Lumentum's (LITE) CEO Alan Lowe on Q2 2016 Results - Earnings Call Transcript

| About: Lumentum Holdings (LITE)

Lumentum Holdings Inc. (NASDAQ:LITE)

Q2 2016Results Earnings Conference Call

February 4, 2016, 04:30 PM ET

Executives

Chris Coldren - VP, Strategy and Corporate Development

Alan Lowe - President and CEO

Aaron Tachibana - CFO

Analysts

Jorge Rivas - Craig-Hallum Capital Group LLC

Michael Genovese - MKM Partners LLC

Joseph Wolf - Barclays Capital

James Kisner - Jefferies LLC

Patrick Newton - Stifel Nicolaus & Company

Simon Leopold - Raymond James & Associates, Inc.

Doug Clark - Goldman Sachs

Alex Henderson - Needham & Company LLC

Dave Kang - B. Riley & Co. LLC

Tim Savageaux - Northland Securities

Meta Marshall - Morgan Stanley

Ashwin Kesireddy - JPMorgan

Operator

Good day, ladies and gentlemen, and welcome to the Lumentum Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Chris Coldren. Sir you may begin.

Chris Coldren

Thank you, Lauren. Welcome to Lumentum's second quarter fiscal 2016 earnings call. My name is Chris Coldren, Vice President of Strategy and Corporate Development. Joining me on today's call are Alan Lowe, President and Chief Executive Officer; and Aaron Tachibana, Chief Financial Officer.

This call will include forward-looking statements, including statements regarding Lumentum's expected financial performance, expenses, trends, and position in our markets, as well as expectations related to our customers and our products.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations. We encourage you to review our most recent filings with the SEC, particularly the risk factors described in our 10-Q filing for the fiscal quarter ended September 26, 2015.

The 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 obligation 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 financial should not be considered as a substitute for, or superior to, financials prepared in accordance with GAAP.

Our press release with our second quarter fiscal 2016 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. Finally, a recording of today's call will be available by 6 PM Pacific Time this evening on our website.

Now, I would like to turn the call over to Alan for his comments and second quarter business highlights.

Alan Lowe

Thank you, Chris. We are in the early stages of a dramatic bandwidth expansion across the globe. Market demand for our products is strong and growing. There are multiple significant new network deployments underway and more are to ramp up in the coming quarters.

Hyper-scale data center operators are readying for the transition to 100G within their data centers, which will drive significant revenue for their suppliers. This is a very exciting time for Lumentum.

In every communication network in the world, from data centers, to the network's interconnecting data centers, to enterprises, to the terrestrial and subsea communication networks, there is an ever-increasing demand for higher bandwidth and greater speed, agility, and efficiency. This demand is relentless. As a result, our technologies and new products are critical to almost every type of communication network today.

At Lumentum, we see the lines blurring between telecom and datacom, which were once distinct markets, both in terms of customer base and technologies they require. Traditional telecom network operators look more like cloud and data center operators every day, in the services they offer to the -- and the underlying networks and data centers they build.

Cloud and data center operators now need to add longer distance, very high bandwidth fiber optic links to interconnect their data centers and to provide network access to their customers. These trends and their requirements they place on the underlying technology and manufacturing capability play directly into our strengths and our technology leadership.

Since our last conference call, demand for our Optical Communication products has gotten stronger. Demand from China and our customers supplying into North America metro builds is particularly strong. The investments we made in industry-leading products, including 100G components and modules, amplifier and pump lasers, and ROADMs position us very well.

While recent company-level growth has been driven primarily by our telecom business, looking forward, we expect datacom will begin to contribute to our growth again. Demand for our 100G datacom products is markedly increasing, and we are ramping production of our portfolio of QSFP28, CFP2 and CFP4 transceivers. These products position us well with both our hyper-scale data centers and enterprise customers as they transition to 100G.

The decline in our datacom business over the past couple of quarters was the result of the lower speed market having become overly competitive and customers at 40G slowing their consumption in anticipation of 100G. We are now at a point where we expect growth in our 100G products to more than offset declines in our lower speed products.

We executed to our plan in the second fiscal quarter and are pleased to report our first quarterly results as Lumentum for the entire quarter. As expected, we saw strong growth in our telecom products. Telecom revenues grew sequentially, driven primarily by the rapid growth of our industry-leading ROADM products.

We saw our overall ROADMs revenue grew more than 44% sequentially and 103% year-on-year. Of note, our TrueFlex ROADMs and blades grew even faster, with a 64% sequential increase.

We believe this strong demand is due to our share gains at key customers supplying into the metro deployments as well as a broad market adoption due to our superior product performance.

We also saw strong 100G component sales in the quarter, which resulted in record 100G modulators and tunable laser revenues. We saw a robust demand across the range of our telecom products, but were capacity-constrained on many product lines. We are adding capacity as we expect strong demand to continue throughout calendar 2016.

Offsetting some of this growth we saw delays in two undersea cable projects which impacted our submarine revenues, which was down approximately $6 million sequentially. We expect the submarine market to the cover in the second half of the calendar year.

Excluding the impact of our lower submarine revenue, our telecom business grew 8.4% sequentially. Second quarter datacom revenue declined $700,000 relative to the prior quarter. Revenue from our 100G CFP2, CFP4, and QSFP28 products grew 22% sequentially, but this growth was offset by declines in 10G and 40G products.

We're winning customers with our 100G products due to our differentiated photonic integration and in-house optical chip platforms and our proven ability to rapidly ramp to high volumes.

We are in production with our single-mode QSFP28 products, which will be central to many hyper-scale data center 100G deployments. Initial QSFP28 shipments are primarily to enterprise network equipment manufacturers. We expect the hyper-scale data centers to transition to 100G in a meaningful way this summer.

We expect our third quarter datacom revenue will be up due to the strong traction of our 100G products. We also expect our 100G datacom products to be a major growth driver of our business moving forward.

Industrial and consumer revenue was up $4.3 million sequentially, though our first quarter revenue was down a bit due to an industrial diode laser customer who had delayed a significant order to the second quarter. 3D sensing revenue was up $1.1 million from the prior quarter, although still at relatively low levels.

Commercial laser revenue was down $3 million, driven by a $3.2 million sequential decline in our kilowatt fiber laser sales. Customer demand for our kilowatt fiber laser remained strong, but we had challenges meeting this demand for one of our products.

Our -- we previously indicated we had encountered an issue on a component that impacted our ability to deliver one of our fiber laser products two quarters ago. We developed a new process in order to overcome the manufacturing issue and increase our fiber laser output, but we have had challenges in ramping this up sufficiently yet to meet our customers' strong demand.

Sales of our solid state lasers, primarily used in semiconductor chip manufacturing processes, were down as expected; but the impact of this was offset by growth in sales of our new ultrafast laser products. For the third quarter, we're expecting Commercial Lasers' revenues to be flat to slightly up.

Book-to-bill for Optical Communications was above one; while that of Commercial Lasers was approximately one. Due to the higher percentage of revenue running through VMI programs and some of our customers placing long-term, multi-quarter orders, we continue to advise caution in drawing conclusions from book-to-bill results. Nonetheless, we saw strong bookings in the second quarter and that strength has continued into this quarter.

I would like to now highlight two organizational changes we are making. First, we are combining our product line management and sales organizations under Jason Reinhardt, our Senior Vice President of Global Sales.

Second, we are combining our R&D and operations teams under a common leader, Vince Retort. Vince has been our Senior Vice President of R&D. Craig Cocchi, our Senior Vice President of Operations, will support Vince during this change and then will transition out of the company on April 1st, as announced earlier today.

Lumentum has been on our own for six months now and these changes will more tightly align our new product development process to our manufacturing process and further strengthen and streamline our new company for growth.

This is a very exciting time for us as demand continues to grow for bandwidth and speeds across the world's data centers and the communication networks that connect them. As a newly independent company, we're strongly positioned with our products, our technology, roadmaps, and our team's ability to execute.

I will now turn the call over to Aaron for more details on our financial results and our guidance for the third quarter. Aaron?

Aaron Tachibana

Thank you, Alan. Net revenue for the second quarter was $218.3 million and above the midpoint of our guidance of $212 million to $222 million. GAAP gross margin was 31.2% and decreased 30 basis points quarter-to-quarter. GAAP operating margin was 2.8% and GAAP net income per share was $0.05.

Our second quarter non-GAAP gross margin was 32.7% and decreased 10 basis points relative to the prior quarter, driven by sequential decline in Optical Communications gross margin, which was not fully offset by the increase in Commercial Lasers' gross margin for the period.

Non-GAAP operating margin for the second quarter was 9%, an increase of 190 basis points sequentially. Non-GAAP earnings per share was $0.31, based on a fully diluted share count of 60.7 million along with $500,000 of other expense from foreign currency losses and zero tax expense.

Optical Communications revenue was $185.8 million, an increase of approximately 5% relative to the prior quarter, driven by a $5 million or approximately 4% increase in telecom revenues of $4.3 million or a 50% increase in consumer and industrial revenues, which was partially offset by a $700,000 or approximately 2% decrease in datacom revenues.

Optimal Communications gross margin at 30.7%, declined 70 basis points sequentially. As Alan mentioned, we experienced lower submarine revenues in the quarter. These products carry above-average margins, impacting our overall optical gross margins. Commercial Lasers revenue was $32.5 million, a decrease of $3 million quarter-on-quarter, driven primarily by lower fiber lasers revenues.

Gross margin at 43.7%, increased 360 basis points due to the impact of cost reduction actions as well as favorable mix that included more of our new ultrafast lasers. We had three customers in the quarter that each contributed 10% or more of our third quarter revenue compared with two in the prior quarter.

Operating expenses totaled $51.7 million, with R&D expense at $32.7 million and SG&A expense of $19 million. The sequential decline in SG&A expenses was due to the prior quarter including certain allocated costs from Viavi for the pre-spinoff time period.

Income tax expense was zero for the quarter and we continue to realize a very low tax rate due to a couple of factors. First, at the time of separation from Viavi, all Lumentum-related assets and liabilities were contributed to an entity owned by Lumentum in a taxable transaction, which resulted in Lumentum tax basis increasing by approximately $715 million. This increased tax basis provides us with long-term annual tax deduction.

Second, we have more than $90 million of NOLs, which are being utilized to offset current year income.

Our cash balance was $161.9 million at the end of the second quarter and increased $19.8 million from the prior quarter. This increase in cash was primarily result of disbursement timing.

Capital equipment additions were approximately $20 million or 9% of revenue during the second quarter. This level of CapEx is meaningfully above historical investment levels of roughly 4% to 6% of revenue.

However, we are increasing our investments in capital equipment in order to expand capacity to meet the rapidly-growing demand from our customers, particularly for our 100G and ROADM products. We expect CapEx investments to be in the range of 9% to 10% of revenue over the balance of the fiscal year.

Now, onto our guidance for our third quarter of fiscal 2016. We project net revenue for the third quarter to be in the range of $222 million to $232 million, with an operating margin in the range of 8.0% to 9.5%, and earnings per share to be in the range of $0.28 to $0.34.

In considering this guidance, please note the following factors that impact our projections. First, the third quarter will have 14 weeks versus the normal 13 weeks; but the revenue impact of the extra week is reduced by lost manufacturing time due to the lunar New Year holiday in Asia.

Because we are capacity constrained across many product lines, it's more challenging to mitigate the impact of this holiday by exploiting excess capacity at other times in the quarter, as we have done in prior years.

Second, we expect demand for our products will still outstrip supply as capacity constraints on certain product lines continue. Additionally, we are encountering shortages and longer lead-times for components from our supply chain.

And third, we expect our operating expenses will increase relative to the second quarter due to the impact of having extra week of salary and benefits expense, the payroll tax reset that occurs in January, and the slight increase in all other expenses for the additional week.

Now, I'll turn the call back over to Chris to begin the Q&A session. Chris?

Chris Coldren

Thank you, Aaron. I would like to ask everyone to limit discussion to one question and one follow-up. Lauren, let's please begin the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from Jorge Rivas from Craig-Hallum. Your line is open.

Jorge Rivas

Good afternoon, guys, and congratulations on the great results. I want to start, first, if you could provide any comments on what you have seen in the annual price renegotiations so far -- whether it's in line with previous years, a typical 10% to 15%? Whether it's on the high end, low end? Any comments on that will be really helpful.

Alan Lowe

Thanks, Jorge; this is Alan. I think it's pretty typical. We saw ASP reductions in Q2 that were typical for that time of year. And some of our customers have changed their annual price negotiations to align with their fiscal years. And so we've seen more of a spreading out of that annual price reduction over multiple quarters.

So, for instance, in Q2 our optical annual price reduction was between 3.5% and 4% and we expect similar kind of reduction in Q3. But those are typically our two largest ASP reductions in optical. So, we don't expect anything different than normal.

Jorge Rivas

Okay, great. And then I wanted to get into your ROADM business. So, pretty encouraging, but I wanted to also ask about the pricing of ROADMs. Do those follow the same typical telecom rates -- the price, I mean?

Alan Lowe

Yeah, well -- sometimes. I mean -- and why I say that is because when we start a development of a ROADM blade with a customer, typically, we set prices far in advance of even production start time and we commit to price reductions over time for some period of time, because our customers are doing a joint development with us and they want to make sure that that development will pay off for them with respect to price reductions over time. So, for a blade program, typically, prices are set far in advance of production start. But for modules, those are typically done similar to the rest of our telecom business.

Jorge Rivas

Okay. And then one last one for me. So, you alluded to some supply constraints and I'm wondering that it's also affecting the components that you source for ROADMs?

Alan Lowe

Yeah, we're seeing -- as we add capacity, as we increase our demand on our suppliers, we're seeing lead-times expand pretty much across the Board with our suppliers. We are seeing component constraints for our ROADMs, but probably more impactful on our ROADM blades.

And we're working anxiously and very diligently to resolve those component shortages with our suppliers and free up that supply base, so that we can utilize the capacity that we're putting in place. But we're still having challenges with that as our demand continues to grow faster than we had originally expected.

Jorge Rivas

Great, thanks a lot. That's all for me, guys. Keep up the good work.

Alan Lowe

Thanks Jorge.

Operator

Our next question comes from Michael Genovese from MKM Partners. Your line is open.

Michael Genovese

Thanks a lot. Is it fair -- kind of a fair characterization to say that the solid optical results in the December quarter were driven by North America? And then maybe the strength of the outlook maybe is more driven by orders coming from China, is that fair?

Alan Lowe

No. I would say in Q2 we saw strength from both North America as well as China. I'd say for outlook, we're expecting similar kind of continued growth and demand for both regions.

And I'll say that EMEA is also starting to look like they're picking up as well. And so I'd say EMEA probably more on an outlook standpoint, but North America and China are both in Q2 as well as forward-looking.

Michael Genovese

Right, right. I mean this is a notoriously lumpy industry, but with the kind of programs you're ramping now and the kind of capacity additions that need to be made in the industry, are you sitting down across from your customers and looking them in the eye and getting more confidence that your visibility maybe extends out further than normal at this particular time?

Alan Lowe

Yes, certainly we sit at our customers' tables and look at them across the eye -- across the table and try and understand their view of the demand picture. But we're also meeting with their customers and understanding what their network deployments look like.

So, I think that's kind of a way that we can understand how much capital we should be spending and how far we should be driving our supply base to meet not only our customers' demand, but their customers' demand as well.

Michael Genovese

Okay, great. And then finally for me, just any update on ROADMs in China? I mean, ROADMs here -- is it in the $30 million kind of range? And any of that into China yet or when would that happen in the future?

Alan Lowe

Yeah, I mean, we're shipping ROADMs today into the Chinese network equipment manufacturers. And I would say that probably most of those are leaving China and going into network deployments outside of China.

However, we are working with those network equipment manufacturers to understand when they believe they will be deploying ROADMs in China because when that happens, that could be a significant bump up in demand. And I still am consistent in my belief that I think that's really a 2017 type of implementation and the evaluations are going on today.

Michael Genovese

I was hoping you'd check my math too on that number. I just kind of threw it out there.

Alan Lowe

Well, I think we tried to help triangulate the number last quarter, where we were about 50% of our peak volume of ROADMs in 2010-2011, when the last North America metro deployment really came up in a meaningful way and so we grew 44% from that. So, we're north of $40 million today in ROADM.

Michael Genovese

Great. Thanks a lot.

Alan Lowe

Thanks.

Operator

Our next question comes from Joseph Wolf from Barclays. Your line is open.

Joseph Wolf

Thank you. I wanted to focus a little bit on the incremental CapEx, which appears to be about double. Could you just talk through geographically where you're adding capacity, given some of the changes in production that you're doing?

And then how much capacity are you adding over the next -- I think you said for the rest of fiscal year for two more quarters of that additional $20 million or so that you're adding, how much more capacity does that get on the products that are at capacity right now?

Alan Lowe

So, year-to-date we spent about $33 million to $34 million in CapEx and the majority of that is going into assembly and test -- mostly test capacity for things like 100G, telecom and datacom products, and ROADMs.

So, most of what we buy ends up at our CMs in China and in Thailand. But we are also investing into our fabs as we consolidate our lithium niobate fab into San Jose. And as we grow our capacity here in San Jose, we are investing in our wafer fabs in North America.

As far as what does that mean for incremental capacity, it's really hard to generalize that, because it really depends by product line how much more revenue we can get per CapEx dollar.

I'd say the two biggest chunks of capital we're spending today are for the ramp-up of our QSFP28 datacom product in anticipation of the summertime flip for the hyper-scale data center guys to move from 40 to 100, as well as ROADM and ROADM line cards. Did that answer your question?

Joseph Wolf

Yeah, that was very helpful. I mean, is there a way to -- well, I don't correlate either volume or dollars to the amount that you're spending or some sort of return that you're looking for before you make the invest decision?

Aaron Tachibana

Yeah, so Joe, this is Aaron. So, we actually do go take a look longer term as well, to see what the return on invested capital is going to be, right? Because it doesn't make sense to deploy a lot of CapEx if we can't see that it's going to be utilized longer term, because the depreciation of that goes over several years.

In terms of being able to tie that back to specific capacity for specific product lines, like Alan had mentioned, it's a little hard to do because some of the capacity you can shift from product line to product line depending upon what that equipment might look like.

Joseph Wolf

All right. Thanks. That was helpful.

Operator

Our next question comes from James Kisner from Jefferies. Your line is open.

James Kisner

Hi, guys. Thanks for taking my question. Just wanted to dig a little bit into your comments about 100-gig datacom and its strength in calendar Q4 and expected strength in calendar Q1. Can we assume that CFP2 remains the majority of that 100-gig revenue and that QSFP28 is still pretty small in there?

And could you also kind of comment on the competitive environment at 100-gig, particularly for QSFP28, just given the number of players that are entering this piece of the market, do you still think the gross margins there will be above average? Thanks.

Alan Lowe

Yeah. So just for background, we skipped over CFP. I think there's still a lot of CFP 100-gig datacom products being shipped today. But we've seen a shift in many of those customers to CFP2. So, the majority of our shipments today are CFP2, although, we saw growth in CFP2, CFP4 and QSFP28 last quarter.

And you're right -- well, the competitive landscape on QSFP28 right now has a lot of people talking and only one person that I know delivering and that would be us. So, especially on the single-mode hyper-scale data center kind of product, like we're doing on our CWDM4, which is our two-kilometer reach product.

So, it's just under $1 million in revenue in Q2. And we expect that to grow dramatically in Q3, when the hyper-scale guys grow, make that switch -- that will grow many-fold times.

James Kisner

That helps a lot. And just separately on ACO, CFP2-ACO for grand applications, I think you said in the past that you're a little late to market, but you're going to be cost effective. And just wondering will you be kind of around participating in the ramp in the Q2, Q3 time frame for that product as well or might it take a little longer for you to benefit from that ramp?

Alan Lowe

Yeah, we are behind the people that are sampling today. We have sampled and gotten feedback from our customers. We still have some work to do. But I still believe that our strategy is the right one, which is a higher level of integration in a single chip for our laser and modulator in the CFP2-ACO.

We are going to be sampling our customers continually, but I'd say that our production ramp is not in Q2 -- calendar Q2 or Q3, but more probably in the Q4 timeframe. And I think that frankly aligns with when the telecom customers will be able to implement that.

So, while we're probably missing the beginning of the ramp for the DCI, or the data center interconnect, on CFP2-ACO, I say we'll be able to catch up on the telecom. And then through having greater ability to ramp in production because of the technology and architects we have, I think we'll be able to ramp up faster and surpass the guys that are sampling earlier than us.

James Kisner

Great. Thanks very much.

Alan Lowe

Sure.

Operator

Our next question comes from Patrick Newton from Stifel. Your line is open.

Patrick Newton

Yeah. Good afternoon. Congratulations Alan and Aaron. Before we jump into my questions, did you provide or did I miss your fiber laser revenue in the quarter?

Alan Lowe

It was down 3--.

Aaron Tachibana

It was down $3 million quarter-to-quarter.

Alan Lowe

Yeah, $10 million last quarter.

Patrick Newton

Great. Okay. And then I guess, Aaron, I guess given your commentary on revenue and the extra week in the March quarter, it looks like we should not look at the outlook as being inflated by an extra week. I just want to confirm that.

And then thinking beyond into the June quarter, I just want to make sure that we should not see an abnormal downtick in revenue given that you will then be operating with one less week.

Aaron Tachibana

Yeah, so that's a great question. So, in terms of this quarter that we're in today, it is a 14-week quarter, but we do have to be a little bit cautious, primarily because of the Lunar Holiday. There's a full week of the Lunar Holiday in Asia and we are capacity-constrained in certain areas. So, it's our belief today that some of the loss capacity due to different situations is hard to make up.

The March quarter is typically a down quarter for us, primarily because we have significant price reductions and negotiations that take place in Q2 and Q3. But having said that, we might have a small benefit from the 14th week and so in terms of how you model it and how we look at it, we don't anticipate a significant drop-off in the fourth quarter, although we're not providing guidance for Q4 at this time.

Patrick Newton

Great. And then, Alan, you seem to have some comfort or visibility around an aggressive summer uptick in hyper-scale 100G datacom. I think that's kind of the universal expectation across the market.

But I'm curious if you could help us understand what is providing you with that comfort? What is causing the inflection in demand around the summertime? And then if you could also perhaps -- thank you for the details on the $1 million roughly in QSFP28. What's the timeframe for you to eclipse something meaningful, something that moves the needle maybe $20 million a quarter with that product?

Alan Lowe

Okay. Well, what gives me confidence is what my customers are telling me and how they are starting to buy pilot runs of our QSFP28. I think as far as why then I think their systems and their switches will be available, the chipsets are available now and I think it just takes them some time to roll out all of the infrastructure and fiber needed for those data centers. So, I think that's what gives me comfort.

I'd say that the feedback we're getting on the QSFP28 CWDM4 is outstanding. And so, I think we're by far in the leadership position on that product today, although a lot of people are talking and quoting prices for it.

As far as when it becomes $20 million a quarter, it's certainly feasible to do that. We have pulled the trigger on a lot of capital. But I'd be hard-pressed to say that gets us to $20 million. I think the capital that we have in place today and on order would get us probably halfway there.

Patrick Newton

Great. Thank you for taking my questions. Good luck.

Alan Lowe

Thanks Patrick.

Aaron Tachibana

Thank you.

Operator

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

Simon Leopold

Appreciate it. Thank you for taking my question. Wanted to follow-up on ROADMs. It's our impression that you've got a significant market share advantage on some of these North American efforts. And I wanted to see if; one, we could confirm that; and, two, get essentially some insight from you as to what's been sort of the secret sauce giving you that advantage and how sustainable it might be? And then I've got a follow-up.

Alan Lowe

Sure. Simon, I think today we have, if not all of the business, 99% of it. And I think that that's due to the secret sauce in collaboration that we've had with the two North American network providers that won that business. We've done blades with them for many, many years. And we work hand-in-hand with their engineering teams throughout the world.

So, I think that gives us an advantage -- and the fact that our transport team making ROADMs and blades is by far the best in the industry, and I think they've done just a fantastic job -- having our customers count on us. And so we don't let them down and we continue to build momentum on those designs and next-generation designs.

So, I think we're in a good position. I don't expect to keep 100% of that business forever. So, we're already working on cost reduction platforms to make sure that we'll be able to compete effectively and maintain the margins that we need to continue to reinvest.

Simon Leopold

Great. And then my follow-up. I wanted to go back to the extra week in the quarter, understanding you've got the Lunar Holiday, which does occur every year with the slowdown in Asia. But on the OpEx side, I assume that we should think about operating expenses on kind of a like-for-like basis should be up roughly 7% plus kind of the annual increases sequentially versus December? Is that the right way to think about it?

Aaron Tachibana

Yeah, I think that's pretty close. So, in terms of the additional week, a couple million dollars from a payroll and benefits expense standpoint. And then the payroll tax reset is another $1 million or so and then there's probably another -- little bit $0.5 million or so for all other expenses being open an extra week.

Simon Leopold

So, roughly -- we're talking about something in the neighborhood of $60 million versus the $54 million pro forma in December?

Aaron Tachibana

No, that's too high. It's probably $3.5 million to $4 million of incremental OpEx.

Simon Leopold

Okay. Well, thank you very much for that.

Alan Lowe

Sure.

Operator

Our next question comes from Doug Clark from Goldman Sachs. Your line is open.

Doug Clark

Hi, thanks for taking my question. My first one is on the comments that you outlined on North America and the strength there obviously impacting the ROADM business. I'm wondering if that's specifically related to kind of the single customer metro build or if it is more broad-based than that and there are kind of other projects going on as well?

Alan Lowe

Yeah, it's broader than just a single customer. Although I think in the long-term that single customer would drive a tremendous amount of business for us. Our TrueFlex ROADMs are being widely adopted in many carriers in North America as well as in EMEA. So, I think the growth in ROADMs is not solely due to the one guy, because I still think that's in the very early stages of deployment.

Doug Clark

Okay, great. That's helpful. And then similarly you mentioned kind of weakness in submarine revenues? Wondering if you can -- to the best extent possible kind of pinpoint what's causing those delays perhaps?

And then just kind of a third, very quick question, the third 10% customer, is that the one that we've seen historically? Or is it perhaps kind of a new customer that's never popped up at that 10% level?

Alan Lowe

Okay. Well, the submarine business is kind of unique in that most of the cables that get deployed across the oceans are built by a consortium of customers. And so them getting together and agreeing upon the terms and conditions of how that cable gets paid for and how that cable gets deployed sometimes creates delays in those deployments.

So, I could be wrong and the cables could come back immediately and we could start seeing submarine business sooner than the second half of the calendar quarter come back; but I think that this is just the typical nature of the submarine business. It is cyclical and it is dependent upon groups of customers coming together and agreeing upon terms of each of the cables.

As far as the third 10% customer, I think you'll probably have to wait until we file our 10-Q -- 10-K before you see that, but I think it's a new one.

Aaron Tachibana

Yeah, it's not the one that historically had been disclosed in our 10-K.

Doug Clark

Okay, that's helpful. Thanks a lot.

Operator

Our next question comes from Alex Henderson from Needham & Company. Your line is open.

Alex Henderson

Great. Just a couple of housekeeping clarifications. The China comment about ROADMs in 2017, were you talking fiscal year 2017 or calendar 2017?

Alan Lowe

Alex, I think it's more calendar 2017. While they may do some pilots in this calendar year. I really think it's more deployments in a meaningful way in calendar 2017.

Alex Henderson

Right. And similarly, off of China, obviously there's been a couple of very large tranches of orders that came in in November then again in December. Could you talk a little bit about what you think the spend intentions will be over the course of 2016 based on your conversations with them on their -- the size of those deployments both in terms of the long-haul backbone build as well as what we're hearing as a number of provincial builds?

Alan Lowe

Yeah, I mean I think we have visibility as far as our customers tell us. And I think the visibility goes through the summertime and into calendar Q3. But given that it's China, it can change. I mean the government can say, slow spending and all of a sudden it could slow.

But I think every indication we have today is that it's not limited to just China Mobile, but also the other two carriers. And they're kind of lining up one after another. So, I believe that at this point in time, from what we can see, the visibility is about as good as it's ever been for China. Keep in mind that the government to change their mind.

Alex Henderson

All right. And just going back to the constrained environment. I assume that it's way too early for double ordering or any of that type of nonsense to show up in the mix here. I mean, it's only been constrained for a couple of months. Usually that takes three or four quarters to develop. Is that a reasonable way to think about that issue?

Alan Lowe

I think so. I mean so much of our business is through VMI; it's very different than it was back in 2010, when everything was pretty much on discrete orders, when it was easy just to double order. I mean, if product is not getting pulled from the VMI hubs, we slow down production and we shift it somewhere else. So, from everything I can see today, we're not seeing double ordering. It's real demand.

Alex Henderson

Perfect. And just one other question on the production ramps here. Is there a particular timeline on when some of these large investments will kick-in or do you think it will be a fairly smooth ramp? And is it getting the test and diagnostic systems? Is that the constraint that's holding things back? And what's the lead-time on those, if that's the case? And then I'll cede the floor. Thanks.

Alan Lowe

Yeah. Thanks, Alex. Well, I guess I'll use ROADMs as an example. There's long lead-time items because we automate -- we have aligners that are automated to do the alignment of the LCoS the ROADM itself. Those lead-times can be three, four months. And so we had placed orders late last year and again this quarter already in anticipation of the need for capacity growth for those alignment stations out through June.

Along with that comes the test capability as well for testing both the modules as well as testing the blades because we test it at both levels. And those are three-plus months as well.

And as our orders with our suppliers increase, those lead-times tend to get bigger as well. So, we're trying to do our best to give them visibility, so they can go out and procure piece parts and add capacity that they need to be able to build that test gear and those alignment stations for our ROADMs.

On the datacom side of it, it's really more -- it's similar to that, because we have to -- we build, we buy automated alignment stations for building the optical subassemblies and then the test equipment that goes along with that both at the OSA level as well as the module. So, it's very similar, three to five months it takes to put this capacity in place.

Alex Henderson

So, it sounds like it feathers in over multiple tranches of orders. So, slug each quarter of capacity add. Is that right?

Alan Lowe

Yeah, I mean, it depends when we get the signal and when I sit across the table from our customers. I mean I'd say that we probably pull the trigger monthly on ROADMs today. Over the last three months, it's probably been three different tranches, so that we can increase our capacity on a monthly basis as that equipment comes in.

Alex Henderson

That's helpful. Thanks.

Alan Lowe

Thanks Alex.

Operator

Our next question comes from Dave Kang from B. Riley. Your line is open.

Dave Kang

Yes. Thank you. Good afternoon. The first question is just wondering how much revenue was left on the table due to lack of capacity. And of that how much was pushed into this March quarter and how much was lost to your competitors?

Alan Lowe

Well, it's hard to quantify, but it's certainly double-digit millions. It spans from ROADMs, to modulators, to 100-gig narrow line-width lasers, I would say, were the three biggest impacted -- as well as on our fiber laser.

We left several million dollars on the table in the fiber laser because of not necessarily component constraints or capacity constraints, but our ability to implement this new process that we have to be able to ramp back up on one of our fiber lasers. So, somewhere between $10 million and $20 million.

I would say that given the state of the industry, not a lot of that was picked up by other of our competitors, because they are all in similar situations with respect to modulators and tunable lasers. So, I think that all kind of falls into the next quarter and the next quarter.

We're already seeing orders come in for requests this quarter that we're not able to satisfy because of components and because of capacity, because once you don't have a component, you lose that capacity -- and you can't make it up.

And that's what Aaron was talking about during Chinese New Year. We just -- typically, we can ramp up ahead of Chinese New Year, because we have some flex in capacity. But this quarter we really don't.

Dave Kang

And the products or components that you source for your products, what are some components that's causing a bottleneck?

Alan Lowe

Well, everything from PCBs to the ICs that go onto those. And we do buy optical components from outside suppliers that are in similar situations to us. So, their lead-times have gotten longer and we're having to work with them to be able to pull those back in and figure out how do we solve those sourcing problems? So, it's across the Board on the types of components that we're after.

Dave Kang

Got it. And then on the MCS, on Multicast Switch, are you lumping that as part of ROADM sales or can you just talk about the demand for MCS?

Alan Lowe

Yeah. So, we are lumping that into the ROADMs. And because our MCS is a TrueFlex MCS, we lump that also into the TrueFlex revenue. It's still low single-digit millions, but it's ramping up as the North America metro builds pick up.

Dave Kang

Got it. And then lastly for Aaron, what was -- actually, never mind. I see it now. Thank you. That was it.

Aaron Tachibana

No problem.

Alan Lowe

Thanks Dave.

Operator

Our next question comes from Tim Savageaux from Northland Capital. Your line is open.

Tim Savageaux

Hi. Good afternoon. A couple of questions here. First, after a pretty strong -- or very strong sequential growth performance on the ROADM side, I wonder if you're able to provide any indications for -- assuming you are probably not expecting to see that degree of strength continue heading forward on a sequential basis, but can you provide any commentary with sort of how you expect that growth to look going forward?

Alan Lowe

We do expect and we are adding capacity to expect, continued growth in ROADMs -- not to the same level of 44% sequentially, but it should certainly be double-digit growth for the next couple of quarters.

Tim Savageaux

Great. And sort of also looking at that strong ROADM growth, it appears to me that even if you account for the submarine weakness and I'll assume that primarily impacts your amplifier pump laser business, but probably has some other impacts and also considering your commentary about record modulator and tunable shipments, the rest of the telecom business, I guess, looks kind of flattish after you take the ROADMs out, even accounting for the subsea.

So, with that overall scenario in mind, was there sort of an area of weakness on the legacy side or am I doing my math right, on the one hand? And then looking forward, how do you expect that subsea delay to sort of come back into the numbers? Do you have any indications on whether that's a gradual thing or coming right back in fiscal Q3 or what have you?

Alan Lowe

Yeah, so let me answer that submarine question first, because that's easy. What we said in the prepared comments was that we believe that that should come back. Those two cables should come back in the second half of the calendar year. So, we're not expecting that $6 million to pick back up in submarine this quarter or next, although I could be wrong.

As far as what's softening because we did see such strong growth in ROADMs, keep in mind, as we build a Super Transport Blade, those incorporate many of our telecom 980 pumps and a lot of our passives into those products.

So that meant we had fewer external 980 pump and passive sales externally, because we were certainly going to use our pumps and passes to build blades for our customers as opposed to sell them as components.

So, the constraint on the ability to meet our customers' demand on pumps and passes was pretty severe last quarter and it continues to be this quarter as we've been trying to add capacity to keep up with it. But those kinds of products were down, but not because we produced less, it's because we used them internally to build blades for our customers. Does that make sense?

Tim Savageaux

It makes sense. And one real quick one; I may have just this. Did you -- I think you may have provided a metric about aggregate concentration for your top five customers last quarter? I don't know if you provided something similar or are able to for this quarter?

Aaron Tachibana

We haven't really provided anything like that. But in terms of concentration for top 10 customers, it's in excess of 60%.

Tim Savageaux

Great. Thank you.

Operator

Our next question comes from James Faucette from Morgan Stanley. Your line is open.

Meta Marshall

Hi, this is Meta Marshall for James Faucette. A question on a previous comment you made about ROADMs shipping into China that where then shipping elsewhere, do you have a sense of where that equipment is going? And is that some of the commentary about EMEA outlook being stronger?

Alan Lowe

Yeah, I would say that when we ship a ROADM into China, it doesn't come back to North America, but normally it ends up in EMEA. And that's where we believe it's going. There are some large deployments in Germany that we believe a lot of our TrueFlex ROADMs are ending up. So, that's what I meant by that.

Meta Marshall

Okay, great. And then I know that you gave a comment that at 100-gig in datacom, you guys are leading the pack as far as having product. But pricing as far as kind of sub-100 gigs, so 40-gig or 10-gig, what are you guys seeing there?

Alan Lowe

Pricing--?

Meta Marshall

In datacom.

Aaron Tachibana

Pricing is still pretty competitive. And so, as we had mentioned on prior calls, we're being selective in terms of what we take for 10-gig and below. And I think in Alan's commentary during the earnings call here, we did mention that there's a little bit of pause in 40-gig, primarily due to some of the folks waiting and looking at QSFP28. Pricing is competitive, it's tough.

Alan Lowe

Yeah. And one of the other things that I mentioned last earnings call was that our 40-gig offering, our single-mode 40-gig offering is not as competitive as it needs to be, because we rely on an outside source for some of the optical chips. So, we made the decision to have everything built inside on our 100-gig, which will give us the cost we need to be very competitive in that market.

Meta Marshall

Great. Thank you guys.

Operator

Our next question comes from Rod Hall from JPMorgan. Your line is open.

Ashwin Kesireddy

Yeah. Thanks for taking my question; this is Ashwin on behalf of Rod. I wanted to go back to your comments on North America. You mentioned something like this trend in North America is driven by a broad set of customers, but, first of all, I want to clarify if I heard that right? And if yes, then how many carriers are really driving the demand?

Alan Lowe

Well, put it this way, my understanding is that all North America carriers deploy ROADMs, and many of them are making deployments today in the metro. Some of the Tier-1s, but a lot of the MSOs as well as some of the second and third-tier carriers are deploying networks today and are deploying our ROADMs through the network equipment manufacturers that we sell to.

Ashwin Kesireddy

Okay. I want to ask another question on EMEA. You said there was some strength driven by deployments in Germany, but as you talk to carriers and customers, do you get a sense of when -- do you have a sense of when other European nations can start deploying your carriers and other nations can start deploying 100-gig in their metro?

Alan Lowe

Well, I think they are deploying today 100-gig, but not in the kind of scale that's going on in North America. To be honest, I don't have a tremendous amount of visibility as to where all of our components and modules end up when we sell them to our network equipment manufacturers, except when they come to me and say, I need to have hundreds of ROADMs for this network. And that's why I mentioned the one in Germany that I do know of.

But there are others that are mentioned. And I think it's pretty broad -- not to the scale of North America, but it is broad in EMEA.

Ashwin Kesireddy

Great. Thank you.

Alan Lowe

Thanks.

Operator

We have a follow-up question from Alex Henderson from Needham & Company. Your line is open.

Alex Henderson

Great, a couple of quick questions. First, the I&C segment, I have no idea how to forecast that thing. Could you give us some hints on what we should be thinking about there? It's not a category that most of the people on this call have a lot of familiarity with.

Alan Lowe

Yeah I think it's pretty stable run rate business. And I kind of believe that the work that we've been doing in 3D sensing and gesture recognition will eventually pay off in a meaningful way, again, like it did with our first two generations of product that when into game applications.

Today in that set of revenue, we sell pumps for other people making fiber lasers, as well as 3D sensing for the games as well as notebook computers. I do think that a year out or so, we could see an uptick in 3D sensing as more of those products get designed into mobile devices, cell phones, and tablets. So, I think from my perspective, it's a pretty stable business today, with some upside if things go as we expect.

Alex Henderson

But I believe it's a fairly large seasonality on that and it looks like the June quarter and the December quarters tend to be your larger quarters and then a big fall-off in the March quarter. Is that the pattern we should be modeling?

Aaron Tachibana

No, not really, Alex. This is Aaron. So, last quarter we did have a project on the IDL side that delayed a little bit. So, we had a little bit of drop-off last quarter, and this quarter it's back up. And so that's maybe what you're seeing, a little bit of lumpiness. But I don't think there's a lot of seasonality. It's been flattish when you look back the last four to six quarters.

Alan Lowe

Yeah, there's seasonality when we get into a major 3D sensing application, because those consumer electronic devices are seasonal. But the vast majority of that business today is pumps that go into fiber lasers with a small portion of it being kind of a run rate 3D sensing stuff.

Alex Henderson

Second question, the short-range optics business, it looks like you guys kind of put your toe in there and then pulled your toe back out and that caused some perturbation in your growth rates in the datacom piece. Are you now functionally no longer exposed to that piece, so that it stops being a drag?

Alan Lowe

No, we still sell a lot of 10 and 40-gig pixel-based multimode transceivers. But it is very aggressive. Although I think, since we do build our own pixels, we have a product that can keep up, albeit at lower than average margins.

So, that's why we're being selective in those products. But we do have pixels. I would say 100G short-range stuff is probably further out than our single-mode stuff that we talked about earlier.

Alex Henderson

And the pricing on the short range that's down what 30% year-over-year or something in that range?

Alan Lowe

I don't have that, but I would say that it's in that ballpark.

Alex Henderson

All right. Okay. And then the last question. Can you give us any break between 100-gig versus 10-gig, 40-gig within the datacom, so that we can get a sense of what portion is the fast growth piece versus what portion we're lugging against? I mean, is it 60-40, 40-60, any sense at all?

Aaron Tachibana

We typically don't give that breakout, Alex. But what we can say is the 100-gig is ramping quite rapidly and so it should overtake the 10 and 40-gig shortly.

Alan Lowe

Yeah, I would say certainly by Q1, 100-gig will be the majority of our datacom business. But today it's not.

Operator

Ladies and gentlemen, that concludes our question-and-answer session. I would like to turn the call back over to Mr. Alan Lowe for closing remarks.

Alan Lowe

Thank you, Lauren. The Lumentum team is excited to support our customers, grow our business, and create value for our shareholders. We see strong market demand from our customers.

Our new products, including our TrueFlex ROADMs and 100G datacom transceivers are winning the market and position us very well as we look forward. As I said earlier, I do believe we're at the early stages of worldwide bandwidth expansion, making the future bright at Lumentum.

We will be discussing our business at several Investor Relations events in the coming weeks. These events are listed on our website in the Investor Relations' section. This concludes our call for today. We would like to thank everyone for attending and we look forward to speaking to you again in another three months. Thank you.

Operator

Ladies and gentlemen thank you for your participation in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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