Good morning. My name is Kelly and I will be your conference operator today. At this time I would like to welcome everyone to Lumentum Fiscal Third 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. I would now like to turn the conference over to Chris Coldren, Vice President, Strategy and Corporate Development. Please go ahead.

Thank you, Kelly. Welcome to Lumentum's third 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, including 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 as well as statements regarding our pending acquisition of Oclaro. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current 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 third quarter ended March 31, 2018, that we expect will be on file with the SEC later 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 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 third 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 reconciliation between our GAAP and non-GAAP results. Our website also has our latest SEC filings, which we encourage you to review, and supplementary slides relating to today's earnings release. A recording of today's call will be available by 11:30 a.m. Pacific Time, on our website.…

Thank you, Chris and good morning everyone. Strong demand drove telecom, datacom and lasers revenue up in the third quarter. Global markets in which Lumentum participates had fundamentally robust long-term trends. Every day the world is reliant on ever-increasing amounts of data flowing through the world’s optical networks and data centers. New networks and data centers need to be built to satisfy the insatiable demand for data. Globally, regardless of who is supplying the optical network and equipment or who is deploying the network, the types of products and technologies, Lumentum supplies are essential. Higher levels of precision, new material, factory and energy efficiency are all increasingly important to manufacturers around the world. To address these trends, suppliers of manufacturing tools globally are turning more and more to laser-based approaches and the types of lasers Lumentum supplies. Laser based 3D sensing is a rapidly developing market. The technology enables computer vision applications that enhance security, safety and new functionality and the electronic devices that people rely on every day. Lumentum strategy is to leverage our photonic technologies across all of these growing markets, investing and quickly ramp the best products, and focus on close relationships with market-leading customers helping them to win. This strategy is succeeding. In the third quarter, our commercial laser segment achieved new record revenues driven by strong demand from customers in both micro and macro material processing markets. Lasers growth margin at 48.4% improved sequentially due to higher volumes and the mix of products. I am proud of the Lumentum team’s whose execution on ramping capacity enabled the strong 18% sequential growth and the large sequential gross margin improvement in the quarter. We expect continued strength in our lasers business as we ramp our newest fiber laser products to meet strong customer demand. Later this calendar…

Thank you, Alan. Net revenue for the third fiscal quarter was $298.8 million, which decreased 26.1% sequentially and increased 16.8% compared with the same period last year. The sequential decline was driven by the expected reduction of our 3D sensing product revenue, partially offset by an increase in telecom, datacom, and commercial laser product revenues. GAAP gross margin for the third quarter was 32.5% and included a $3.5 million inventory reserve related to ZTE. Our revenue from ZTE during the last 12 months was less than half a percent of total revenues. GAAP operating margin was 8.5% and GAAP diluted net income per share was $0.04. Our third quarter non-GAAP gross margin was 36.3% which decreased 8.6 percentage points sequentially and increased 1.9 percentage points compared with the same period last year. Non-GAAP operating income was $49.4 million and operating margin for the third quarter was 16.5% and decreased 11.8 percentage points sequentially. The decrease in operating margin was primarily due to the 8.6 percentage point decrease in gross margin from the change in mix and lower volumes. Non-GAAP net income was $50.6 million for the third quarter. Non-GAAP earnings per share as $0.78 based on a fully diluted share count of $64.8 million and included $2 million of interest income and at $800,000 tax expense. Now for some additional detail. Optical communications revenue including 3D sensing was $246.3 million, a decrease of 32% sequentially and an increase of 14% compared with the same period last year. Telecom revenue at $122.6 million increased 11% sequentially and decreased 25% compared with the same period last year. Our industry leading ROADMs increased 27% quarter-on-quarter. Datacom was $36.3 million and increased 6% sequentially and declined 7% compared with the same period last year. Consumer and industrial revenue at $87.4 million decreased 59% sequentially…

Thank you Aaron. Before starting the Q&A session, I would like to remind everyone of the earlier comments relating to the pending Oclaro acquisition, we will not be adding anything further on this matter than we had in our prepared remarks and all questions about the pending acquisition will receive such a response. As usual, 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.

Certainly.[Operator Instructions] Our first question comes from Alex Henderson from Needham & Company. Please go ahead.

Great. So I’d love to ask question about Oclaro, no I was just kidding. So I was hoping you could give us a little bit of the color on what you’re seeing in China, whether -- and specifically whether you think there’s any change of behavior as a result of the commerce department actions against ZTE and while [ph] way and along those lines, are you seeing the acceleration and the ROADM demand particularly in China or is that broadly globally, can you give us any color on those two elements? I assume by the way the – you’ve read the street reading on -- that says suggest that most of the people on the street think that that will not come to a blockage, just would you agree with that?

Well I’m not going to speculate on what the U.S. government and China relations are going to do overtime, but I can tell you the behavior that we have seen has been no change in overall demand pictures from China. I’d say that the strength in ROADMs was primarily outside of China although I’d say that the growth in Q3 in China was modest. I’d say that the forward-looking demand for us and backlog looks to be growth across the globe, including China. So, I think what we’ve always been saying is that you know the ROADM deployment in China as well as America continues to look very strong and strong for quite sometime. So really no change in behavior so far.

Great. Thank you.

Thanks, Alex.

Your next question comes from the line of Simon Leopold from Raymond James. Please go ahead.

Great. Thank you very much. Last quarter you were kind enough to give us some color on the 3D expectations that you thought you would do in the neighborhood of $60 million in your March quarter, presumably you exceeded that nicely, but it’s not crystal clear, so could you give us a little bit more color on 3D this quarter and the expectations of what’s implied in your June quarter.

Okay, Simon this is Aaron. So in terms of specific product breakout we’re not going to provide exact numbers, but in terms of what Alan has said in the prepared remarks, 3D sensing was down in the March quarter due to seasonality like we expected going into the quarter. And in terms of the June quarter, same type of seasonality is expected in terms of directionally down.

Okay. And I wanted to shift gears to the more traditional optical component business. I’m a little bit confused by what’s going on in gross margins, in that we’ve generally thought that ROADM and WSS gross margins were particularly good. And I understand and heard you talk about pressure and datacom, but I’m still surprised by what’s implied in your gross margins for the traditional components looking like they are certainly below 30% gross margin in the quarter based on our estimates around 3D. Could you help us understand what’s going on in that segment?

Yes, so Simon as we had said during the prepared remarks, in terms of the optical communications gross margin of 33.7%, yes it does include better than corporate average 3D sensing margins, however, Datacom have been very challenging, and the pricing and the hyper scale arena, there has always been other areas that datacom products go into had been challenge and that's why we been unable to make money in that arena. And so, it's been very very dilutive to our optical communications gross margin, also noting that we have started start up expenses in terms of bringing up our Thailand operation as well which has been dilutive and will remain diluted for the next five, six quarters or so.

But can you confirm – yes, I just wanted to make sure you can confirm that the ROADM WSS products are certainly much better than that that average?

They are. ROADMs and most of the transport products do have a better margin than the rest inside of Optical Communications, aside from 3D sensing.

Sure. Sorry, Alan, go I didn't want to cut you off.

No problem. Just to comment on the Datacom, you know as I talked about in the prior earnings call as well as in my prepared remarks we are very close to releasing a very low cost hyperscale focused Datacom transceiver later this year and continuing those engagements with those hyperscale, it is our strategy to keep that door open as we introduced the new lower cost product. And so, through this quarter and next we're going to continue to have some challenges with respect to the margins on the hyperscale, but we expect to rectify that later this year.

Great. Thank you.

Your next question comes from the line of Joseph Wolf from Barclays. Please go ahead.

Thank you. Hi. I wanted to focus on the comment on the Android market being potentially or far more business in fiscal 2019 and the rest. Given the difference in types of approaches technology wise how much capacity do you have on the non-VCSEL side of that business in terms of meeting that kind of growth? And when you said far more business is that a technology or is that just the number of customers and the kind of demand curve that you're seeing from customer engagements?

Yes. Joseph, I want to imply that edge-emitters or Android business would be far more than our VCSEL business. I implied that it would be far more than it is today which is relatively small. So, we do have capacity to handle the demand over the next several quarters and are adding capacity in anticipation of really a calendar 2019 more significant ramp on edge-emitters side. What we have seen though is that the Android market is mix with respect to edge-emitters and VCSELs, so we are supplying VCSELs to some Android market, but some Android customers as well as edge-emitters, and in some cases one of these. So, I think we're still trying to sort out exactly where we need to add capacity and when we need to add it. Our comments were really more to the point of each contributes significantly to our growth in 3D sensing both in fiscal 2019 as well as beyond.

All right. That's helpful. And just as a follow-up, how much more room is there for gross margin in the expansion of the commercial laser business. They got pretty high, pretty fast, can that go through 50%?

Yes. So, Joseph the commercial laser's gross margin at 48% or still not where we believe they can go. We still believe that there's plenty room to operate. In terms of dependency, the mix of product inside the commercial lasers does have a factor. Over the past several quarters we been working to ensure that we can meet customer demand and ordainment the amount of demand and the next phase here is to through cost reduction activity as well.

Thank you.

Sure.

Your next question comes from the line of Michael Genovese from MKM Partners. Please go ahead.

Thanks very much. First of all on the 27% growth in the ROADM sequentially, seems like it was driven by the U.S. more than China. I assume that Tier 1 carriers in the U.S. can you talk about the sustainability of that for the rest of the calendar year? Is this is a spike or should this level of strength continue?

Yes. Michael, as we said in the past ROADM development tend to lumpy, although I would say at this point in time we're seeing sustained growth both from the North America Tier 1 carriers but also the cable operators and MSOs. So I think it’s a broad based growth that I believe will continue through this calendar year and I think we're gaining share as a result of our leading edge technology will continue to really drive us forward. And then you put on top of that real, real deployment in China and I think we have a pretty interesting long-term growth story for ROADM.

Great. And then just secondly, could you talk about the evolving competitive landscape in 3D sensing. How you're seeing your share trending? How you're seeing your yields trending? And whether you're picking up anything on any competitor yields out there?

Yes. You know, it’s a pretty secretive industry and our customers don't tell us a lot about what's going on with respect to share. I think just based on some of our competitive earnings results, I'd say we still have a very, very large share of the business and we expect to do our best to maintain that. Our yields are very solid and through this slower three months and into the June quarter we're focused on continuing to drive yields and eking out 1% or 2% more to be able to drive the cost down and the margins up and be able to really make sure we maintain our share and do what our customers need from a supply standpoint as we look into the second half of the calendar year.

Thanks, Allan.

Thanks Michael.

Your next question comes from the line of Doug Clark from Goldman Sachs. Please go ahead.

Great. Thanks a lot for taking my question. My first one is on 3D sensing as well. I'm curious if as you're working with customers, if for kind of next generation product to the extend that you started on those to certain customers, are those specs and designs of the VCSELs array is changing in anyway or the designs kind of from prior years or prior generations being reused?

I would say, that's in the short term specs are changing and modifying slightly and I'd say that for next generation products they range from slight complications to radical changes in design, so I think as we address, the new applications for 3D sensing I think we're going to see a range of improvements and changes in both the design of the VCSEL and how our customers use it, as well as the design of edge-emitters and how they use it. So I think we've seen a broad range of it. And whether that the result of both the front facing and world facing applications coming or not, our customers don't tell us, but we can kind of imply the products they we're working on are addressing different applications in different use cases and so that's why we're pretty excited about the opportunity ahead of us.

Okay. Great. And to be clear, so from year-to-year you see at least some modest kind of tweaks or modifications to the specifications?

Yes.

Yes. Okay. And then my second was actually back on China you mentioned that overall, the overall demand picture in China hasn't changed much, but I was curious if that overall demand pictures one of stabilization in trophying or you're seeing a return to growth. How would you just characterize China in terms of growth and go forward expectation?

Yes. My comment about not seen a change in behavior, I think was really around all of the U.S., China discussion. I'd say that we are seeing demand in China being robust especially as we look forward to ROADM. So I'm pretty bullish on expectations for China mostly in the second half of 2019. So our positioning is pretty solid there and the relationship with multiple customers is strong.

Okay. And then some of your competitors have talked about inventory restocking, would you agree with that characterization?

From what perspective?

From optical systems vendors in China, restocking historically low inventory levels?

I think it depends on products. We are constrained on 980 pump lasers, Raman pump lasers, ROADMs and so I'd say that there's not a restocking event happening with respect to those things. But I'd say that overall the levels of inventory from what we can tell anecdotally seem to be in a much healthier position. And I think from that standpoint the sale-out on their end and the sale-in from our end is getting more equalized that both where its been in past where they were shipping out more than then they were taking in. So I think we're to a point equilibrium has been reached and the real demand that Chinese customers are seeing to results in real demand to [Indiscernible].

Okay, great. Thanks a lot guys.

Your next question comes from the line of James Kisner from Loop Capital. Please go ahead.

Thank you. So, I know you said, you wouldn't talk about the Oclaro acquisition. Why don't you just answer a factual question? Can you clarify does -- have to approve this deal. Can you give us any thoughts there? And just on 3D sensing I'm just wondering do you have sense of visibility for the inventory levels that you're customer, I mean, obviously in demand for some key models that use 3D sensing was very low and you start shipping a pretty decent size number of why its versus looks like you in the March quarter. I mean do you feel confident that you're shipping to end demand. I guess netting for all the yield issue at the module level or perhaps inventory building right now? Thanks.

Hey, Jim, this is Chris. I'll handle the first question. So, in our prepared remarks we highlighted that transaction is subject to China antitrust review, but beyond that we're not going to add any additional color. I'll hand it to Alan on the 3D sensing question.

Yes. Our customers don't share a lot and they're at just not to a share a lot with respect to inventory and demand. So I prefer not to comment.

Okay. And to clarify, your guidance, I mean, could you kind of go through business by business here. Where do you expecting the ups versus down as the sequential downtick in the midpoint of all 3D sensing; Telecom is up with commercial lasers doing obviously capacity constraints. And also maybe you'd also comment on the trends for OpEx in gross margin at the high level on your guidance? Thank you.

Yes. So James, in terms of what we said and in terms of direction, yes, so 3D sensing obviously will be down primarily because of seasonality. All other are going to be up. In terms of what's baked in to the guide from gross margin standpoint, our gross margins will be down a bit from the Q3 or March levels primarily again because of the 3D sensing and the mix. OpEx levels, so the OpEx levels will be probably similar to what we saw on the March quarter, plus or minus 100 basis points or so.

Thank you very much.

Thank you, James.

Your next question comes from the line of Thejes Venkatesh from UBS. Please go ahead.

Thank you. I was hoping you could comment on gross margin, again. You mentioned datacom as a reason it came below street expectations, but I was wondering if it reflective of ASP pressure at all in 3D sensing?

Thejes, in terms of pricing we're not seeing anything unusual from a pricing standpoint company-wide in terms of our price point today versus what we've seen historically. As we had mentioned in terms of gross margin pressure in Optical Communications, Datacom has been very, very dilutive in terms of our gross margins. We're unable to make money in that marketplace today and Allan had talked a little bit about some of the strategic reasons for continuing in that regard. We are able to cover our cash cost and be able to make some variable margin and that's why it still make sense to stay there as well as our customers and strategic reasons for the next generation of the product. Also we've got a little bit of dilution there from Thailand manufacturing costs or startup.

Got it. And is fiber laser demands still driven by the major Japanese customer or is demand broadening?

Yes. Historic demand is still mainly a modern relationship we have. And as I said in the prepared remarks later this year what we introducing our own turnkey fiber laser which is a complete solution that other customers will readily purchase and put it in their tools as an alternative to [Indiscernible] supply or other technologies. So we're looking to broadening our customer base later this year.

Got it. And one final one. I was hoping you could comment on why you aren't seeing the same sort of sequential decline for 3D sensing in the June quarter as some others in the supply chain of this major mobility customer?

Well, I think we did say sequentially the June quarter is going to down from the seasonality standpoint and all other products will be up.

Got it. Thank you.

Thank you, Thejes.

Your next question comes from the line of David Williams from Drexel Hamilton. Please Go Ahead

Hey, thanks for taking the question. I wanted to see if you could give us a little indication or maybe what you're seeing in the Android space and kind of those adoptions trend and what your expectations are for maybe the OEM as we head into the first half of 2019?

We're engaged with several of those customers and as they finalize their designs and get pass the pilot stage of build, they'll be introducing a models that includes 3D sensing. I'd say that, our expectations are that most of these customers will introduce this technology and capability on a high-end phone and then it'll proliferate over time. So I'd say that our expectations in the calendar 2019 will be a modest start, but a ramp up from then as it gets on to more and more of the models and further down into their product line.

Great. And then may can you rank order that geography for maybe a strength sampling we're seeing the most demand maybe to the least demand?

On which product?

Well, I guess company-wide what you're seeing in terms – from a geographic standpoint do you see anything strong around China. I guess -- and you are some of your North American customers or where do you seeing the greatest strengths overall?

So, I think you have to look product-by-product or area-by-area for example in terms of Telecom transport with ROADs, seeing very strong demand here in North America, but that doesn't mean China is not growing either. There is some strength in China as that's coming up. Most of our business in terms of what we ship product to is heavily weighted to shipping product internationally and more specifically into the Asia region. And so it's hard for us to know exactly where that product ends up over time, but in terms of strength we are seeing strength across the globe at this point in time.

Your next question comes from the line of Meta Marshall from Morgan Stanley. Please go ahead.

Great. Thanks. First question on Datacom and just what are your thoughts are currently about the timing of the 400 gig transition and when you could see some uptick there? And then second question just on the 3D sensing and android, any trends as far as what the use cases are of security versus AI and if there's anything discernible – is discernible trends currently? Thanks.

Sure. So I'd say timing of 400G is still a ways out. I don't think we'll see anything meaningful until the end of calendar 2019 and into early 2020. I'd say from a 3D sensing android market it varies and they don't tell us what they're doing with them there. They're all very very secretive, so I think from that perspective it's hard to really comment or know, I can only speculate at this point, I hate to even speculate.

Great. And then, sorry, just to follow-up on Doug's question. I just missed, when you said on China uptick in second half of 2019. Were you referring to fiscal year or calendar year?

Doug's question -- I was speaking specifically about ROADMs and the growth in ROADMs in second half of calendar 2019 expectations are that become more meaningful ROADMs, off of pretty base today, but we expect more meaningful deployment within China as well as our customers there exporting from China.

Great. Thanks.

Your next question comes from the line of Mitch Nordon from B. Riley & Co. Please go ahead.

Yes. Hi, good afternoon or good morning. Thanks very much for the call. Just with regard to two things, ZTE what's your view there? You took a small reserve in the quarter, going forward how are you viewing that? And secondly, with regard to that side of the merger proxy, but we haven't seen that yet, its been about a month and a half. When might we get a look at that?

This is Allan. In terms of impact of ZTE on the Lumentum business and that's what we can comment on. Like I had mentioned in the prepared remarks the business ZTE has been looking backward the last 12 month, less than a half of percent of total revenue, so the impact is minimal for us. We did take a charge of $3.5 million for an inventory reserve primarily because of the ban not been able to ship to ZTE. The inventory is going to be excess and potentially obsolete. We can't reconfigure that or use it for any other customer, so we've written down.

Yes. And this is Chris. On the comment on the filing of the S4, yes we will file an S4. We're not going to comment on any timing at this point in time.

And just curious, I mean, you're talking about this transaction being a major milestone for you, yet you seem hesitant to talk about the transaction and it appears to be a compelling transaction. Can you speak to – is this related to the ZTE news or why not tow [ph] the benefits that you towed back on March 12?

I don't think we're not towing the benefits of March 12. You're asking procedural questions about a transaction which we don't have information to share at this point in time.

Thanks very much.

Your next question comes from the line of Jun Zhang from Rosenblatt Securities. Please go ahead.

Thanks for taking my questions. So, could you talk little bit about the VCSEL content than positive [ph] trends compared with the first new version by in the smartphone 3D sensing module in order to support this market model to adding some of the new functions or applications for the 3D sensing in the second half of this year. And also could you talk about – little bit about the current lead time for the VCSEL [Indiscernible] wafer production and 3D sensing module shipment to the end client. So considering this lead time we do start shipping the new VCSEL in the month of June so the main model in the second half? Thanks.

I'm sorry, Jun, we had a little bit trouble hearing your first question. Can you repeat your question please?

My first question is about the VCSEL content and the pricing trend compared with the first new model in order to support the new function or application in the 3D sensing in the second half this year?

Yes. So we're not going to comment on specific customer pricing. I would say that pricing usually is a function of chip size and the yield of those chips. And so I think from our perspective we're comfortable with our pricing and our yields and our costs if we able to maintain better than corporate average margins on all of our 3D sensing products. Lead times for VCSELs and after we ship the VCSEL our customer doesn't their leadtimes or their yields. So it's hard to me to comment on that. Given our guidance for 3D sensing in the June quarter, I would say that it would very limited new products that would be shipped in the June quarter for the second half new product introduction should there be new products introduce.

Okay. Got it. Thanks. And also could you talk little bit about how we'll see the benefits from bringing manufacturing internally with the further expansion in the Thailand factory? Thanks.

Yes. So in terms of bringing manufacturing in-house today the data rates are far more advanced than they were many years ago. And so we did have internal production, 10 years ago or so in China and today we believe that we're going to have some benefits with regards to improving flexibility -- overall cycle time to bring new products to market, let aside customer requirements, improve quality and reduce cost, right and you have to be a good compelling return on investment for doing this. In terms of our manufacturing model, that's not to say that we're moving away from contract manufacturers. We're going to continue to use a hybrid model. We will have partnerships that we have today and continue to use contract manufacturers were it makes sense.

Okay, great. That's all my questions. Thanks.

Thank you, Jun.

Your next question comes from the line of Tim Savageaux from Northland Capital Markets. Please go ahead.

Hi. Good morning. Two questions; one on the comp side and one on 3D, I guess kind of related and this has to do with the magnitude of the decline in you're forecasting for 3D and what that says about guidance across the rest of the business? Assuming it's in the range of what you saw and that is the sequential decline in 3D sensing revenue in the March quarter, in June or somewhere in that neighborhood now looks to me to imply a significant uptick in acceleration on the telecom side. I wonder if you can comment on whether that's the case?

Yes. So Tim this is Aaron. Yes. In terms of specific numbers we won't quantify that but that's correct. So in terms of 3D sensing it is seasonally down again in June quarter from the March quarter. The rest of the business will increase and most notably would be coming from Telecom transport. We have a lot of demand for ROADMs pumps apps things that drive the network in terms of install.

Okay. And at least my interpretation is you'd expecting acceleration in that sequential growth rate from 11% you saw in June. If you can comment on that if you like? Moving over to the 3D sensing side, coming out of OFC some commentary around there, the company's Lumentum's VCSEL array capacity kind of running or standing at a level of 10 million units a week which actually [Indiscernible] pretty nicely into kind of 100 million unit iPhone build plus some iPads in the second half and depending on what you assume on pricing I think puts revenue capacity on a quarterly basis well above peak levels you achieved in the second half or in the fourth quarter of last year. I wonder if you could talk to those capacity metrics whether they make any sense and what sort of expectations we should have with regard to potential peak quarterly revenue levels in the second half when expensively phones are being build?

Yes. So, I think Tim, if you recall the calendar Q4 ramp, we ramped production through that quarter and produced approximately $200 million of revenue, but we had more capacity exiting the quarter than we had entering the quarter and that capacity is still exist. So I think you can extrapolate from there what our capacity is and lot has to do with the size of the chip and yields but I'm confident that our yields have increased since then and I'm not going to comment on whether going into other products on existing customers or other, but I think you're not crazy with respect to your math on capacity.

And just to follow-up to what Allan has articulated, wafer fabs are very expensive in terms of the reason we've chosen this model in terms you can count the partners as to A, go up the ramp that's deep that quickly and be able to reap the benefits and then when the cycle or the seasonality turns down and we're not stuck with that fixed cost load on our balance sheet and income statement, lot of benefits of the foundry model.

Thanks very much.

Thanks, Tim.

Your next question comes from the line Richard Shannon from Craig-Hallum. Please go ahead.

Hello guys. Thanks for taking my questions as well. I guess most of mine on probably 3D sensing. Allan, wondering if you look at your 3D sensing negotiations for customers in the calendar second half of the year, to what degree is capacity and important to metric meaning maybe not as much coming from your other competitors versus other things like functionality yield or really to deliver on a short timeframe. What is the most important metrics in those negotiations?

Well, I mean, I think they all play into the equation. I think proven capability on scalability. I think reliability and dependability are super important as well. There were ship lot of big souls at extremely high reliability rates and that goes a long way as well. So I think it's a combination all of the above. And that I hope to be challenged again with respect to capacity. So I am looking forward to the second half of that calendar 2018 rather to go up another significant ramp.

Just follow up on that, Alan. Is there anyone of those [Indiscernible] six that are more important as you get into the second half of the year or are they all kind of balanced?

I mean, I think it’s a function of how we are performing and how our competitor is performing and how continue to gain confidence in our customers with respect to vulnerability to meet their needs and our ability to continue to give high performance, high quality, very reliable product into their product mix. That’s a huge concern of their with respect to making sure that every component works every time we ship it. So I think it’s a combination of all the above and I’d say that you know reliability and performance of that’s the reliability and quality is so critical.

Okay, fair enough. About my second question again on 3D sensing, in the prior question you talked about changes in specs. And you said some of them were modest changes and some were more radical. How long does it take to change a spec and does that provide you any competitive advantage given your long experience and frankly high volume experience and manufacturing after that as well?

Well I think the comment around specs is around different customers and changes in designs to address different functionality and different applications for various products and various customers. I’d say from a time that we engage with the customer until that product becomes production is two years. And so we are working on products today that we are not going to introduce into production for two years from now. So that gives us confidence that our continued pipeline of new products and growth in 3D sensing as 3D sensing becomes more ubiquitous I think gives us excitement that this is a long term trend that has very good growth rate.

Okay that’s great. Thanks for taking my questions guys.

Your next question comes from the line of Alex Henderson from Needham & Company. Please go ahead.

Thanks. Just a couple of pieces, could you just remind us what you think your tax rate would just look like in FY 2019, I know that’s a little further out than you normally guide, but it is something that seems like it’s a fairly important piece of the out period puzzle.

Sure, Alex. In terms of our tax rate historically has been relatively low, sub 6% or so. In terms of 2019, we’re still evaluating a lot of the new tax legislation, but it’s our belief at this point in time that our tax rate will probably be somewhere in the 8.5% to 10% range, so modeling 9% is probably reasonable. Longer-term beyond 2019 the tax rate could go up to 11% to 12%.

Okay. And going back to the Thai facility for a second, you’ve decided to ramp up costs as one of the elements that’s pressuring gross margins, can you give us some scaling of the magnitude of that and what the trajectory is for that cost to fall back out as you get the benefit of that facility running more smoothly?

Sure. It’s probably close to a 100 basis points of impact to gross margins. And as we look forward here, we are continuously ramping and investing and it’s probably five to six quarters of continued delusion until we hit a breakeven point.

Okay. And going back to 3D sensing if I could, very briefly there was a lot of discussion about other competitors ramping some capacity in 3D sensing, a lot of noise around Finisar getting Sherman up and but the other side of that coin there has been a fair amount of concern around the yields that Alan being a pressure point and constraining their ability to supply, can you talk a little bit about how as we went into or as we go into the seasonal trough period that’s reflected into the relative shares, are you gaining share in the June quarter as a result of being the dominant supplier and the best yield or is any of the competitors bringing capacity up that would in turn result in some diminishment of your share as we go into that seasonal trough.

Well, Alex I mean, I think we’ve had such high share rise, I would be surprised if we are gaining share from where we’ve been in the past. I don’t know that we are losing it either. You know as we went up the ramp a year ago, there were challenges in that we whizzed through and we used to still release that are used to making high volume 3-inch gallium arsenide before. And so I think while there is the learning curve that everyone has to go through, we had a jump start on all it, so I can’t really speculate on what’s going on with our competitors it’s probably a better question to ask them. I think just anecdotally based on what some of our competitors have said in the past, I’d say that we still have a significantly high share of the existing market and expect to do that as we go forward with the new designs and new customers and new products that we have in our pipeline.

One last question and then I’ll see the floor. On the Edge 3D products, to what extent do you see your ability to sustain the same high level of share in that space, do you see any difference in the competitive landscape there and when do you think the edge side of the market starts to metastasize into meaningful contributor?

Well I think from a competitive landscape there are fewer competitors in the world that can make edge-emitters for 3D sensing so from that perspective I expect that our share will be large. I can’t predict how our competitor will perform with respect to the ramp of edge-emitters. I’d say that while we are relatively small, volume today we expect that to pick up as we look at the beginning of calendar 2019 in more of a meaningful way.

Thank you very much.

Thanks, Alex.

Your last question comes from the line of Dave King from FBR Riley. Please go ahead.

Yes, good morning. Thank you. First of all clarification on – Alan did you say that China ROADM cycle will really begin in second half of calendar 2019 or fiscal 2019, just wanted to clarify?

I think we’re seeing a pickup in order rates as we speak so royalty growth in the June quarter in China I’d say that more meaningfully deployments within China will happen in the second half of calendar 2018.

Well Calendar 2018. Got it. All right, and then on the datacom side, as far as growth margin is concerned, so right now it’s dilutive but when you introduced new products later this year, will their products have corporate average gross margin or will they still be below corporate average?

Yes, so a lot of that is going to depend upon what the market prices are going to dictate Dave. Right now, it’s our belief that we are going to be able to be very competitive and be able to make decent money with it, but we’ll have to wait until that point in time and say. And then…

Certainly a whole lot closer to corporate average than we are today.

And then are they targeting like maybe September, December any granularity?

I would say it’s in that September, October timeframe that we’d see volume picking up on those products. And that’s why we’ve stayed engaged with the hyper scale guys even at you know margins that are not very attractive at this point in time. We want to have that footprint and that experience and be able to prove to them that we can be a reliable supplier with high quality shipments on time and so we are going through that now in anticipation of having this low cost product coming out in a few months.

Got it. Thank you very much.

And there are no further questions at this time. I would now turn the call back over to Mr. Alan Lowe, President and CEO for closing remarks.

Thank you, Kelly. I want to thank our customers for the business and partnership. I also want to thank our employees for all their hard work 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 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. Thank you.

This concludes today’s conference call. You may now disconnect.