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Good morning. My name is Kelly and I'll be your conference operator today. At this time I would like to welcome everyone to Lumentum Holdings Fiscal Second Quarter 2018 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]
Thank you. Chris Coldren, Vice President, Strategy and Corporate Development, you may begin your conference.
Thank you, Kelly. Welcome to Lumentum's second quarter fiscal 2018 earnings call. This 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 the markets in which we operate, potential market sizes, trends and expectations for products and technology, purchasing trends and demand for our products, Lumentum's expected financial performance, expenses, and position in the market. 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 the most recent filings with the SEC, the risk factors described in our 10-Q filing for our second quarter ended December 30, 2017, that we expect will be on file with the SEC later today. 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 second quarter fiscal 2018 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 11:30 a.m. Pacific Time, this morning on our website.
Now, I would like to turn the call over to Alan for his comments and second quarter business highlights.
Thank you, Chris. Good morning to everyone. Three years ago, Lumentum announced – Lumentum name was announced to the public. The Lumentum not only refers to the emission of light, it can be as momentum and forward progress. I think the necessity to reflect upon this now as we discussed our second quarter results where we achieved record – new record of revenues and earnings. These results exemplified the strong forward momentum we have in achieving our strategic priorities.
Headlining our results was a very strong performance of our 3D sensing business. We supply laser diodes into leading consumer electronic manufacturers, who are in the early stages of introducing 3D sensing capabilities into products. There is clear momentum in this market and our business serving it. Before providing more details on 3D sensing, I would like to highlight that we had new record revenues from nearly all of our laser product lines. Our commercial laser segment achieved new record revenues driven by strong demand from customer supply and equipment used in the production of next-generation consumer electronic devices. Devices such as new smartphones and wearables are increasingly using components that require laser-based processing.
These include flex circuitry, LCD and OLED displays and advanced semiconductor chips. Our industrial diode laser production product line also achieved record revenues driven by strong demand in customers building material processing tools including those building kilowatt glass-fiber lasers with our pumps. In addition, our Telecom Pump Laser product line achieved new record revenues in the second quarter as network operators around the world continue to wide-up new fiber and expand their networks. These second quarter results highlight our strategy of leveraging our photonics technologies across multiple growing markets critically dependent on photonics, investing in and quickly ramping the best products and focusing on closed relationships with market leading customers is succeeding. This is a very exciting time with Lumentum.
Now for more details. In the second quarter, we rapidly expanded 3D sensing pixel capacity and production volumes. Due to strong execution, we shipped more than $200 million of 3D sensing VCSEL arrays. This revenue substantially exceeded the amount considered in our second quarter guidance. The steep production ramp and our consistently high yields were enabled by our proprietary laser design and production capabilities that have taken us years to develop.
We have irreplaceable learnings and volumes of field data from multiple high volume 3D sensing ramps. This, along with our decades of experience supplying laser diodes into the industrial and subsea communication markets, allows us to produce high performance, highly reliable volumes of lasers.
Our laser chip and manufacturing processes are specifically designed to enable the short-design cycles and high-volume production ramps needed by the fast pace of consumer electronics customers. These requirements are quite different from those of other customers in the industrial and communications market.
We spent nearly a decade developing unique capabilities to address the 3D sensing market. During the second quarter, we continued to book new 3D sensing orders and exited the quarter with a solid order backlog for deliveries through June.
Looking to the third quarter. In our guidance, we are projecting 3D sensing revenues to be down significantly. Third quarter projected 3D sensing revenues consist primarily of revenue from shipments already made to date with the conservative view on revenues from additional shipments this quarter. Demand from consumer electronics customers can be seasonal as we saw in prior 3D sensing cycles.
Given our 3D sensing customer mix, we are in a seasonally weaker period now. We expect third quarter revenues to include contributions from new 3D sensing customers in the Android space, including some who have designed in our newest high-performance edge-emitting lasers.
These new opportunities are in the early stages and are only expected to contribute a few million dollars to third quarter revenues. These new customers are expected to drive far more business as we look to our fiscal 2019 and beyond.
We believe 3D sensing market is accelerating. Underscoring this is recent public commentary from industry leaders and my experience at the Consumer Electronic Show in Las Vegas a few weeks ago, the network leaders from major smartphone manufacturers as well as other consumer electronics and automobile system leaders.
We heard detailed plans to incorporate 3D sensing into numerous brands, models and applications throughout calendar 2018 and 2019. Consumer electronic manufacturers throughout China, Korea and North America are looking to 3D sensing to enhance security, to enable augmented and virtual reality and to add other new functionality.
Given the volume that these manufacturers produce, it is not difficult to imagine the annual market for 3D sensing lasers to exceed $1 billion in the next year or two. To capitalize on these market opportunities, we are rapidly ramping our R&D investment in 3D sensing and in additional manufacturing capacity for VCSELs and edge-emitting lasers.
In fact, given lengthy qualification times, we are already in the process of qualifying new equipment to permit even higher production starts in our fourth quarter for first half fiscal 2019 deliveries. With our proven manufacturing scalability, proven field reliability and new product pipeline, we are positioned well to be the partner of choice for 3D sensing customers around the world.
Turning to our optical communication business. Second quarter demand for optical communication products highly varied between our different product lines. As highlighted earlier, Telecom pump laser sales achieved new record revenues. Growth in revenues rebounded quarter-on-quarter. North American customers had strong demand, having worked down their ROADM inventories in prior quarters.
We expect strong North American ROADM demand to continue in the quarters ahead. Chinese demand for ROADMs was strong in the second quarter, and we expect will grow throughout calendar year 2018 and 2019 as China continues its march towards large-scale domestic deployments. In contrast to pumps and ROADMs, coherent components and Datacom transceivers declined sequentially. We believe the long-term trends are favorable in our Optical Communications business.
The growth in bandwidth across the world data centers and communications networks is unrelenting. Network and cloud operators' only solution to deal with the enormous growth in data they are experiencing and on which their business models depend is to deploy more advanced, higher-performance optical network.
And finally, turning to our commercial lasers business. Revenue increased significantly quarter-on-quarter to new record levels given – driven by growth in both micromachining and kilowatt fiber lasers. Demand continues to be strong for both of these product lines, and we expect commercial lasers to be on a growth trajectory over the coming quarters.
I've highlighted significant long-term trends, the mix of markets in which we participate increasingly dependent upon our photonics solutions. These trends, along with our investment in new products and technology and intimate relationships with industry-leading customers, create strong long-term growth opportunities for us. It is indeed an exciting time at Lumentum.
I will now hand the call over to Aaron for more details on our financial results and our guidance for the third quarter of fiscal 2018.
Thank you, Alan. Net revenue for the second fiscal quarter was $404.6 million, which increased 66.4% sequentially and 52.7%, compared with the same period last year. The sequential growth was driven by the ramp of our 3D sensing products, Telecom pumps and ROADMs and strong demand for micromachining and kilowatt laser products.
GAAP gross margin for the second quarter was 42.3%. GAAP operating margin was 22.4% and GAAP diluted net income per share was $3.17. The net income per share includes a onetime $124 million income tax benefit from the valuation allowance release, which was previously set up against our deferred tax assets several years ago. The release of reserves occurred at this time due to cumulative profits generated over the last 2.5 years as a standalone company.
Our second quarter non-GAAP gross margin was 44.9%, which increased 10.9 percentage points sequentially and eight percentage points compared to the same period last year. Non-GAAP operating margin was $114.6 million, and operating margin for the second quarter was 28.3% and increased 16.5 percentage points sequentially. The increase in operating expenses margin was primarily due to the 10.9 percentage point increase in gross margin from favorable mix and improved operating leverage from higher volume.
Our second quarter operating margin performance demonstrates the strength of our operating model as volume increases. We delivered $86 million or 300% more operating income dollars sequentially on incremental revenue of $161 million.
Non-GAAP net income was a record high of $107.8 million for the second quarter. Non-GAAP earnings per share was $1.67 based on a fully diluted share count of 64.6 million and included $900,000 of interest income and a $7.7 million tax expense.
Now for some additional detail. Optical Communications revenue was $360.1 million, an increase of 73% sequentially and 52% compared with the same period last year. During the quarter, we significantly ramped consumer and industrial revenue, which includes 3D sensing, while Telecom was flat and Datacom declined as previously expected.
Telecom revenue at $110.2 million was flat sequentially and declined 31% compared with the same period last year. Although Telecom did not grow, our industry-leading ROADMs increased 22% quarter-on-quarter. Datacom was $34.4 million and declined 24% sequentially and 49% compared with the same period last year.
Consumer and industrial revenue at $215.5 million increased 312% sequentially and over 2000% compared with the same period last year. The significant growth for consumer and industrial revenue came from our 3D sensing products. Optical Communications gross margin at 45% increased 10.3 percentage points sequentially from the favorable mix of products and higher volumes.
Commercial lasers revenue was $44.5 million, an increase of 26% sequentially and an increase of 57% compared with the same period last year. The increase in volume was from both micromachining and kilowatt laser products. Second quarter commercial lasers gross margin was 44.7% and increased 14.7 percentage points sequentially. The commercial lasers gross margin returned to the mid-40% level, which reflects the longer-term profile we expect.
Operating expenses totaled $67.2 million or 16.6% of revenue compared with $54.1 million or 22.2% of revenue for last quarter. R&D expense was $38.9 million and SG&A expense was $28.3 million. The increase in operating expenses was primarily due to our investments in new product programs, infrastructure investments to support growth and variable incentive compensations. We exited the second quarter with cash and short-term investments of $624.5 million, which increased $92 million sequentially. Capital equipment additions were approximately $26 million in Q2.
Now on to our guidance for the third quarter of fiscal 2018, noting again that all projections are on a non-GAAP basis. We project net revenue for the third quarter to be in the range of $280 million to $305 million with operating margin in the range of 15.5% to 18% and earnings per share to be in the range of $0.65 to $0.80. For Q3, we expect our non-3D sensing revenue to increase by $25 million to $35 million sequentially.
Now I will turn the call back over to Chris to begin the Q&A session.
Thank you, Aaron. I would like to ask everyone to limit discussion to one question and one follow-up. Kelly, let's begin the question-and-answer session.
[Operator Instructions] Our first question comes from Alex Henderson from Needham & Company. Please go ahead. Your line is open.
Congratulations on the quarter. It’s pretty amazing results. I guess the problem, from our prospective, at this point, is how do we think through the ramp of that business and the seasonality of that business? Obviously, down a lot into the March quarter, but it looks like – should we be thinking that June quarter is the seasonal trough? And then, could we actually have growth off of the fourth quarter as you expand the multiple lines, multiple vendors as we get into the calendar fourth quarter of the year? How do we think about the curve over the course of the year? Obviously, it's $1 billion market in a year or two. You guys have the lion's share of that, but what's the shape of that curve to deliver it?
Yes, Alex, good question. Thanks. I think – we don't guide more than one quarter at a time, but I'd tell you, as I said in my introductory comments, we're investing today both in edge-emitters as well as additional capacity for VCSELs in anticipation of the second half of the year – calendar year that has been extremely strong. Whether some of that gets pulled into the June quarter or not, it's hard to say. I think it really depends upon both our Android customers ramps and when they actually take place.
And as I said, we have a few million dollars in the March quarter that should increase in the June quarter, but I wouldn't say substantially. And then it all comes down to really how the seasonality affect it and do we need to start producing earlier in the June quarter to be able to meet the really massive expected ramp in the second half of the year.
So just – if I could follow-up on that, so there sounds like there's two pair of variables into the back half. When do you feel inventory, in anticipation of the back half ramp into – is the back half ramp suppliable? I.e., can you deliver enough volume industrywide to make the forecasts in the back? Should – it sounds like it should be tight even as you're adding capacity. Is that the right way to think about it?
And then, laying all the other pieces, can you give us some sense of where do you stand on pricing? That's the other variable that people don't have a handle on.
Yes, I think, as we demonstrated in the end of 2017, we can add capacity very rapidly and ramp to volumes that are pretty steep. And that's really enabled by both our manufacturing process as well as our design to hit high yields. So I'd say, whether we build inventory in the June quarter for the second half of the year, it's still being worked out. I do expect that we will start higher levels of production in the second calendar quarter to be able to meet the needs and demand of the third calendar quarter or the fourth calendar quarter.
As far as your question on pricing, we stay away from that. I will say, though, that I think that through continued improvements in yields and cost reduction of our supply chain, we expect that the gross margins will still be very healthy as we go forward into fiscal 2019.
Great. Well, congratulations. Thanks.
Thanks, Alex.
Our next question comes from Joseph Wolf from Barclays. Please go ahead. Your line is open.
Thank you. I guess as a follow-on to that prior question. If you think about the trajectories and what you're thinking about as you add capacity for the edge, what kind of mix do you think you're going to have customer-wise if we look at 18 months?
That's a good question. I would say it's very dependent upon a number of models that the Android customers put 3D sensing on. And they're very, very secretive with regards to that. So it's hard to say. I will say, though, that I would expect 18 months from now that we'll have substantial revenue edge-emitting revenues, 12 months from now, edge-emitting revenues. So it'll certainly be much more balanced as we bring on multiple customers. Some of which will use VCSELs and the others will be using edge-emitters.
Will the margin profile for the company be the same based on the strategy of manufacturing in-house versus outsourcing as the edge comes online?
I think it won’t be dramatically different. I think that the manufacturing structure and partnerships we have on VCSELs today is extremely efficient, and I would put our supply chain up against any vertically integrated supplier today. At the edge-emitters, I think is unique and that the process and technology that we have for edge-emitters allows us to hit high volumes at, I think, pretty aggressive cost. So I think that the margin profile will be similar.
All right, thank you.
Our next question comes from Patrick Newton from Stifel. Please go ahead. Your line is open.
Yes. Good morning, Alan, Aaron and Chris, congratulations on the solid quarter. I guess on 3D sensing. If we look at the 3D sensing supplier landscape, you have a competitor that's vertically integrating sensor at market in 2019, another has an aggressive ramp that looks unlikely to be able to achieve production that need to carve out the largest customers' design cycle the back half of this year, and you have a final one that's only supplying the flood arrays. So you're in a very enviable position.
I'm curious if you've been able to turn this position into longer-term supply agreement with your key customer. And given the ramp you see in the second half of the year, you did talk to expanding capacity with long lead times. Would you expand capacity without some form of guaranteed share or units?
Yes, thanks, Patrick. I hesitate to comment on our negotiations or contracts with any customer, but I would say that our confidence is high enough that we are spending time, resources and capital on expanding our production capability, both on our edge-emitters as well as on our VCSELs and with our partners that we – use our supply chain. So I think our confidence is high that the demand will be substantially higher than it was in 2017. And that we should maintain a very high level share of that business.
Great. And then as my follow-up. I believe you said that non-3D sensing revenue is actually going to increase by $25 million to $35 million sequentially. So I’m calculating that your implicit March 3D sensing guidance is about $60 million. Is that accurate? And if so, if we balance Android and EMLs and the potential for building June added to back half, the June transaction will be flat or maybe even up? And then on the flip side of that, that sequential uptick in the non-3D sensing business is pretty impressive given seasonality. So you spoke that laser as being higher, but can you walk through some of the optical drivers?
Yes. So Patrick, thank you. In terms of the drivers for the non-3D sensing being up, Telecom pumps, ROADMs are very, very strong. Our industrial lasers, commercial lasers for both micromachining and kilowatt lasers, we have more demand that we can supply at this point in time. Both kind of picked up. Our commercial lasers will exceed $50 million. And that’s been a target we’ve been pursuing for a long, long time. Healthy margins as well. In terms of your calculation at a high level for 3D sensing, what we can say is our 3D sensing will be materially down or significantly down here in the quarter, probably 60 to 5 – 6% to 5% or so down. So in terms of the exact number, we’re not going to comment on the exact number, but from the seasonality standpoint, yes.
The March quarter and June quarter are seasonally lower periods. However, as Alan had mentioned in his prepared remarks and in some of the Q&A already, we look at the June quarter with ramps heading into the back half of calendar 2018. We’re adding capacity and so we’re not going to – we only guide one quarter at a time, but we feel pretty confident on where this business is going balance of calendar 2018.
Thanks for taking my questions. Good luck.
Thanks, Patrick.
Our next question comes from James Kisner from Loop Capital Markets. Please go ahead. Your line is open.
Yes. Thank you very much. So I appreciate the comments on ROADMs. I was wondering if you’re able – there’s a little bit more detail. Maybe talk about where that revenue kind of is now. I mean, you kind of peak around $60 million a quarter. Are we there yet? And – or in this last quarter, we hit that kind of high-water mark and you’re close to it? And just wondering the longer-term outlook you meant ROADMs had a kind of annual high here in calendar 2018?
Yes. Thanks, James. So in terms of ROADMs, we’re not going to give out the specific number, primarily because we’re not doing that for any of these different products. But, yes, ROADMs bounced back. It was strong. We were up 22% or so. We saw a strength in both North America as well as in China. China was about 20% of the total ROADM volume. So a healthy rebound there as well. And as we have been mentioning in previous calls, the ROADM deployment in China, we believe is going to occur here in the back half of calendar 2018 and through calendar 2019 as they go and build out a lot of the networks and – in a lot of the large cities going forward. And in terms of North America, we’re beyond a lot of the inventory rebalancing that has occurred the last couple of quarters, and we’re seeing stronger demand from our customers who deploy into the folks in North America.
Yes. I think maybe just to add to that, we are adding capacity for ROADMs today, so I would expect, to your point, our ability to get a new peak level of ROADM revenue this year is very highly likely.
Great. And then just one follow-up. On Datacom, you said they were becoming pretty well known on CWDM4. I’m just wondering, you comment on your participations – just the larger trajectory of that business in calendar 2018. Thank you.
Yes. I think the CWDM4 business is highly priced competitive. As I said in earlier earnings calls, we have a very focused effort in our development team to introduce an extremely low-cost version of that product to be able to compete at the hyperscale level. And today, we don’t have that to make – it makes sense to have a big volume at the hyperscale guide. But later this summer, we’ll have a product that, we think, we can have decent margins or good margins selling at the hyperscale level at the prices they expect. So I’d say that it’s challenging today, but we have a plan to invest it in the coming quarters.
Okay, thank you.
Our next question comes from Tim Savageaux from Northland Capital Markets. Please go ahead. Your line is open.
Yes, good morning and congrats on the strong quarter and the cash generation. I guess I’m looking to dig a little bit deeper into the semantics of really massive, I guess. And I did a little work on that, actually, earlier this week and making some assumptions around unit volumes, concluded that the total dollar value of the opportunity with – just with your largest customer, could more than double, substantially more than double year-over-year, say, from the second half of 2018 versus 2017. So we’re hearing suppliers – I think you referenced maybe up and down the food chain, industry leaders talking about these types of ramps in the second half.
You mentioned a couple of times an increase in production starts heading into Q4, although I’d be curious as to increase relative to what. Perhaps, an increase relative to what you just reported here in the December quarter. So I’ve thrown out a few metrics there. You can take your pick, but I’m trying to get a better sense of the type of year-over-year growth dynamic that you might be looking for kind of second half 2018 versus what you’ve just reported second half 2017 and whether that kind of your doubling tight metric is reasonable.
Yes. I think if you just look at units, models that should have 3D sensing capabilities in it, you’re spot on and that unit volume should more than double. And then you layer on top that the market for Android and the timing of when they’ll be introducing 3D sensing into their product lines, I think you could have more than double the – of that potential market in the second half compared to what the second half of fiscal – or rather, calendar 2017. So I think your numbers are aligned with our expectations about market growth.
Thanks. Congrats.
Thanks, Tim.
Our next question comes from Troy Jensen from Piper Jaffray. Please go ahead, your line is open.
Hey, congrats also guys on a great results. So on the ROADMs being up sequentially in March, just to be clear, you’d expect both the U.S. and China growth?
Yes.
In the U.S., can you say whether or not Verizon seems to be accelerating in their orders?
We’d stay and away from specific customers, I’d say that North American metro has seen a pick up in deployments and demand expectations for us in both the March quarter as well as the June quarter.
Okay, perfect. And then maybe one for Aaron here. I’m not an accounting expert, by any means, but guess I thought when you take the deferred tax asset out of the balance sheet, you need to start reporting a full tax rate. And I understand you won’t be – on the cash flow statement, you’re assuming – absorbing the NOLs. But should we be modeling a higher tax rate here in future quarters?
At this point in time, Troy, I think our tax rate is going to be similar to what we’ve seen in the past, so somewhere between 6% and 10% depending upon the geography of where the income is generated. But when we separated from JDSU, we had a tax-optimized structure. And so I think we’re still in good shape. We’re going to be evaluating the new tax legislation over the next few months. And there could be some pluses and minuses here or there, but I don’t think there’s going to be anything material at this point in time.
All right, perfect guys. Keep up the good work.
Thank you.
Our next question comes from Simon Leopold from Raymond James. Please go ahead, your line is open.
Great, thank you for taking a question. I want to make sure I’m really understanding your commentary of non-3D sensing business being up $25 million to $35 million. You were kind enough to indicate lasers would be over $50 million, so that gives us some boundary around where the rest of it comes from. It sounds like strength from ROADMs and pumps would need to be in the neighborhood of $20 million sequential growth to get to that March suggestion. I just want to make sure I’m interpreting all of these correctly, given that March is typically a tough seasonal quarter on price resets. Did I get the math right here?
Yes, that’s correct, Simon. In terms of the commercial lasers product lines, both micromachining and kilowatt lasers, we have more demand than we can satisfy. And so we’re going to be growing in the $50 million range. In terms of the Telecom product line, very strong demand for Telecom pumps. We can’t produce enough in some cases. And then in terms of ROADMs as well for both North America and China, we have demand picking up.
And so as Alan had mentioned, we’re going to be adding capacity as we look forward here through calendar 2018.
Okay. Thanks. And in terms of where the 3D sensing business is going. I appreciate, you don’t want to give us full June guidance, but just to give us order magnitude of what kind of patterns to expect given sort of product cycles, your new customer wins. Is it reasonable to think of June as sort of the bottom for 3D sensing, given sort of normal patterns of orders that it could be roughly half of the March sales and then ramp after that? Is that the right way to think about June 3D.
I would say that we don’t guide more than one quarter at a time, but I’d say that the first half of the calendar year is the trough. And how that’s spread between the March quarter and June quarter is still to be determined. So I think we’re expecting and preparing for a very rapid growth in the second half. And that means ramping up production again and with whatever starts in the April or May time frame. So I think second half is what we’re focused on, and whatever happens in the March and June quarter is what’s going to happen.
Thanks. And then a longer-term question. There’s been a lot of press around the Chinese government trying to reduce the nation’s dependence on imported optical components. And they’ve named a number of categories, which includes 3D as well as ROADMs as areas where they’d like to develop domestic supply. We’ve generally thought about this – all of these technologies as pretty hard to do. And so it’s not an easy barrier. But one, if you get your perspective of how this may differ from your past expectations, how you gauge the threat and what sort of trend you expect in terms of China reducing its dependence on imported products such as yours?
Simon, this is Chris. This is Chris. I think in the products that you’ve highlighted, 3D sensing and ROADMs, while there may be some objectives of having domestic supply in China, these are products that are quite challenging to make a lot of intellectual property where, in the case of ROADMs, over the years, I’ve seen fewer competitors, not more competitors emerging. We think that’s a space where there’s probably going to be limited developments in China domestically.
We think the – where we’ll continue to see China supply develop around – that’s probably around transmission products, whether that’d be Datacom or Telecom at the module level. And so that’s why we’re heavily focused on ensuring that we have world-class and world-leading component capability to be able to either compete at the module level or in areas where we’re challenged due to government support in China, to be able to just provide at the component level and still get our fair share of the big spend in China.
Great. Thanks for taking my questions guys.
Our next question comes from Doug Clark from Goldman Sachs. Please go ahead, your line is open.
Great. Thanks a lot. Just one quick question on 3D sensing. Can you give us an update on what your expected timing for the auto adoption is?
It’s longer term. I’d say that it’s not meaningful revenue probably until 2020 calendar year.
Okay. And then a question or a clarification on some comments that you made on China kind of ramping ROADM deployments throughout the year. Is this also an indication of your broader expectations as for China procurement across kind of modules and transceivers for the Telecom business? Or is this a more ROADM-specific comment and expectation?
Yes. Our comment on ROADMs was really more to look at deployments of ROADMs as incremental opportunity for us. And we believe we’re capturing a very large share of the high-end ROADM deployments in China. I’d say that China, overall, has reduced inventory levels. So we’re encouraged by that, in the non-ROADMs space. But they’re – we’re struggling to satisfy the ROADM demand that we have a day for China. So I think longer term, as major deployments happen – I mean, we’re adding capacity to be able to address that. And that’s why I said earlier that we believe this year, we could achieve a new record level of ROADM revenue.
Okay. That makes sense and that helps. Final question. Just with an influx of cash and just a more cash-generative business, can you give us an updated view on M&A? Or potential kind of product adjacencies? Or supply capacity adjacencies that might be interesting?
Yes. So in terms of M&A and cash generation, Doug. So we continuously evaluate our capital allocation strategies and our use of the cash. And in terms of strategic alternatives, the industry, probably, will consolidate at some point in time. The industry structure needs some change. But in terms of being able to discuss anything at this time, we're not prepared to talk about anything specifically. But in terms of the cash generation, we are pleased with what we've achieved here in the quarter. And it highlights the operating model and the strength that what we're able to produce here as volume increases.
Got it. Thanks a lot guys.
Our next question comes from George Notter from Jefferies. Please go ahead. Your line is open.
Hi, there. Thanks very much. I guess I wanted to ask about 3D sensing orders and aggregate. I think last quarter, you guys talked about having received $300 million in orders and aggregates since the 3D sensing opportunity really emerged. Can you update that number announced out of curiosity? And then typically, I guess I had a question about the upside in the quarter on 3D sensing. Any more you can provide in terms of – was that driven by yield improvements? Was that driven by just volume increases and capacity? And then any gating factors as we look forward as you think about capacity on 3D sensing? Thanks.
Yes. We gave specifics on the backlog previously just to let you know that our guidance was founded on obviously what we had in the house. We're not going to do that anymore. We don't give booking updates on any product lines, so we're not going to do that. I will say that during the quarter, we did receive significant orders. So that's why we believe that we're in good shape for the first half of the calendar year. And as far as upside in the December quarter, I think it was really a matter of strong demand and our ability to ramp at high yields on the two products that we have in volume. So we're very pleased with the progress that the team has performed and expect to continue to perform at even higher yields and lower costs to be able to maintain those nice margins.
Got it. Thanks.
Our next question comes from Thejes Venkatesh from UBS. Please go ahead. Your line is open.
Got it. Thank you. 3D sensing question from me as well. We know you're at – above$40 million of 3D sensing revenue in the October month. And then generated $216 million for the whole quarter. So based on that, it looks like you have $1 billion of annual 3D sensing VCSEL capacity already, implying you can handle doubling demand next year potentially. And you're still talking about adding additional capacity. So can you sort of help reconcile that?
Yes. So just one clarity. The $216 million was our consumer – that our industrial diode laser business included with our 3D sensing. So total 3D sensing was just over $200 million. So you're right. We did $160 million in the November and December time period. I'd say that we're adding capacity because we think it's going to be even bigger. But it's also seasonal, so you can't just expect to build $80 million a quarter to get to – $80 million a month to get to $1 billion market.
And so the other thing is that we are introducing edge-emitting lasers, which uses a different supply chain and different technology. So we have to add capacity for both VCSEL to be able to hit the peak demand as well as for edge-emitters that we're starting to ramp in the 2019 time frame that we'll see it – first real revenue this quarter.
Got it. And just a follow-up. Looks like the profitability of this business is better than previously thought. Can you talk a bit about how you're thinking about competition in fiscal 2019? And if there's potential to continue improving yields?
Yes. I mean – I think we're always fearful of competition. That's the nature of the business we're in. And the only way we can compete effectively is to continue to drive costs down. We believe that our supply chain is super efficient, and we'll – I'll put it head-to-head with any vertically integrated supply chain. And so I think from that perspective, even with price reductions, we expect that the margin profile of 3D sensing across our product line – across our customer base is going to be as we go into 2019
Our next question comes from Mark Kelleher from D. A. Davidson. Please go ahead. Your line is open.
Great. Thanks for taking the questions. I just want to look at the gross margins a little bit. Very strong sequential uptick. And you mentioned that that's in mix. And I'm kind of curious as to how we should look at the range of gross margin going forward given the seasonality of your VCSEL sales? Is there a cycle that goes through? Are there – or is the ROADM sales and the pump lasers? Is that pulling it up as well? Can you just tell us some puts and takes on what we should look for in gross margin? Aaron L
So in terms of the margin in commercial lasers, product lines. So we were 44.7% in Q2 or so. And we believe we're going to be in that range, and our longer-term model has us going towards 50% over time. More of the volume was weighted towards Optical communications primarily because of the big quarter we had with 3D sensing. We had indicated in the past that our 3D sensing gross margins would be overall corporate average. And they were significantly
over our corporate average or historical corporate average in terms of going forward. So it's going to be a function of the mix of 3D sensing against our total volume as well as the mixture of commercial lasers as well. Our Telecom pumps and ROADM product lines have good gross margins as well, which should help us as we go forward.
So the 10 points increase sequentially, can you break that out as to what contribution came from 3D lasers?
Yes. So we're not going to split that out specifically. But it was a function of the mix from 3D sensing as well as the large volume uptick. 66% increase in top line contributed a lot to that as well.
And 14 % improvement in commercial lasers.
Okay. Great. Thanks
Our next question comes from Meta Marshall from Morgan Stanley. Please go ahead. Your line is open.
A couple of quick questions. On the Datacom market, are there any kind of 400G product introduction that we should think of kind of towards the latter half of 2018 or into 2019? And then second, on ROADMs in China. Is that still primarily China Telecom demand? Or have you seen any movement on China Mobile to incorporate ROADMs in 2018 versus 2019?
Sure. Datacom 400G, you won't see revenue really this year. It's really more of a back half of calendar 2019. As far as ROADMs, China Telecom, as you say, is clearly leading the way. And we expect that the other carriers in China should start deploying late this year – late this calendar year or early calendar 2019. But the majority of the deployments today, they've been China Telecom as well as the ROADMs that we shipped into China that end up in EMEA or other regions as well.
And our last question comes from Richard Shannon from Craig-Hallum. Please go ahead. Your line is open.
Hey, guys thanks to taking my questions as well. Me also, a couple of questions primarily related to 3D sensing. I wonder if you can give us your sense as you see it right now of kind of the go forward opportunity two, four, eight quarters out, both for the Android ecosystem versus your – kind of your current customer base? And also get a sense of scale of what you think the edge-emitters can do versus your initial early stage or your initial with – ramp ups with VCSELs?
Yes. Well, so I think the edge-emitters certainly have various set of strength. And customers come to us because they can try both different technologies and choose whichever one they want. And we're – we don't care which one they choose. We have the technology to supply both.
So I’d say that customers have chosen their paths. And many of them have chosen edge-emitters, us really in a very, very solid position. I’d say, for question about the go-forward three, four, eight quarters out, my expectations are that we add significant numbers of customers that are Tier 1 smartphone device manufacturers in the four to eight quarter range for sure. And a question in my mind is really that, do we see meaningful Android customers in the second half of calendar 2018
And I think the answer is probably yes. But it’s really up to us to execute and them to execute as well. So I think from our perspective, we’re adding the capacity in anticipation of that happening. But I think that calendar 2019 is going to be a solid year with less seasonality like what we’re seeing here today given the introduction and timing of the different smartphone manufacturers. Did I answer your question?
It’s helpful. Thank you. Yes. Yes, I know you can’t size this quantitative. I think that’s a good starting point. I’m sure we’ll continue to ask questions on that topic. So thanks for that one. My follow-up question related to gross margins. Obviously, you mentioned 3D sensing gross margins would be over our corporate average, and will you haven’t quantified what they are, how do you view the gross margins and 3D sensing issue kind of ramp up in two to four quarters from now? Can they be at the same level they’ve been at the last couple of quarters? Or will it be higher or lower?
Yes. So thanks for that. In terms of gross margins, as we go forward, it’s our belief and expectation that gross margins will be similar to where we’re at today primarily because, as Alan had highlighted, we have continuous cost reduction initiatives, yield improvement aspects, throughput. And we’ll continue to optimize our supply chain, which will give us lower costs over irregardless of what happens with selling prices.
Okay, perfect. That’s all for me guys. Congratulations on the great execution.
Thank you.
And there are no further questions at this time. I’ll now turn the call back over to Alan Lowe, President and Chief Executive Officer for closing remarks.
Thank you, Kelly. I want to thank our customers for their business and partnership. I also want to thank our employees for all their hard work in helping us achieve new record revenue and earnings results and putting us 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 regularly updated. This concludes our call for today. We would like to thank everyone for attending, and we look forward to talking with you again in another three months.
This concludes today’s conference call. You may now disconnect.