were the primary driver for our growth in industrial and consumer diode laser product lines. Revenue from our industrial and consumer product lines was up 72% sequentially and up 154% relative to the same period last year. This strong growth was driven by earlier ramp of 3D sensing products into a broader array of models and device types at our customers compared with last year. We expect to continue to ramp production into the second quarter to meet strong customer demand.
We remain highly focused on broadening our 3D sensing customer base and product mix over time. Total revenue from multiple Android customers approximately doubled quarter-on-quarter. Since our last earnings call, additional customers have announced high-end 3D sensing-enabled devices. These new customer products demonstrate the wide appeal of 3D sensing functionality in mobile devices. We also believe these new customer products are the first step to broad incorporation of 3D sensing and lower priced higher volume devices in the years to come.
We are engaged with additional Android customers who are yet to announce their products. Our product development pipeline is full. We are working with a wide range of new and existing customers on new laser designs that enable 3D sensing in a broad range of device types and price points. Similarly, these 3D sensing laser devices also bring new capability, such as world-facing 3D sensing, which increased the laser content per customer device. We also continue to work on 3D sensing and LiDAR automobile applications and expect this to be a growth driver in 2021 and beyond.
Within our Commercial Lasers business, we again achieved record revenues from our kilowatt class fiber laser, which grew 24% sequentially. During the first quarter, we benefited from capacity expansions and further ramped volumes of our newest fiber laser product to meet strong customer demand.
As noted on our last call, we have also increased industrial diode pump capacity in our Thailand factory. These industrial diode pump lasers are at the heart of our fiber laser as well as those of our external pump customers. Our solid state laser product lines were down sharply, which resulted in a larger-than-expected sequential decline in our total commercial laser's revenue. These products serve the semiconductor and consumer electronic application markets, which are usually seasonally soft in our first and second quarters. Manufacturers typically install laser-based equipment capacity in the spring and summer in anticipation of the annual fall consumer electronics cycle and holiday season.
This year, we believe we are seeing larger than normal seasonal declines, which could be related to overall market softness, as reported by some of our larger peers. While we aren't totally immune to market dynamics, with our rather limited market share, we have opportunities for growth more driven by new product design wins than market growth. As such, we are making healthy investments in new ways of product development and production capacity, targeting higher growth material processing applications.
Datacom revenue was down slightly sequentially as we continue to be selective in our sales of this margin challenge product area while we develop our next-generation 100G and 400G products. We continue to make progress on these new products and expect them to contribute in the years to come. However, in our second quarter, we expect a meaningful decline in our datacom revenue as we passed on certain unprofitable customer opportunities.
Earlier in my remarks, I highlighted significant long-term trends that make the markets in which we participate increasingly dependent upon our photonic solutions and create terrific market opportunities for Lumentum. Our strong year-over-year improvement in results demonstrate that we continue to make good progress on our key strategic objectives to accelerate growth and drive sustainable margin expansion and customer and end-market diversification.
We have a lot going on, and it is a very exciting time at Lumentum. I will now hand the call over to Chris for more details on our financial results and our guidance for the second quarter of fiscal 2019.
Thank you, Alan. Good morning, everyone. Net revenue for the first quarter was $354.1 million, which increased 18% sequentially and increased 46% compared with the same period last year. GAAP gross margin for the first quarter was 35.6%, GAAP operating margin was 16.1% and GAAP diluted net income per share was $0.72. First quarter non-GAAP gross margin was 40.3%, which increased 310 basis points sequentially and increased 630 basis points compared with the same period last year.
Gross margin improvement relative to last quarter and the same period last year was driven by an increase in the mix of higher margin telecom and 3D sensing products as well as overall higher volumes. Non-GAAP operating margin for the first quarter was 23.9% and increased by 610 basis points sequentially and more than 1,200 basis points compared with the same period in the prior year.
Operating expansion was primarily driven by gross margin expansion, combined with leverage over operating expense. Non-GAAP net income was $85.8 million for the first quarter and includes $1.7 million of other income and expense and a tax expense of $600,000 recognized in the quarter. Non-GAAP diluted net income per share was $1.31 based on a fully diluted share count of $65.4 million. The sequential decline in other income and expense was primarily driven by lower interest income as we move some of our short-term investments into cash holdings in preparation for the closing of the Oclaro acquisition.
Operating expenses totaled $57.9 million or 16.4% of revenue compared with $58.5 million or 19.4% of revenue for the prior quarter. R&D expense was $31.6 million and SG&A expense was $26.3 million.
Turning to segment and product line details. Our Optical Communications segment revenue at $310.1 million increased 27% sequentially and was up 49% relative to the same period in the prior year. Within our Optical Communications segment, Telecom revenue at $142.9 million was up 7% sequentially and 29% year-on-year. As Alan highlighted, transport products, including ROADMs, were significant contributors to the Telecom group. Datacom revenue at $34.2 million was down 1% sequentially, but down 24% year-on-year. Industrial and Consumer revenue at $133 million was up 72% sequentially and up 154% relative to the same period the prior year due to 3D sensing expansion into more customers, models and device types.
Optical Communications segment gross margin at 40.3% increased 550 basis points sequentially and 560 basis points year-on-year. The driver of expanded gross margins for the higher mix of industrial and consumer revenues, which were higher than segment average gross margin, improvements in telecom margins associated with the higher mix of higher margin products and a lower average manufacturing cost due to the higher volume.
Our laser segment revenue at $44 million declined 22% sequentially, but was up 25% relative to the same period in the prior year. Sales of our fiber laser saw strong growth both year-over-year and sequentially. However, as Alan highlighted, sales of our other laser products, which are primarily solid state lasers, were down quarter-on-quarter and year-over-year. First quarter laser's gross margin was 40.2% and declined 770 basis points due to the significant increase in fiber lasers in the revenue mix and lower volumes of non-fiber laser.
Turning to selected balance sheet-related items. We ended the first quarter with cash and short-term investments of $734.3 million, an increase of $22.8 million relative to the prior quarter. Net inventory declined $17 million sequentially as we consumed significant levels of 3D sensing inventory. Capital expenditures during the first quarter were 31.$1.
Now onto our guidance for the second quarter of fiscal 2019, noting again that all projections are on a non-GAAP basis and do not take into account any effect from the acquisition of Oclaro as we currently cannot predict the timing of the closing. We project net revenue for the second quarter to be in the range of $405 million to $430 million with an operating margin in the range of 28% to 30% and diluted net income or earnings per share to be in the range of $1.60 to $1.75. Notable quarter-on-quarter change in product line revenue in our projections include Telecom being up, driven by continued transport product revenue growth, industrial and consumer being up due to the ongoing 3D sensing ramp, while Datacom being down due to again being selective in sales opportunity.
Before turning the call over to Emily to start the question-and-answer session, I would like to ask everyone to limit the discussion to one question and one follow-up. Emily, let's begin the question-and-answer session.
[Operator Instructions]. And our first question comes from the line of Alex Henderson from Needham.
I wanted to just drill down a little bit on the Datacom side. So you're saying it's going to be down, I mean, is that - are we talking about a kind of a 20% sequential decline, how big a nut is that? And then second on the industrial laser side, if you could talk about whether that would be down as well? Certainly, there's so much noise out there about weakness in the semiconductor space. I assume that that's pressuring you. On the other side of the coin, you didn't call that out at all. So I wondering if you can give us a little bit more granularity around those two pieces?
Yes. So, Alex, the Datacom business, I would say it's more in the 20% to 30% decline expected. And then on the laser's piece, we expect it to be flattish quarter-on-quarter, plus or minus.
And that's a function of you having new product growth that's driving that, offsetting industrial weakness?
Well, as we said in the script, we continue to expect the seasonal weakness, although this year probably stronger than normal seasonal weakness, and some growth in the fiber lasers maybe offsetting that a little, but pretty much the mix and the revenue levels being roughly the same quarter-on-quarter.
Our next question comes from the line of James Kisner from Loop Capital.
So just quickly on the guidance. I was hoping you clarify a little bit what you're expecting for gross margin and OpEx. I know you don't guide explicitly, it seems like you could have something like 43%, 40% gross margin. And then separately, I was hoping you could - you mentioned we're facing - you're hoping to give sort of your latest thoughts on that. I mean, you said it in March [indiscernible], Alan sounded very confident it is something that would be broadly adopted in the handsets by second half of calendar next year. I'm just wondering if you could update us on that. Do you still feel confident about that, are you feeling more or less confident about that prognostication?
Yes, we don't guide gross margin. I would expect gross margin - I think, if I heard you correctly, it being in the 40% range, I think it's going to be higher than that. I think the piece that maybe is missed here is OpEx. We expect we'll be increasing. We had a bit lighter quarter on OpEx probably than expected given timing of some R&D offset payments we received from customers where we're developing products specifically for them as well as, as we entered the new fiscal year, we started trimming investment and less profitable product lines, which you can do pretty quickly and plan to grow investments in other more attractive product lines, and that tends to take a little bit more time as you need to hire people and ramp up spending. So I think that's probably more of the missing piece that you're hitting on and the guide is that the operating expenses should be coming up quarter-on-quarter.
As far as - this is how I'm going - as far as the world-facing work, we are shipping today production volumes of world-facing. So I'm expecting that either products will be announced or have been announced imminently and should ramp through 2019. Again, as I said in my prepared remarks, today, they're going into high-end mobile devices and we expect that through 2019 and 2020, they'll be expanded to a broader range of product portfolio.
And just to quickly follow-up, what I said was like 43%, 44% of it. Is mid 40s gross margin realistic, Chris, just to follow up?
Mid 40s realistic, yes.
Our next question comes from the line of Troy Jensen from Piper Jaffray. My apologies. It looks like Troy has left the queue. With that, we do have Simon Leopold from Raymond James.
Hard to stick to one question on this, but I'll try. Within your outcome, it looked like gross margins were nice improvement versus the last quarter. I know you don't disclose by the sub-segments, but did the improvement sequentially come from 3D or telecom? I'm just trying to get a sense of the sorts of what led to that improvement, what got better?
Yes. So I would say it's both. So as we highlighted, we shipped record revenues of our ROADM products, and they garner better than average telecom margins. So with an improvement in mix of products like pump lasers and ROADMs in the telecom piece, telecom is up and then certainly 3D sensing is above corporate average as well as above the overall optical Communications segment average gross margins. So the increasing 3D sensing as well as the industrial products that are in there in the mix continue to accrete gross margin.
And just to clarify that point though, did the 3D sensing gross margin get better or is it better because it's more in the mix? I'm just trying to get a sense of whether it improved. It's just a mix question.
I would say that given our manufacturing strategy, we tend to have a more variable cost. So we're not seeing huge increases in margin or with volume. But we do have some element of fixed costs and pricing from our suppliers that is volume-dependent, if you will, and therefore, we have seen improvement quarter-on-quarter in 3D sensing gross margin.
And just as my follow-up, on the ROADM WSS business kind of guesstimated you're little bit over $70 million in the quarter. Can you help us understand where you are in terms of your targeted capacity, planned capacity, what's the most you're capable of producing?
Well, the most we were capable of producing last quarter was what we produced. I mean, we've - as I said in the prepared remarks, we have more demand than we're able to satisfy. And early this calendar year, we made decisions to add capacity that's coming online now and will continue to come online through the first calendar quarter of next year. So I would expect that from your baseline gas, we're going to continue to add significant capacity on a quarterly basis, I would say, of the magnitude we saw last quarter, if not greater.
So just rough math, you'd be at like 80-ish million kind of capacity?
We certainly have demand beyond that and so we're trying to chase that as fast as we can both from added capacity as well as improved productivity and yields that we're seeing and we're focused on. So I don't think that's out of the question.
Our next question comes from the line of Mark Kelleher from DA Davidson.
I wonder if you could just talk a little bit more about 3D laser market, the market share there, what are you seeing in terms of competitive pressures, are you going up or down in your market share? We've been seeing company after company come out and say they had great 3D sensing revenue. So just wondering maybe - and maybe compare that to the Android share versus the iPhone share and maybe talk a little bit about seasonality going into Q4 on 3D lasers as well? That'd be great.
I think we're not going to be specific about what share we have at each customer and breaking it out the way you asked, we'd probably do that. I did say that we're very happy with the share that we've got both on today's products as well as the design efforts that we've got going for next generation of devices. So I'd say we still have a very, very high share. Doubling or tripling output on a small number is still a small number. So I would say that given our leadership position on manufacturing, on cost and on the design funnel that we've got and our ability to ramp our R&D investment in 3D sensing has been quite confident that we're going to have large share for the foreseeable future.
And the seasonality in Q4, is that expected to be greater than Q3 calendar?
For 3D sensing?
Yes.
So as we highlighted that our - one of the primary drivers of growth quarter-on-quarter is going to be 3D sensing going into the December quarter.
Our next question does come from the line of Troy Jensen from Piper Jaffray.
Alan, maybe for you, could you give us an update on Oclaro and just maybe your thoughts on timing to close the transaction? And I guess I'd be curious to know how their performance has been over the past six months since they've been kind of quiet?
Well, I think you'd have to ask them, but I think, as Chris indicated in the prepared remarks, we're continuing to work with the China regulatory approval and continue to make progress there. But beyond that, it's hard to say. I can tell you we'll close within a couple of days of getting approval, and that's in the agreement. So that's why, for instance, our interest expense - our interest income was down as we move more of our investments to cash in preparation of that. So we can't predict the future, but I would say that we're making progress and continue to be hopeful that it will happen sooner rather than later.
Are there any hard deadlines in the contract where if you don't get some approvals in certain time frames that it gets shelved?
So, yes, certainly, the document is filed publicly, that there are dates that the transaction continues and if the outstanding item is antitrust approval, it will continue for an even further time period. But ultimately, yes, there is an outside date in all acquisition agreements generally.
Okay. Maybe just one last follow-up from me. Just the telco strength, seems like it's been a couple of quarters now where we've had really good results from you guys and even the rest of the industry last quarter, and we'll probably see it as a report more now in the next few weeks. But do you think the telco strength is sustainable? I mean, is the driver prepping for 5G, is it the 400G cycle, just update your thoughts on the sustainability of the stream.
I'll give you my view on it and then Chris can chime in as well. I'd say we've got some fundamental growth drivers around ROADM deployments, not just in the regions where ROADMs have been strong, but also we are - as we've been talking about for the last couple of years, we are seeing real ROADM deployments in China for RealNetworks and no more trials anymore. So I'd say that from that perspective, when you have more ROADMs, you have more amplifiers and more pump lasers, and that's what we saw from growth drivers in last quarter that I think fundamentally will be sustainable as we continue our differentiation in the Twin 1x35 and the MxN ROADM that really is getting a tremendous amount of traction.
Yes, and I'd add to that that certainly as we have commented in the script that we believe we're seeing a big shift in how networks are being built ultimately, which means over the long run, the ROADM and certainly all the other parts that go in and around ROADMS are an increasing part of network deployments, if you will, from a percentage spend standpoint. Compounding that, if I look at our percentage of revenue on ROADMs from customers outside of North America, it's lower than I would expect given the percentage market share that our customers outside North America have of their business if you were saying we were fully saturating the ROADM markets, but the reality is our customers outside North America, primarily in China, have been slower to adopt ROADMs particularly for domestic deployments, but are rapidly from a product design standpoint closing that gap, so we expect that there's a lot of upside just in bringing other geographies from a customer standpoint up to the same level that, for example, our North American customers have been spending on ROADMs. So we think obviously the telecom market can move around quite a bit. As Alan highlighted, we're sold out on those products and adding a lot of capacity. So I think short to medium term feels good and long-term feels good, but in between is always hard to handicap.
Our next question comes from the line of Samik Chatterjee from JPMorgan.
I just wanted to broadly ask you about if across your portfolio, you're seeing any impact on either demand from tariffs or even as you kind of guide into pretty strong margins, are you embedding in any kind of impact on margins from tariffs overall.
Yes. So we did pay tariff last quarter. It was in the hundreds of thousands of dollars, less than a penny a share, and we factor that into our guidance going forward. I think fundamentally, we are - we have been over the last couple of years in that transition period of moving out of a large contract manufacturer in China and into other contract manufacturers outside of China, including in Thailand, as well as our own factory in Thailand. So we've already seen some benefit and some flexibility with respect to shipping product out of our Thai facility to the US. Whereas if it happened a year ago, we'd be paying tariffs on those products. So that transition's happening over the next three or four quarters and from that perspective, we'll be producing very little in China. So I think we'll be in good shape.
Yes, I think it's also good to add that the nature of our business, our customers are folks who build hardware and generally build that hardware in low-cost geographies, not in the United States. So even shipments that do come from China - from our contract manufacturing partners in China generally land in places like China, Thailand or Mexico.
Okay. And if I can just follow-up on 3D sensing, I think in your prepared remarks, you did mention that you had a faster ramp-up in F 1Q than you expected probably. Are you kind of thinking that's more of a pull forward of inventory from fiscal second quarter or was there certain kind of volume drivers that came in better than you expected in the quarter?
It's hard to tell. I think it's real demand. I don't think there is inventory sitting as our customers are at their integrators. So it's either higher share or our customers' products are doing better than expected. So I think from that perspective, we're pretty happy with our share and how our product is being accepted by the market. I'd say that our yields continue to be very solid, our quality performance is extremely solid and having that track record of having shipped hundreds of millions of these things with extremely high quality gives us confidence that we're going to be the partner of choice down the road as well.
Our next question comes from the line of Joseph Wolf from Barclays.
I want to ask two competitive landscape questions. One is you talked about very strong demand in ROADMs, new products out there and not enough capacity. What is the competitive landscape there versus your new products? And are your customers waiting - what are the dynamics going on in the telecom market versus your new product?
Well, I'd say from the leading edge products, we have a very strong competitive advantage. I'd say our customers waiting. Based on the number of phone calls I get and have to deal with on that topic, I'd say they don't have a lot of patients and they want more product sooner, but at the end of the day if you're talking about 1x35 or MxN, if you want that product, you've got to get it from the person that's producing it, and that's why we are adding more and more capacity both on the existing product lines, but as well as on those really game-changing network enablers of ROADM. So waiting, not very patiently.
And then on the world-facing side and specifically on the Android ecosystem where you talked about doubling, I'm wondering if that's a measurable number for us just yet, but can you talk about competition and world facing and particularly from perhaps non [indiscernible] based or non-optical-based solution sets that you're seeing as you prepare for that market?
Yes. Well, maybe kind of start in reverse. It's tough to say entirely what we're competing against if it's not optical just because customers in this space are very secretive about what they do. With that said, what our customers continue to message to us is that optical techniques are the preferred mode of operation for whether it be front or world-facing given the ability to operate darkness and lights doesn't pass through the body, if you will, which certain microwave or RF techniques that can do. In terms of customers and products, there's a wide range of customers who are looking at world-facing and either have or will be shortly launching products, and I think it's a tremendous opportunity given it is - as we mentioned in our prepared remarks, has the ability to increase the content per device beyond the front facing. It also has the ability to broadly spread from being just a pure mobile device to other devices and consumer appliances, if you will.
Our next question comes from the line of Tejas Venkatesh from UBS.
And my question was actually a follow-up from your last sentence, Chris. Are there new markets emerging outside of mobile consumer that could be exciting over the next one to two years? You called out auto in your prepared remarks, but that sounds like a longer term opportunity given longer product cycles. But are there other markets with faster product cycles that could be exciting in the next year or two?
Yes, I mean, certainly in the consumer electronics space, there's a wide range right even going back obviously years ago in gaming and people talking about putting it in televisions and other smart devices. But as we look going forward, whether we're talking about personal assistance, smart speaker, AR/VR headsets, appliances, there's very definite action out there in customers pursuing such products. The overall volumes of each of those individual products or markets sub-segments, if you will, still will be lower than as we look to smartphones and devices like that just given how high the volumes of the products are. But in aggregate, those other consumer electronics can become a pretty meaningful amount of revenue over time.
Understood. And is it fair to say that most of your Android revenue today is world-facing and then all are the Android guys also asking for 6-inch pixels?
So I'd say that no, we're working with Android customers on both front facing and world facing and some products have already been announced in the Android market with front-facing devices, but there is also a great deal of effort and I think imminent product announcements on world-facing. As far as our customers asking for 6-inch versus 4-inch, I think frankly they don't care how we produce it, they care with the cost is. And I think that given our manufacturing strategy on 6-inch, on foundry partners and the yields and design capabilities that we have, we're able to meet their requirements for volumes, quick ramp ups, as well as the cost that they need and gets us the margin that we need as well.
Our next question comes from the line of Rod Hall from Goldman Sachs.
I guess I wanted to start off with 3D capacity and what you guys are thinking about investment there and how that's changed since last quarter. Are you thinking that you need to add additional capacity early next year or do you think you have plenty of capacity to meet demand? And then I have a follow-up or two.
Sure. I'd say that what we continue to get better output from improved yields as well as improved methods to produce the product. So I would say that not a tremendous amount of investment is needed to increase capacity of existing products. With that said, there are investments that are needed to produce newer technology, different type of test technology, specifically for world-facing, that our partners are going to be putting in place over time. So I'd say from a from our balance sheet standpoint, our model is not to have to put out big capital investments, but to work with our partners to have them do that, and that's really their job and how we pay them. So I'd say that it's not a tremendous amount, but I think our productivity and methodologies for driving yield improvement gets us what we need in the short-term horizon.
Okay, Alan. And then just to follow that one up, in terms of capacity need expectations, notwithstanding all the yield improvements and so on, how has that changed in the last quarter? I mean, are you thinking that you're going to need to be able to produce more now than you thought you would a quarter ago as you look into next year?
I don't know about relative to a quarter ago. I mean, we have a design funnel that is bigger than I had expected a year ago and the timing by which those go into production and our customers' decisions around is it a high-end phone or is it going to the more lower cost, higher volume devices, that we work with our customers in a real-time basis and make decisions as needed. So I'd say it's kind of a - our customers and our design team and business guys in that market, we're very closely to make sure that there's no surprises, and we get them what they need when they need it.
Okay. And then I wanted to go back to this ROADM question. When do you think you're going to be - actually able to meet demand with capacity on ROADMs?
Well, I mean, we certainly thought that we would be meeting the demand today three quarters ago when we made those investments. So we're just continuing to try to anticipate what's happening with future demand. And as I said, products that are hugely differentiated and have a lot of traction like Twin 1x35 and the MxN, we're adding capacity hoping that we're going to be able to meet the customer demand. But those things take six months to have that capacity show up and be productive. I'd say that for next few quarters, we're going to be still in a capacity constrained environment at least. And then when you layer on top of that, these differentiated products, we're trying to get ahead of that. So I'd say through the middle part of next year, we're going to have lots of discussions with our customers on how we get the more products.
I appreciate it. And my last question is on lasers. I just wanted to know what kind of visibility do you think you've got there and do you think that - do you feel like that bottomed or you just don't have enough visibility to be able to tell where that laser business might bottom out?
Yes. From my perspective, lasers revenue in the short term is flat. I think it's probably the bottom from our perspective because fiber laser demand is continuing to be quite strong, and we have a new product pipeline from our ultrafast products that will be introduced next year that should drive new design wins for us and new design wins for our customers. That should propel the growth.
And our next question comes from the line of Meta Marshall from Morgan Stanley.
It's [indiscernible] Anderson on for Meta. Any changes to the demand environment there beyond just ROADMs, any pickup or is it still relatively muted? And how do you feel about where expectations heading into 2019 on this?
Well, I think in the products that we talked about, ROADMs, pump lasers and amplifiers, China is extremely strong today, and I think it's really still in the early, early stages of ROADM deployment within China. So my expectation is that the China growth continues in the transport side where our strength is. I think we have less visibility in what's going on in the transmission side just given where we put our R&D dollars in the transport side. So I think from our perspective, China is going to continue to grow over calendar year 2019.
Okay. And just a second question on this. Any updates on the CFO search there? Any idea when a decision could be made? And on the Oclaro deal, any color there would be helpful?
Well, on the CFO search, we're continuing to meet excellent candidates and trying to find the right person for the type of company we are becoming and the type of company we want it to become in the future. And as I said on last call, Chris hasn't screwed things up quite yet. So I'm in less of a hurry to find someone as opposed to find the ideal person for the job. So it certainly is a priority, but I think from my perspective, things are working pretty well. The finance team is doing a great job under Chris, and so I'd rather find the perfect person than just fill that hole because Chris is doing a good job.
And our next question comes from the line of Tim Savageaux from Northland Capital.
One on telecom and a follow-up on 3D. On the telecom side, it seems like your discussions and guidance that you're talking to perhaps an acceleration in sequential growth in telecom into the December quarter. I wonder if you can comment on that and maybe in that context, also comment on sort of what was left on the table, if you will, capacity wise in the September quarter and whether given the Datacom decline and accelerating telecom, this trend of gross margin expansion within communications is likely to continue?
Yes. I would say that our expectations are for accelerated growth in our transport side of the business, and that's allowed us to be more selective per your comment about not chasing lower-margin business. And so that's why we have been more selective because we have been growing the higher margin businesses, and we can pass on some of that lower margin customer opportunity, and that will drive both the short-term gross margin and operating margin performance as well as the longer term. So we're going to continue to focus on investing in those higher margin products and portfolios and being more selective in some of those lower-margin products like Datacom.
And then just a follow-up on the telecom side real quickly. Do you think given your capacity situation in ROADMs and elsewhere that there's enough of a dynamic there to offset or even more than offset what's typically downward seasonality in the March quarter based on pricing declines?
Well, maybe to finish the question you asked in the first part, how much should we be leave on the table, we got tens of millions of dollars on the table. And I think that we're trying to work down that backlog, but there will be a significant amount of backlog going into the March quarter that's unsatisfied. So I can't predict the future, but given where we're at and what our customers are telling us, I think that we could - there will be pricing reductions in the first calendar quarter, but we could see a different kind of seasonal effect in the March quarter than we typically see.
And if I could just follow that right along on the 3D side and ask you the particular future some more. And given your guidance, it doesn't look you're going to reattain kind of your peak revenue level in 3D that you saw last quarter - sorry, last year. But I wonder given the recent announcement of face id equipped iPads as of yesterday, the Tenor ramping kind of mid-month, what we might see kind of a much less dramatic seasonal drop-off and also given the number of devices in Android that we're talking about into the March quarter from December than we saw last year or if you have any early thoughts on what sort of profile you might see seasonally in 3D?
I'd say that our customers can count on us. And from that perspective, I don't think people are over-ordering or forecasting, whereas, I'd say that last year, there was probably inventory on the shelf at the end December in fears that the product wouldn't be there in January. So I think from that perspective, we may not see the kind of drop off. But again, I can't give you guidance more than one quarter at a time. I would say that our broader customer base is better for that seasonalities moving out. But again, it's hard to tell what's going to happen as these new products get introduced and what kind of traction they have with consumers.
And our last question comes from the line of John Marchetti from Stifel.
I appreciate you fit me in here under the wire. Just curious, as I look at that Datacom business and the expectation for a fairly significant drop here going into the December quarter. Do you think that sort of the floor there as you look out next year, should we think about that potentially picking up as we get into the sort of middle of next year or second half? Just curious how you think that sort of plays out over the next couple of quarters as you start to bring on some of the new 100 gig and 400 gig products.
Yes. I'd say probably, this is the low point. We will be introducing our low cost CWM4 later this quarter and getting traction through calendar '19. So, at least, my expectations are that we do grow in calendar '19, whether that's a big growth. It all depends upon what happens in market pricing because we're not going to chase bad margin unprofitable business, and it just seems like every time we get a new update from our Hyperscale friends that their price expectation goes down. So it's hard to tell. I'd say that at least from my perspective, the new product development is going very well, and we think we're going to come out with a cost differentiated product that should be able to address that growing market.
And I will turn the call back over to Alan Lowe for closing remarks.
Thank you, Emily. I want to thank our customers for their business and their partnership. I also want to thank our employees for all their hard work and putting this into an excellent position for long-term growth. We regularly discuss our business at Investor Relations events. These events are listed on our website in the Investor Relations section and are regularly updated. This concludes our call for today. I would like to thank everyone for attending, and we look forward to talking with you again in another few months. Thank you.
This concludes today's conference call. You may now disconnect.