Good day, ladies and gentlemen, and welcome to the Q3 Lumentum Holdings Incorporated 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, Vice President of Strategy and Corporate Development. Sir, you may begin.

Thank you, Bruce. Good morning, and welcome to Lumentum's third quarter fiscal 2017 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, including trends and expectations for products and technology, purchasing trends, Lumentum's expected financial performance, expenses, and positions in our markets. 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 our fiscal third quarter ended April 1st, 2017, which will be filed today. 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 financials should not be considered as a substitute for, or superior to, financials prepared in accordance with GAAP. Our press release with our third quarter fiscal 2017 results is available on our Web site, 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 Web site also has our latest SEC filings, which we encourage you to review, and supplementary slides relating to today's earnings release. Finally, the recording of today's call will be available by 7.30 AM Pacific Time this morning on our Web site. Now, I would like to turn the call over to Alan for his comments and third quarter business highlights.

Thank you, Chris. At Lumentum, we are focused on accelerating the speed and scale of cloud, networking, advanced manufacturing, and next-generation 3D-sensing applications with our photonics technologies. Our strategy to invest in growing markets, develop the best products and technology, and foster the closest relationship with our market-leading customers is succeeding. Since our last call, we have made very good progress on our strategic goals in each of our markets. Our revenue from 100G QSFP28 transceivers nearly quadrupled in the third quarter. We grew our road on revenue, and shipped record levels of next-generation TrueFlex ROADMs. Our Commercial Lasers' business returned to growth, and we achieved major milestones on 3D sensing products for mobile device applications. To answer the inevitable question and not to keep you in suspense, yes, we have received volume 3D sensing production orders for delivery in the September quarter. However, like many in our industry, we had some near-term headwinds. Late in the third quarter, we saw demand from China slow significantly. Before last quarter's call, we anticipated some softness in China. We expected demand to pick up late in the quarter, and increase into the June quarter. This did not happen. Demand from our Chinese customers continues to be at significantly lower levels than we saw in the first half of our fiscal year. Third quarter revenues were $255.8 million, up 11% relative to a year ago. Optical Communications revenue grew 10% year-on-year. Commercial Lasers returned to growth with revenues of $39.7 million, up 20% year-on-year, driven by increases in both fiber and micromachining lasers. During the third quarter we started shipping our new higher performance Gen 3 [ph] fiber laser, and recognized our first revenue. Telecom revenue increased 3% quarter-on-quarter despite seasonal factors and softer-than-anticipated demand from China late in the quarter. We saw…

Thank you, Alan. Net revenue for the third quarter was $255.8 million which increased 11% compared with the same period last year and decreased 3.5% sequentially due to softer demand from China and seasonal facts from annual price reduction. GAAP gross margin was 32.1% and decrease 70 basis points quarter-on-quarter. GAAP operating margin was 5.3% and GAAP diluted net loss per share was $0.92. The GAAP diluted net loss per share includes the impact of a $0.94 loss per share from a non-cash unrealized loss on the derivative liabilities for both series a preferred stock and convertible notes and also the non-cash effected interest on the convertible notes. Our third quarter Non-GAAP gross margin was 34.4%, which increased 220 basis points compared with the same period last year. The year-over-year increase was driven by a 330 basis point improvement in Optical Communications' gross margin. Non-GAAP operating margin for the third quarter was 12.6%. Our operating margin increased 380 basis points year-over-year from the gross margin improvement and operating leverage from higher volume. Non-GAAP net income was $30.8 million, an increase of 56% compared with the same period last year. Non-GAAP earnings per share was $0.49 based on a fully diluted share count of $63.4 million, compared with earnings per share of $0.32 last year. Third quarter earnings included $500,000 of other expense, and $900,000 of tax expense. % : Optical Communications gross margin, at 33.1%, increased 330 basis points compared with the same period last year as a result of higher volume and mix of products. Commercial Lasers revenue was $39.7 million, an increase of 20% compared with the same period last year. Third quarter Commercial Lasers gross margin was 41.3%. Operating expenses totaled $55.7 million or 21.8% of revenue compared with the same period last year, of $53.9 million…

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

Thank you. [Operator Instructions] And our first question comes from Patrick Newton from Stifel. Your line is now open.

Yes, thank you. Good morning Alan and Aaron. I guess just two questions. First on the China side, given the lack of visibility now, do you have any thoughts on when China trends could turn positive? And if we think about the current China revenue that's baked into June quarter guidance and assume no rebound, would you anticipate a return to sequential growth in your Optical business excluding lasers and 3D sensing in the September quarter?

Patrick, I think the visibility in China is pretty tough right now. Like I said in the prepared remarks, we are seeing some small tenders for ROADM deployments in the provincial networks. But I would expect that the first half of our fiscal '18 to rebound from where we are today. The question in my mind, does that happen in the September quarter or is there a continued bleed off of inventory during that quarter, and then rebound in the December quarter. And at this point in time it's too hard to say.

And in the potential to grow if China remains flattish from current levels in the September quarter with the rest of your optical business?

Certainly would expect so, yes.

Great. And then on 3D sensing, it's great to hear that you have volume production orders in hand. I'm curious if you could help us understand the potential revenue contribution in the September quarter or any color on the magnitude of revenue potential in FY18. And then I think that capacity is somewhat of a concern. I'm sure you don't want to talk about specifics, but if the ramp of this product is successful over the next 12 months, and given you're talking about multiple OEMs and automotive, can you help us think thorough how capacity needs to come on relative to current levels. Does it need to increase by a factor of 2X, 3X; any color there would be appreciated.

Sure. Well, we're at very low levels this quarter. The orders that we received for the September quarter are multi-million units. We expect that to continue to grow. And we're bringing on capacity at our partners this quarter, and into early next quarter that we believe should suffice -- be able to meet the initial ramp, and then we'll revaluate as we make progress with other of our customers. I think our partners and we have invested sufficiently for the existing ramp, and are brining capacity online as fast as we possibly can to meet the ramp.

And any commentary around revenue potential?

At this time, Patrick, I think it's tough to say. We will certainly give guidance three months from now for our September quarter, and we can give you some color directionally. But as I said in the prepared remarks, we expect significant revenues in fiscal '18 sensing, but it's too early to quantify.

Thank you for taking my questions. Good luck.

Thanks, Patrick.

And our next question comes from Simon Leopold from Raymond James. Your line is now open.

Thank you very much. I just wanted to see if we could clarify what happens in the mix in the June quarter in the Optical Communications segments, Datacom, Telecom, give that you've already had a very significant sequential step-down in the Datacom. I'm just wondering how to think about the components in the June quarter relative to the guidance. Maybe if you can give us a little more color on CFP2 versus ROADM what you're expecting?

I would say that Datacom is expected to be up as we've brought on more capacity to meet the needs and demand for QSFP28. So I expect the June quarter Datacom to be up. Telecom will be down mainly due to the China slowdown that we saw start really in March and continue through beginning of this quarter. Lasers flattish, but pretty exciting times as we've brought on our new Gen 3 fiber laser, and start to ramp that into a meaningful way this quarter, and then 3D sensing up slightly, but not significant revenue from the June quarter.

Great. And then just my follow-up on 3D sensing is there any thoughts you have on the competitive landscape. I think what you've said in the past is that one key aspect of your advantage is working through the partnership fab is your ability to ramp volume. If you could provide us may be some thoughts on your competitive position in 3D sensing? Thank you.

Sure, Simon. As I said all along, I think we have selected partners that know how to manufacture in high volume, and the combination of our partnerships and our design capability to design the kinds of products that our customers need really put us in a leadership position. I think we're often running, and I think we're significantly ahead of our competitors, so we should be able to capture a good share of the business as it comes on in the September and December quarters.

Great. Thank you.

And our next question comes from Alex Henderson from Needham and Company. Your line is now open.

Thanks. So if we were to ignore China altogether and just take that out of the mix, can you give us some sense of what the rate of growth in Telecom might look like sequentially outside of China, so that we can at least have a better gauge of what the ambient demand conditions look like in the rest of the world?

I haven't studied that in detail, Alex. It's a good question. But I think we're seeing normal growth demand from North America as expected. And in fact, if you look at different countries in Asia, like India, for instance, is driving a very strong demand. Europe is looking okay to a little bit better than expected. So I think, outside of China, business is good for Telecom. And then you couple that with the Datacom hyperscale growth and demand as the 100G transition is happening, things look pretty good outside of China.

And on the pump lasers side, I assume that you're adding capacity pretty aggressively there. Can you give us some sense of what the capacity add looks like to address the tightness that you're experiencing in supply, and the assumption that ROADMs ramp as Telecom ramps in China eventually kicks in?

Yes, so pumps, we've been adding capacity over the last year-and-a-half. We have more capacity coming online this quarter. If you look at this from the December quarter to the June quarter, I'd say it's probably another 20% to 25% of capacity going online. And we think that that puts us in a pretty good position to have flexibility to meet our customers' demands. We are seeing additional demand from Raman pumps which is unique, and I think positions us pretty well. So I think overall, the [indiscernible] pump business is good. And what happened in the last quarter, maybe it wasn't clear, was we used a lot more of our pump capacity for internal blade production, and that constrained us for external revenue on pumps. I think we're to the point now that, while we're still tight on capacity, as we bring on the capacity through this quarter we should be in pretty good shape.

If I could just take one last thing, any change in the status of the ROADM qualification, your competitors that you can see evidence of?

I think it's a better question to ask them, but we're focused on making sure we meet our customers' demands, and I think we're doing a very good job of that. I haven't seen anything that would indicate that we're losing any share at either of our major blade customers.

Okay, thanks.

Thanks, Alex.

And our next question comes from Rod Hall from JPMorgan. Your line is now open.

Yes, thanks guys. Thanks for the question, and appreciate the clarity on 3D sensing. I just got a few follow-up questions on that, and also obviously on China. I'd like to just understand, Alan, you were talking about multimillion unit orders for the September quarter. When do you start delivery on that, can you give us any ideas? Is that representative -- what you're talking about in September and what you'll eventually guide for, is that going to be representative of kind of full volume capacity, or are we talking about a half-a-quarter's worth? Just help us understand when that volume ramp starts. And then are we at full volume output in the December quarter? So that's the first question. The second quarter on 3D sensing is could you help us understand what you think your share position is now. I know it's hard to know. But given you now have orders, do you have a feeling for where your share position stands on that. And then on China, just coming back to that, I just want to understand how conservative you think you've been on China in your guidance for June. Particularly -- and I don't know if you want to comment specifically on this, what you're assuming for Huawei? And you say you've seen these tenders starting to come through, do you think there's a little bit of unlocking in terms of the Chinese movement? Any other color you can give us from the carriers there would be helpful. Thanks.

Sure. Well, starting with the 3D sensing, these multimillion unit orders are just the initial orders. We expect to be receiving orders on a weekly basis moving forward to cover our lead times. As I said in the prepared remarks, we have been approved to start volume production. And so, we are ramping our production to be able to achieve the volumes and our customers need in the short-term. And you can imagine that the cycle time of 3D sensing for us a few months, and so, given that we are in production today, you can determine when the production ramp starts and given a 13-week lead cycle time. So we will be ramping through the quarter. And in the December quarter, we will be at full volume production capability assuming the program goes as we expect. As far as share concern, it's hard to tell. But given the attention that we are getting and the volume orders that we are receiving, I think we are in a very, very good position relative to our competitors and are getting more than the majority of the share of the business at initial ramp. Does that answer your question on 3D sensing?

Yes, that's helpful. Thanks, Alan.

Okay. And then on China, how conservative are we? I don't know that you can be too conservative. Given the visibility, it's pretty tough. So, I have always anticipated being surprised by China. And I think we're trying to take an approach that even if this were to come back, I don't think that that's going to drive incremental volume for us over our existing plan in the June quarter. It could drive business in the September quarter over and above the current levels. But, I think it's too early to state the benefit at this point in time.

Okay. Thanks a lot. I appreciate it.

Thanks, Rod.

And our next question comes from Troy Jensen from Piper Jaffray. Your line is now open.

Yes, thanks for taking my question and congrats in the 3D sensing order. I guess in my first question I would like to know for the volume 3D sensing, is it multiple flavors as in different power vessels [ph] or is it just one?

Troy, I think we are under all sorts of confidentiality agreements with our customers. I prefer not to say what the number of different chips we are providing or the applications. Suffice to say that we are very well positioned with this new customer. And I think the fact that we've got volume production orders for production ramp in September places us pretty good. So I prefer to stay away from any of the details.

All right. Yes, totally understand it. I just had to ask it, then how about a just to follow-up on the QSFP28. I just wanted to know -- I would like to know what percent of the business do you think is going in the Web 2.0 versus the network equipment companies? And then maybe the number of hyperscale customers that you have for QSFP28?

So Troy, this is Aaron. So in terms of the third quarter, it was less than half. And here in the near-term in the June quarter, it's still going to be a little bit less than half, but it's continuously growing in terms of what's going to hyperscale.

And number of hyper scale wins?

We haven't set the exact number, but there are several.

Okay.

And we're engaged with all of them. So whether we are in production today or about to be qualified, I think it's just a matter of time.

Yes, totally understand, and congrats, gentlemen; nice job.

Thank you.

Thanks, Troy.

Thank you.

And our next question comes from Michael Genovese from MKM Partners. Your line is now open.

Great. Thanks. First question, just want to ask about ROADMs seems like in the March quarter, you had a strong demand in both the U.S. and China, but that China maybe built some inventory, so they're going to fall off in June, but specifically in the U.S., are you expecting growth in ROADMs in June? Or, will it be like before where the customer kind of shifts to transmission lines for a while before coming back to ROADMs again?

Well, from a China perspective, I think you categorized accurately in that we shipped ROADMs last quarter. Don't expect to shift very many ROADMs this quarter. As far as U.S. is concerned, we put the ROADMs blades in the VMI hubs. And they get pulled or they don't get pulled. I haven't looked exactly as where we expect that to go, but I think there is nothing that says it's going to be highly lumpy this quarter compared to last quarter. So, I think constant growth would be my expectation.

Okay. And then my follow-up is back to 3D, I mean, I think the last time you guys did a call like this, there were some discussion, I can't remember, say, it was publicly or in the callbacks later, but there were some discussion about a potential $50 million revenue level for 3D sensing in the December quarter in this project. So I guess, my question would be has there been any change to that particular outlook?

Yes. Michael, I don't know that we gave any specific numbers like that. I think what I did say was that we believe the 3D sensing market for optical components, it will achieve a billion dollar annual type market over the next coming years, and that over the next year or so, one could imagine a market that tries a $100 million a quarter kind of business. Our shares are yet to be determined. So I think, we'll continue to update you on quarterly calls, but I don't think we've ever said what we expect the December quarter revenue to be.

Okay, fair enough. Thanks, Alan.

Thanks, Michael.

And our next question comes from Tim Savageaux from Northland Capital Markets. Your line is now open.

Hi, good morning. The question on your comments about internal manufacturing capacity additions, I wondered especially in light of kind of current demand conditions where that capacity is sort of focused if there are certain pain points on the comp side or across industrial or even 3D sensing where that capacity might be focused and what the timing of that might be? On the one hand, and then a potentially-related follow up, I don't know if you said, obviously you saw some strong uptick on the laser side of the industrial aside, what do you expect that to continue into June relative to your guidance for the overall revenue line? Thanks.

Sure. Tim, in terms of the manufacturing that we did, buy a building in Thailand for $10 million, we're currently in the process of setting the building up. And in terms of getting it ready with infrastructure, meaning IT systems, networking systems, capability, it takes several months to do that. So, some of that has been in the works in terms of the preparation. In terms of which specific products, so 3D sensing I think, Alan, we've noted we're using an outsourced foundry model. This facility in Thailand is going to be primarily used for our base business. In terms of the specific products, we're not in a position to really state which products will be the first to go in. Those are things in the plans. We're working through them at this point in time. In terms of the timing of readiness, we expect to be shipping some initial units out of the factory from a production standpoint early in our fiscal 2018 period, which is the September through the December quarter. In terms of your second question on commercial lasers, that we did achieve $39.7 million in the March quarter. Looking into the June quarter, we believe that the laser volume could be flattish, and there could be some variability depending upon customer inventory level. So, it could vary a couple of percent either way in terms to the top line.

Great, thanks.

Sure.

Operator, next question please.

Our next question comes from Richard Shannon from Craig-Hallum. Your line is now open.

Hi, guys. Thank you for taking my questions as well. Maybe I will ask first question on Datacom, where you can give us a sense of the mix within, it within that group between the CFP form factors collectively and QSFP28, I'm assuming QSFP28 is still well below that, kind of curious if you can give us a thought process of how long it takes before that crosses over where QSFP28 is larger?

Thanks, Richard. So, in terms of the QSFP28 volume it was almost 50% of the volume in the March quarter, into the June quarter here so as Alan had mentioned on prepared remarks, we are ramping QSFP28 form factor especially for hyperscale, so it's going to grow to be the majority here in the June quarter.

Okay, great. Thanks for the recollection there. Second question will be on 3D sensing, any sense to how we can think about what gross margins, should we expect from this revenue stream either initially? And then how we go over the next several quarters that we do, please?

In terms of the gross margin on 3D sensing, so what we've been saying is significantly north of our corporate gross margin average and it's going to be should be over 50%.

And I would say that we're extremely happy with the current existing yields as we start up the ramp, so there is no reason to believe that the initial ramp gross margin would be anything different than that.

Okay, great. Thanks for that perspective. That is all from me, guys. Thank you.

Thanks, Richard.

And our next question comes from Doug Clark from Goldman Sachs. Your line is now open.

Great, thanks for taking my question. I want to come back to Datacom first actually, I know you talked a little bit about China being a drag on the March quarter but could you give us a little bit more detail into kind of what led to the I think 43% sequential decline in that business?

Hey Doug, in terms of the sequential decline the bulk of that was due to China. So our China business was down close to 40% sequentially and most of the CFP2 volumes was going into China, so that is the bulk of the decline. We do see recovery here not from CFP but we do see Datacom recovering in the June quarter primarily because of the transition to QSFP28 for hyperscale, in the June quarter both CFP2 and QSFP28 shared the same capacity or manufacturing capacity. We were not able to really shift all of that capacity in the March quarter, so we weren't able to fulfill lot of QSFP28 orders, we're doing that now and we expect QSFP28 to ramp significantly in the June quarter.

And as evolved to that how long does it take to convert that capacity from one product line to the other?

Yes. So the [indiscernible] conversion is not a big deal, there's a component, as well as a different way for that we produce for the QSFP28 to meet the power requirements so, I think we've already visited the supply chain and the wafer to focus primarily on QSFP28 in different varieties of short and medium and long reach so, I think we're provisions pretty well the really capitalize on the growth in demand for a QSFP28 in June and September quarters.

Okay and then I also have one question on 3D sensing and kind of a clarification to a comment prior. I think you said the initial order was for multi millions of units in the September quarter does that satisfy the entirety of the September quarter demand or do you expect to kind of get additional orders for that period between now and then as well which could take it into, tens of millions of units.

Yes, we're going to quantify exactly how much it is but I say that the orders that we have today that we categorize is multimillion units is just a very, very start we expect orders to be streaming in through this quarter in a meaningful way.

Got it. Thanks a lot.

Sure.

And our next question comes from James Kisner from Jefferies. Your line is now open.

Thank you guys so, I want to drill into datacom for a moment again I mean you said the majority here, is that you give in volume comments on QSFP28 I wonder if you could talk about proportion of revenue is QSFP28 over 20 million at this point how much of the business is still legacy I think it was low 20% last quarter 10 and 40; longer term on CFP2, you made some comments here that they think this market is really not that big going forward, what do you think opportunities received you at this point is it kind of on the wane at this point or could it be more growth or as a recovers. Thanks.

Yes, so Aaron, you want to take the 10 and 40?

Yes, in terms of the percentage games so that are speed meaning 40 gig and above 77% in the March quarter. Last quarter was 83% just to calibrate but we had more CFP2 volume last quarter so, legacy 10 gig and below was 23% in the March quarter. In terms of the [indiscernible], so our 100 gig data comp volume was about $25 million or so in the March quarter. So, 12.5 million was QSFP28.

Yes, as far as the long-term outlook for QSFP28 and CFP2, I think CFP2 first of all has a long tail. I think it's a matter of inventory buildup in China that created the issue. And there's still a lot of CFPs being deployed in the world and that transition from CFP to CFP2 is well under way. And I would say that the demand for QSFP28 is very strong both from the 300 and 500 meter short reach products in the hyperscale data centers as well as the 2 km CWEM4, and the transition from CFP2 to QSFP28 LR4 is underway as well. But that transition is going to take a little bit longer. But we are positioned very well. Qualifications are happening, and so, I think our broad portfolio in QSFP28 [indiscernible] has really positioned us well across the portfolio from short reach all the way to 10 km kind of product.

Great. Just a follow-up; commercial lasers it's nice to see that recover a bit. The gross is margin is not what I would expect just given the revenue levels. There is startup cost in there. Is this kind of what you would expect going forward in terms of gross margin commercial lasers or might we see that kind of get to the higher levels again? Thanks.

So, James, in terms of commercial laser's gross margins, we are 41%. In terms of what we have been in the past, we were close to 50% in the past. And there is no reason we can't get back to it. It's highly mixed dependent. So we have added capacity capability as we brought new generations of fiber lasers to market. Unfortunately, it requires investments in terms of some fixed cost that have been put in place. So there is a little bit of a drag on gross margins from that perspective. As Alan had mentioned in the prepared remarks, micromachining lasers have come back in this quarter and represented close to 40% of our mix or $16 million. Those products have very high gross margins which are higher than our average commercial laser. So if that can continue in most of those lasers going to semi conductor for slicing and dicing -- and if that continues and continues to grow back where it once was in terms of over $20 million per quarter, there is no reason our gross margin can't get back into the high 40s and close to 50%. So the way we look at it, it could be 3 to 5 quarters out that we get back.

Yes, I would say just one of the dynamic is that in the March quarter, most of the fiber laser business was Gen 2 and that's been in production for quite some time. So the margins as we end of life products like that are lower than the new products. so as we bring on the Gen 3 and as we started revenue last quarter and that becomes a bigger percentage for fiber laser that will help the overall gross margin of both the fiber laser as well as the overall commercial laser's gross margin.

Great. That's really helpful. I was just thinking about just one more, do you guys comment on OpEx sequentially in your guidance?

No, we didn't breakout gross margin and our OpEx in our guidance. But in terms of the operating margin and the midpoint there, where we guided 10% or so, if you go look back 4 to 5 quarters ago, we were below 9% in terms of operating margin. So in terms of some of the near-term headwinds, we are keeping a close eye on discretionary spending so to speak and keeping expenses under control, so we can maximize our operating margins.

Thank you.

In terms of fixed cost over those five quarters, we put a lot of fixed cost in place both on the operational side as well as within OpEx. And you can see that our are operating margins are still expanding by at least 100 points, which means our variable margins have increased over that period of the time which translates into -- translates from the richer mix of products; newer products with higher margin.

Okay. Thank you.

And our next question comes from Meta Marshall from Morgan Stanley. Your line is now open.

Great. Thank you. Just wanted to circle back on China and just see overall pricing environment is there any kind of going back and renegotiating prices as, they work through inventory and then second, I don't think it's been touched upon around ACO timing and that has been kind of planned for the second half of the year is that still on track or was some of that going into China and so there's a little bit of a slowdown and getting that product out. Thanks.

Yes So for China pricing, we set pricing annually with our Chinese customers and there's no, there's no renegotiating because demand is softening and I would say that as far as ACOs concerned, we've made tremendous progress over the last three months. We've been shipping a data unit now not just evaluation units to data units to Tier 1 including in China but I'd say that we won't expecting nor with I think the industry is expecting China to be consuming a lot of CFP2 ACOs even in this calendar year that's really more of end of calendar 2017 and really ramped into 2018. So, I think that our expectations for China on ACO rest of world I think that we're still on track over the next couple of quarters to start volume production as we get qualified outside of China.

Great, thanks.

And your next question comes from Joseph Wolf with Barclays. Your line is now open.

Thank you. You had a comment about the relatives of value on the QSFP28 in terms of the revenues and the capacity in terms of the margins given with just the shifts right now on the and the movement can we see any, how much room is there for margin improvement in the Datacom business as you get to really high levels of QSFP28 in the mix 28?

Yes, so that the majority of the QSFP28 in the March quarter was more of the two kilometer CWDM or and it comparing that to 10 kilometers CFP2 the prices average selling pricing, a factor of 50% lower plus or minus little bit. So, I do think that, that as we introduce new generation of QSFP28 and we have two new products coming out that are focused primarily on cost production as we ramp up volume we should the continued improvement in gross margin in our QSFP28 datacom business even with the hyper scale pricing pressures that we see in the industry. So I think from that perspective we're in very good position I do think the CFP2 will pick back up but we're not counting that in the short term.

Okay, and then just as you look about if you take this I guess relative softness in China and think about what that means in terms of the components that were on allocation where you had supply constraint, how is that shaping up for the rest of the calendar year as you look across those components what kind of opportunities do you have in terms of additional capacity in getting the supply chain set for the pick-up in China?

Well I mean we've added $100 million of CapEx over the last three quarters, so that capacity is coming online and becoming productive this quarter and next and so I think we're very well positioned for when China comes back, we still are constrained on some of our products but I would say that we are focused on making sure that when the demand comes back, we have the capacity to supply what our customers need. So the question in my mind is it in the September quarter or is it in the December quarter not is it ever. So I would say that we're confident in our ability to meet demand as the demand comes back in China.

So this hasn't changed any of the build plans?

Well, yes. So in terms of capacity that Alan was alluding to, it typically takes six to seven months and the time you launch orders and approved it, when it comes starts to come online the qualification that takes place. So a lot of the CapEx that landed in the March quarter was launched several months ago. Same thing as of last quarter, you know there are some things we're still ramping for example pump lasers are still tight. So we're continuously adding capacity there 100 Gig transceivers we've been capacity constrained in that regard. So we've added a lot of capacity and more is coming online, in terms of the next couple of quarters some of the traditional or base products have some near term demand challenges from China and it could take couple of years to rebound but we think when it does come back we're going to be well positioned to take advantage of it because we will have the capacity in place.

Okay, thank you.

And prime estate rational is well not get too far ahead of ourselves in terms of capacity but unfortunately it does take six to seven months to get it online. Thank you, Joe.

Thank you. And at this time there are no further questions. I would now like to turn the call back over to Alan Lowe for any closing remarks.

Thank you, Bruce. I want to thank our customers for their business and our employees for all of their hard work in growing our business, putting us in an excellent position in the market. I believe we are in a world wide bandwidth expansion and photonics are increasingly becoming critical to manufacturing a next generation high volume 3D sensing applications, making the future bright at Lumentum. We regularly discuss our business at investor relations events, these events are listed on our website in the Investor Relations section and are regularly updated. This concludes our call for today. We would like to thank everyone for attending. And we look forward to talking with you again in another three months.

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.