NeoPhotonics Corporation
Q1 2021 Earnings Call Transcript

Published: 29 Apr 2021

[Operator:]

Good day. Welcome to the NeoPhotonics First Quarter 2021 Conference Call. This call is being webcast live on the Company's website at www.neophotonics.com on the Events page of the Investors section. This call is a property of NeoPhotonics and any recording, reproduction or transmission of this call without the expressed written consent of NeoPhotonics is prohibited.

[Erica Mannion:]

Good afternoon. Thank you for joining us to discuss NeoPhotonics' operating results for the first quarter of 2021 and outlook for the second quarter of 2021. On the call today are Tim Jenks, Chairman and CEO; Wupen Yuen, Chief Product Officer; and Beth Eby, Chief Financial Officer. Tim will begin with a review of the Company's business in the first quarter and a discussion of relevant market issues and trends. Wupen will provide a summary of products, technologies and growth drivers for our high speed products. Beth will then provide financial results for the first quarter and provide the outlook for the second quarter of 2021. The operator will then open the call for questions. The Company's press release and management statements during this call will include discussions of certain non-GAAP financial measures and information, including all income statement and balance sheet amounts and percentages other than revenue, unless otherwise noted. These non-GAAP financial measures are not prepared in accordance with GAAP and are not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. These financial measures and reconciliation of GAAP to non-GAAP results are provided in the Company's press release and related Form 8-K being filed today with the SEC and can be found in the Investor Relations section of NeoPhotonics website. Material contained in the webcast is the sole property and copyright of NeoPhotonics with all rights reserved. Certain statements in this conference call, which are not historical facts, may be considered forward-looking statements that involve risks and uncertainties. And include statements regarding future business results, product and technology development, customer demand, inventory levels, economic and industry projections or subsequent events. Various factors could cause actual results to differ materially. Some of these factors have been set forth in our press release, dated April 29, 2021, and are described at length in our annual and quarterly SEC filings. Now, I will turn the call over to CEO, Tim Jenks.

[Timothy Jenks:]

Thank you, Erica, and good afternoon. NeoPhotonics again delivered strong results in the first quarter with revenue of $61 million, which was in the upper half of our guidance range. Gross margin and operating margins were in the high end of the range as well. These results were driven by the more than doubling of 400Gigabit and above product revenue which grew 134% on a year-over-year basis and comprised 52% of total revenue in the quarter.

[Wupen Yuen:]

Thank you, Tim, and good afternoon. During previous calls, we have talked about the three legs of our coherent product suite for the highest speed over distance applications. These are, first, our coherent components, including our industry-leading ultra-pure light tunable lasers, which we provide to network equipment manufacturers for their line card and chassis-based systems operating at 400Gig to 800Gig. We also integrate these high-performance and high-volume components into 400ZR pluggable modules, such as our QSFP-DD, for use in datacenter interconnect applications with reaches of around 100 kilometers. And finally, we extend the performance of these pluggable modules to achieve longer reaches in 400ZR+ versions, covering metro and even long-haul distances. Our 400ZR modules are designed to comply with the Optical Interworking Forum’s Implementation Agreements and have been successfully tested at multiple hyperscale datacenter customers demonstrating interoperability with other vendors’ 400ZR modules. We believe that our 400ZR modules are industry-leading in performance and in maturity.

[Elizabeth Eby:]

Thank you, Wupen, and good afternoon. NeoPhotonics continued to execute well in Q1. Increased demand for our highest speed products resulted in slightly better than expected revenue and gross margin above our range. As Tim mentioned, revenue was $60.9 million, on strong demand for our 400G and above products, which comprised 52% of Q1 revenue. As expected, we did ship an immaterial volume of U.S. EAR compliant products to Huawei. Non-GAAP gross margin of 22.4% was just above our range, as a result of favorable product mix and good execution of cost reductions. Product margin of 40.5% was offset by the expected high levels of excess capacity charges. Non-GAAP operating expense for the first quarter was $21.5 million, down $2.2 million from Q4 and lower than expected, as some expenses pushed to Q2. Non-GAAP operating loss for the quarter was $7.8 million. Interest and other charges were offset by $1.1 million of FX gains. Tax expense was $0.6 million, on full year losses, as opposed to the effective tax rate benefit we had expected. This resulted in a non-GAAP net loss of $7.5 million and a loss per share of $0.15. This is at the midpoint of our estimate, as the consistent good news in the operations and operating profit were offset by the change in the tax estimate methodology. I will close out my discussion of the first quarter income statement with a review of our GAAP results. First quarter gross margin was 21.9%, down slightly from Q4, but higher than expected, given the higher product margins and the use of previously reserved materials for production. Operating expense was $24.4 million, up $1.1 million from Q4 as the prior quarter included one-time gains. Those gains were mostly the settlement of litigation.

[Operator:]

We’ll take our first question from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Hi, good afternoon. My question, you made a comment about sort of initial volumes of 400ZR, I guess, in the current quarter – second calendar quarter being in the hundreds. As we get closer to your kind of expectation for volume production for ZR, I guess, I want to – maybe try and give a little color on your definition of volume production, that thousands of units or what sort of visibility do you have at this point to those type of volumes? And would you say that would be the predominant factor of this three that you enumerated in kind of making up for this some weakness in Q2?

[Timothy Jenks:]

Yes, Tim, thanks for the question. I think the most important thing would be moving into other, say, four digits in terms of production and by four digits what I am really referring to is, whether it’s a 1,000 plus units a month or in that order I think that would be volume production.

[Elizabeth Eby:]

And then the second part of your question, those three areas that we enumerated are roughly in the same order of magnitude.

[Tim Savageaux:]

Sorry. Quick follow-up, I was muted there. And also in your guidance for Q2, what are you factoring in for Huawei there? I imagine I am not sure of the timing, but you said you had immaterial revenues in Q1. Would you get up to some level of materiality in Q2?

[Timothy Jenks:]

Yes, I would expect to have a level of materiality, but I still think there will be a modest size customer just because it’s very few of the legacy products that are involved. And so, it would still be a modest number. We are not going to give specific numerical guidance on individual customers, but our point really is just to point out that they are there, but there is still modest size.

[Tim Savageaux:]

Okay. Thanks.

[Operator:]

Thank you. We will take our next question from David Kang with B. Riley Securities.

[David Kang:]

Yes. Good afternoon. Thank you. My first question is that that you are still targeting third quarter to be profitable or at least break-even. Just wondering if it’s – I am not asking for guidance, but at least maybe just how should we think about like a metric, top-line margins and all that?

[Elizabeth Eby:]

You know our break-even model Dave is, it runs at 80, 85 in revenue OpEx, but we are going to hit average for the year of 22.5%, which kind of backed into a 28%, 29% gross margin. So, break-even is going to be positive in Q3 is going to be somewhere in that range.

[David Kang:]

Got it. And then, regarding chip shortages, I mean, can you tell us which chips are really impacting this current quarter?

[Timothy Jenks:]

I think that one of the things with chip shortages is – sometimes it surprises. There are two really issues is we are seeing, the lead times extend and I think several companies have talked about that that started a number of months ago. And essentially, the – for us, as Beth said in the prepared remarks one of the issues is that to the extent that there are chip shortages. Sometimes they affect the newest products and that often have a flow through effect on margins. But I don’t think I will say more about which specific chips.

[David Kang:]

Got it. So is it fair to sort of summarize that, it sounds like a sort of a double whammy for you, I mean, 400Gig and above, demand is strong, but then, chip shortages is impacting that negatively, whereas 100Gig and below, it seems like demand is soft due to various factors that you mentioned in U.S. and China slowing down. Is that a fair summary?

[Timothy Jenks:]

Yes, I think it’s a good observation. I think the supply chain, we do expect the supply chain will work through and the comments about overall demand, we did see 134% growth year-over-year on 400Gig and above products, I mean, for products that we are shipping to customers other than Huawei on a year-on-year basis, we were up 28%. And so, the underlying business is certainly doing well. But we think it would be doing better if we didn’t have a semiconductor chip issue.

[David Kang:]

Okay. Thank you.

[Elizabeth Eby:]

Thanks, Dave.

[Operator:]

Thank you. We will take our next question from Alex Henderson with Needham & Company.

[Timothy Jenks:]

Hi, Alex.

[Alex Henderson:]

Thank you. Hi, now it’s good to hear your voices and I am hoping to see you guys at some point this year. I know that things are starting to improve in the broader economy. So, I was hoping you could tell us a little bit about the mechanics around the assumptions here. Is it the high end of the band you have – you still have some visibility to the components that you need for the current quarter and at the lower end of the band it’s a mix shift between products that causes maybe a little less visibility. How do we think about the supply constraints relative to the top and the bottom of the band?

[Timothy Jenks:]

Well, what we see in the highest speed products is we see good rates of growth in a number of cases as we see some acceleration, but the ability for less mature components to be accelerated through foundries that already are full and have long lead times. That’s pretty tough. And we think we have reasonably good visibility to the things that we need, but essentially, if we give the example of customer winning a new order, a significant deployment that is above and beyond their prior forecast, it can be hard in some cases to respond on the upside, unless we buffer that inventory. So, for example, we’ve seen some impact in international deployments of 400Gig and above systems, where under the pandemic the deployments may slow in a region. Well, by the same token, if there is an opportunity to accelerate if it’s already in the forecast, you have limited ability to pull in and accelerate. And so, what we have done is we work to buffer our inventory, we’ve tried to protect that where we can and we are working with suppliers where we have some concern or limited visibility. But these are the things that we see as, if you will risks near term. I hope that helps.

[Alex Henderson:]

Yes. The question really is do you have in hand in sites all of the inventory necessary to hit the high end of the band and under what circumstances would you be at the low end of the band? I assume it’s not a demand problem. The demand is outstripping the supply capabilities. Is that not accurate?

[Elizabeth Eby:]

I would say that’s absolutely accurate in our coherent markets where it’s definitely a supply chain constraint and there is opportunities in there. We continue to work the supply chain things. We are comfortable with the – at the low end of the range as you say. At the high end of the range it’s – we have good visibility on getting to the materials. But it’s some of the upside things that we could have been able to go after, but we don’t have lot of – be able to get. And as you know, Alex, last year – a year ago we kept highlighting, yes, we are going to have about $10 million of risk on supply chain and it didn’t materialize. So, we didn’t – we continue to work that and we are pretty effective at working it.

[Alex Henderson:]

So, the second question is, do you have line of sight to the products and components that you need more to ramp the products that are driving the acceleration in the second half or is the risk in the second half as prevalent or even greater that is it’s further out? And is there any risk of decommissioning or decommittments?

[Timothy Jenks:]

I would say, we do have good line of sight. We know what we need. We are working that with our suppliers. We buffered parts where we think there are risks. We think we have good line of sight. That said, you don’t know, you don’t know. But I think at the moment, we feel pretty good about line of sight.

[Alex Henderson:]

Alright. I’ll get back in the queue. Thanks.

[Timothy Jenks:]

Thanks.

[Operator:]

Thank you. We will take our next question from Richard Shannon with Craig Hallum Capital Group.

[Richard Shannon:]

Good afternoon, guys. Thanks for taking my questions. I mean, like it’s my first one is on the third quarter here suggesting I getting to a break-even level or above here pretty significantly ramp from the second quarter guidance you just gave us. If you think about the bridge here in sales in terms of ZR and other products, how do we think about this, Tim, given what you suggest like unit volumes in the four figures here, what prices I can probably guess at is, it seems to suggest that ZR might be a majority of that bridge from the second or third quarter. Is that the right way to think about that? Or how would you have us think there?

[Elizabeth Eby:]

Yes, on an order of magnitude basis, I will start and Tim can pile on is, those three areas that I mentioned, the unsatisfied demand from Q2 that we hope to satisfy in Q3, the ramp of the 400G and above components is continues to be excellent and that is where we are at part of the supply chain issues we are having. So that’s one. And then you get coherent modules and both the telecom module, the CFP2-DCO and the datacom module of 400ZR. And then, China, because some of the – as Tim mentioned, some of the China customers have been pretty well not doing a great deal of 5G stuff in the first half of the year. So between those three, I would say there, roughly equal, plus or minus $5 million or so. So, 400ZR itself is not a – is not a majority of it at all. Tim, do you want to pile on?

[Timothy Jenks:]

Well, the only thing I would add is, is, yes, it’s not the majority, but there is more upside to it. It’s – we talked about the fact that the overall business ex Huawei grew 28% year-on-year and the fact that the 400Gig and above products as they are grew 134% and that’s without any real material 400ZR. So, the ongoing 400Gig and above component business is more predictable and the 400ZR has start dates for the second half, but it’s a little more unknown. So, this is the view as we see it today.

[Richard Shannon:]

Okay. And that’s fair enough. I am going to extend the question here, ZR specific little farther into the year. I can refer this on your fourth quarter call and the tech trans call you did in March, you talked about ZR. I think getting in – I think you touched as a favorable impairment getting too much as 10% of your sales this year. Do you see that bogie as achievable or is that a stretchy there due to the deployment timeframes or component shortages or both?

[Timothy Jenks:]

It’s still in the cards, Richard. But this is the category of predicting – trying to be predicting in two significant digits where the ability to do so actually is limited. So, I think it’s still a possibility. But it’s difficult to say specifically what percent of the forecast will be. It’s also worth saying that that in 400ZR we have two different levels of participation. We of course have modules that were supporting in the – in both the QSFP-DD and OSFP. But we also sell our ultra-pure light tunable lasers into other vendors’ 400ZR modules. And so, if we think about those two pieces, the sale lasers actually is in the more predictable part because it’s a component sale. But we will be supporting both of them on an ongoing basis.

[Richard Shannon:]

Okay. As I remind you the last quick question for me on ZR here is on the gross margin impact. Anymore precise thoughts and obviously has been asked in past quarters, but anymore precise thoughts on what you expect that relative to your current portfolio?

[Elizabeth Eby:]

Relative to our current margins, higher for those current margins are slightly depressed right now. But no, we don’t have a good picture of what margins are going to be until we get a little farther along. And as we’ve discussed in the past, there are frequently start-up yields as you – that you have to work through. So, it’s a little early to be predicting margin on that.

[Richard Shannon:]

Got it. Okay. Thank you for those thoughts. That’s all for me. Thanks.

[Timothy Jenks:]

Thanks, Richard.

[Operator:]

Thank you. We will take our next question from Paul Silverstein with Cowen and Company.

[Paul Silverstein:]

Thanks guys. First off, Tim, can you tell us what the high speed and 400Gig growth was as you did the last several quarters? Maybe I missed the…

[Timothy Jenks:]

That 400Gig and above growth in total, is that what you are asking?

[Paul Silverstein:]

Yes sir.

[Timothy Jenks:]

Let’s see. In the current quarter, we said that it was 52% of revenue, but actually…

[Elizabeth Eby:]

Compared to 46% last quarter.

[Timothy Jenks:]

Yes.

[Paul Silverstein:]

And what was the year-over-year growth rate there?

[Timothy Jenks:]

And the year-over-year growth rate was 134%. So, first quarter 2021 over first quarter 2020, 134%.

[Paul Silverstein:]

All right. And for high speeds Tim, what was the year-over-year growth? 100Gig and above, I think you are telling the 400 high speeds.

[Elizabeth Eby:]

Yes, now 94% a year ago versus 92%. So, it’s actually going to be down, because it had Huawei in it.

[Paul Silverstein:]

I suppose you all been disclosing that ex Huawei on a year-over-year – am I wrong? I thought you’ve been discussing the metric within Huawei?

[Elizabeth Eby:]

We’ve been doing that for the 400Gig stuff. Talking about 100 – not for the 100Gig.

[Paul Silverstein:]

Okay. My fault. Alright. I’ll move on. Beth, I was confused, I am sure, sort of coming new in that year, but I was confused your response on the question about demand versus supply. Let me ask the question directly. I thought that you are talking about softness in the market, but in a response to your question you said demand for coherent is strong, the issue is supply, if I understood you correctly. I am been on the impression, go ahead.

[Elizabeth Eby:]

So, two things going on. The bigger factor absolutely is supply, but there is also some softness in the market that we are seeing in the first half of in the U.S. after their large spend on spectrum and in China where it’s looking like the 5G roll out has gotten a little – has slowed down a little bit. So, it’s – but the bigger factor is supply and supply on our highest speed products because of chip shortages. There is upside to the Q2 number that we would have been able to get.

[Paul Silverstein:]

Alright. I am not sure I understood the operating trend that you are seeing, when you responded that coherent demand was strong, is the reconciliation in that statement to your statement about some softness in the market in particular close some options and trying to roll up with the reconciliation that coherent demand is strong other than in the U.S. and other than in China? Or was it just a misstatement?

[Timothy Jenks:]

No, we weren’t trying, Paul to talk about geography. The point was about timing. So, we are seeing overall demand. Customers are forecasting up. Customers are saying that they will be higher in the second half and that reflects in the backlog and the ordering pattern, but in the near-term, how much of the delivery is in 2Q. And there is current softness for the reasons that we stated and that’s articulated. In North America, and in China for backbone provincial long-haul networks, it’s soft right now. But it’s stronger later in the year.

[Elizabeth Eby:]

Yes, my statement was that little more annual 18 month type of thing rather than Q2.

[Paul Silverstein:]

Got it. Just for clarification, but just to be clear, Tim, that the softness with respect to the U.S. based on the rolling forecast you are ceding that is a larger view that it’s largely, if not entirely a 2Q issue and not a second half issue or is it something different?

[Timothy Jenks:]

We think it’s Q2 issue.

[Paul Silverstein:]

Alright. So you – and it’s not the sales on your books, you have a basis we believe that is a near term 2Q issue not a 2021 issue?

[Timothy Jenks:]

This is based on what our customers are telling us, yes.

[Paul Silverstein:]

Alright. Just one or two quick more. Tim, it’s better that you say that you are expecting a 1,000 or multiple thousands of units on ZR. Am I wrong that revenue perspective that would translate to a relatively low couple of million much more than that, from a revenue impact, just to gauge the impact from a model minable? I know pricing seems to be good, but you are not – that kind of revenues you are talking about low sales, right?

[Timothy Jenks:]

Well, so, let me first start with the premise. I didn’t say what we are expecting. The question I was asked was, what would constitute volume production and I said volume in four digits per month would be, what we would call volume production, okay. And then, we subsequently responded to another question that’s saying, it’s not the majority of our second half ramp or revenue target, but there is potentially more upside with ZR just because of the units, the potential for units and volume, it remains to be seen. So, I hope that clears up the assumption versus the forecast.

[Paul Silverstein:]

Yes, that’s fine. I’ll take that offline. Thanks. I appreciate the responses. Thank you.

[Timothy Jenks:]

Thank you.

[Operator:]

Thank you. We will take our next question from Fahad Najam with MKM Partners.

[Timothy Jenks:]

Hi, Fahad.

[Fahad Najam:]

Hey, Tim. Thank you for taking my question. A couple for, me as well. First, if you didn’t have any component shortages, would it be fair to say that you would have met your Q2 guidance or maybe some over above that guidance range?

[Elizabeth Eby:]

We said low to mid-single-digit million. So, I don’t know where your guide was, Fahad.

[Fahad Najam:]

Just trying to get a sense if you would have…

[Elizabeth Eby:]

Yes, we’ve never given guidance…

[Fahad Najam:]

And see just you can touch on something.

[Elizabeth Eby:]

Sorry?

[Fahad Najam:]

Just trying to get a sense if you did have component shortages, would you have exceeded street consensus, that was – I think it was around $56.5 million for the quarter.

[Elizabeth Eby:]

Low to mid-single-digits of impact. So, I think that would have been in the range making a little light.

[Fahad Najam:]

Okay. Tim, the softness in China, if my checks are correct, increasing the hearing from a number of your peers and others in the supply chain, that there is an increase in China insourcing risk that the Chinese customers are now kind of sourcing from within China. To what extent is the softness related to insourcing? And do you – or you could – concerned about insourcing in China impacting your long-term outlook this year and maybe next year from China?

[Timothy Jenks:]

Well. Insourcing in China is not new and certainly with the U.S. China trade tension, it’s heightened. So, the fact of the matter is, with our highest speed products, we have very significant growth rates, certainly on a year-on-year basis. But some of the legacy products or as we call it network products and systems have not really been growing. So, some of that is because of customers in China increasing their business with local partners either with direct competitive products or with suitable alternative products. But essentially, what we are working on most aggressively is things that are 400Gig and above where in fact, we don’t believe that they really have the alternative of using domestic suppliers in China for those – for the lot of those products. So, I think insourcing is continuing to be a relevant element of the forward look. However, it’s not new. It’s been with us for years and we are continuing to fight the battle of competition through innovation. And I think that’s what we are building our forward model on is those newer products.

[Fahad Najam:]

Okay. I have a clarification question from that. Can you just remind us what 100Gig and beyond was in the quarter? You’ve in the past given that number, but I don’t think you gave it this quarter.

[Elizabeth Eby:]

Yes, it was 94%.

[Fahad Najam:]

94%, okay. Thank you. That will be all for me.

[Timothy Jenks:]

Thank you, Fahad.

[Operator:]

Thank you. We will take our next question from Samik Chatterjee with JPMorgan.

[Timothy Jenks:]

Hi, Samik.

[Samik Chatterjee:]

Hi, thanks for the questions. I guess, I just want to start off with the – I know you mentioned the expanding market for 400ZR with network operators, as well beyond just behind the little customers and you mentioned, I think you were in qualifications as well. Just wanted to understand if, like when you get to that stage, have they already – the network operators kind of already decided there and shortlisted only modules at that point or are they still evaluating adjust the basis, vis-à-vis on 400Gig module and ZR module and like what does that indicate? Who are you generally competing against at that? And then I have a follow-up question.

[Timothy Jenks:]

So, the mechanics of process are that, when you are selling components or when you are selling modules, you are working through a qualification and seeking design wins on systems or on applications that require that products. So, for example, if it’s a chassis-based system at 600Gigabit per second or if it’s a chassis-based system that will run up at 800Gig per second, you are competing for a socket win on that and then as you win it, ideally you would have an ongoing business for some period of time such as the pace with the ZR, 400ZR module qualification. It’s in the process of doing the module qualification, doing the design win and doing the potential first article sale, the purchasing decision of the customer, whether it’s a datacenter operator or a carrier the purchasing decision of what their system level or architecture level trade-offs is left with. And so, we do know that ZR is new. We do know therefore that essentially all the incumbent installations are not ZR. They are all chassis-based systems. And so, really the question is, those down to – is the customer looking at new architecture and new way of doing business with their network or are they going to stick with the way they have been doing it on legacy basis, if it gives them appropriate economics. So I think that probably varies by customer. But just I think it would be a little bit – more at the side of hope to say that, gee, if they qualify the module, then they’ll make all systems decisions in favor of that system. I don’t think that’s the way it works. So, there is not a direct one-to-one correlation. So, we expect that there will continue to be for some time, there is going to be a mix and as Wupen said in his prepared remarks, certainly the highest performance, the longest distance, the submarine networks where you really have to have the high performance – that the highest performance at the highest speed. Those are going to continue to be chassis-based and so, I hope that addresses your question. Wupen, do you want to chime on this at all or you think it - all right. Yes, Samik, so, go ahead.

[Samik Chatterjee:]

Yes, that was clear. Thank you. So the second one, I was just going back to the ramp that you have in front of you in the second half and understand there is a supply component to it, as well as a demand component particularly when it comes to North America and China demand. But just wanted to – like, I would have thought if there is very high confidence from those network operators in relation to demand and your customers seeing that demand from network operators in the second half. They would try to knowing the component shortages kind of try to pull some of your orders ahead in relation to coherent components. So, I am just wondering, like what are you seeing in your order patterns, because if there is high confidence in that second half revenue ramp and knowing component shortages, wouldn’t it be logical for some of them to start moving orders around and pulling them in?

[Timothy Jenks:]

It would be logical and they are.

[Samik Chatterjee:]

Okay. Okay. That’s clear and thank you. Thanks for the clarifications.

[Operator:]

Thank you. We will take our next question from Michael Genovese with WestPark Capital.

[Michael Genovese:]

Thanks a lot. First question, just quickly I want to go back to your earlier question about the macro and just understand is the first quarter and the second quarter are the same, if there is any changes in the first quarter to the second quarter? Because I mean, you have very slightly weak first quarter and maybe adding back the components are very slightly missing the consensus for the second quarter. Is it, but is the macro is the same in the two quarters, it’s actually worse. Are there are more push outs in the second quarter?

[Timothy Jenks:]

I think there are more push outs in the second quarter if you put it in that terms, but there are other things that have happened. We talked a bit about China Telecom, China Mobile and slowness in deployments, which really derived from the 5G overall. So that those are slower in China now and then, additionally in the North American market, we saw the completion of the wave of spectrum auctions. So that the major carriers in North America completed that. And so, then, they – early in the quarter or late in the last quarter, they kind of outlined some of their plans, their multi-year plans for deployments. Those take a bit of time to get rolling. And so, I would describe that there is a little bit of an air pocket while we are transitioning from what was the plan to what will be the plan and that’s more of an impact in the second than the first quarter.

[Michael Genovese:]

Okay. That makes sense. And my follow-up on a different topic is that, number of the ZR - potential ZR customers. I mean, we are just talking about the hyperscalers and the switch and router vendors. So that – ten potential customers and related to that, how many trialed you and – or is it many more potential customers than that?

[Timothy Jenks:]

Well, there is two ways to think about that and that is that 400ZR interconnects in the top level, the attractive point is it allows direct connection between switches and routers. So, while hyperscalers are the leaders in terms of time, schedule and deployment, anybody who uses switches and routers at 400Gig is a potential customer for 400ZR. So, if you will, there are those two broad categories of customers. And so, when we first made our early 400ZR module deliveries early last year, and we were among the earliest deliverers and certainly the earliest of all the different form factors here. We’ve been working on therefore for some period of time. But those, without a doubt were focused on the biggest guys with the earlier schedules. We are now more than a year down the road. And so, there are numerous other companies in different parts of the world and different bits of business that, as Wupen said in his prepared remarks, that our operators, high-performance networks that are now doing their own testing, trials, proofing of 400ZR. So, there still will be a relatively small number of very large customers. But I think there will ultimately be a large number of customers in the traditional sense of the long tail.

[Michael Genovese:]

Great. Thanks a lot, Tim.

[Operator:]

Thank you. We’ll take our final question from Simon Leopold with Raymond James & Associates.

[Simon Leopold:]

Great. Thank you for taking the question. How are you guys doing? Hope everybody is well. Couple things I wanted to ask about, one was, on the ZR opportunity, I believe you are among the three leaders with products being actually being evaluated and trialed, but we’ve definitely heard about many participants expressing interest in coming into this market. I wanted to get your view on how many companies do you expect to be completing and how you think about what the margins could be like, overall, if it’s a crowded space or if you expect it won’t be crowded. What’s your thought on industry structure of the ZR market? How many players will there be?

[Timothy Jenks:]

My crystal ball is not perfectly clear on this kind of question. I agree with you about the fact that there are three companies who have been in the fray for all of the last year with operating modules in multiple tests at different vendors. How many companies ultimately, the way things have gone in the industry for years is that, things start with complete module vendors. And then over time, some people who were able to build this component or that component but couldn’t get the module business, then they start to be merchant vendors of the components. And that allows assemblers then to get into the business. Now in this case, we are talking about pretty sophisticated capabilities to be doing this business. And the leading players with leading schedules are really demanding vertically integrated manufacturers to have the ability to stay with the program over the long-term and then extend it from ZR to ZR+ and then from 400 to 800. And so, I think there will be additional entrants. But I think it will still be, let’s call it a large handful. I don’t think it will proliferate.

[Simon Leopold:]

Great. Appreciate that. And then, in terms of the outlook for the second quarter gross margin, you are looking at revenue that’s not that different than what you just reported, but a lower gross margin and I am imagining that some of the headwind has to do with higher input costs. And I’d like to see if you could help us unpack what aspect of the relative gross margin in Q2 versus the quarter you just reported is related to input cost, likely related to things like airfreight and shipping or it’s related to just your own pricing? Could you help us understand the bridge between the two quarters?

[Elizabeth Eby:]

So, our cost of our major components, just like our customers are pretty much negotiated annually. So we won’t see any inflationary aspects until the annual contracts come up. What the real story is on the Q1 to Q2 gross margin is product mix. As you know well, we have done a great job on increasing our product margins over the last year. We are up five points year-over-year. So, if we start to sell some of the older products, the less favorable mix that I talked about in the script were – it’s going to show up. And that’s exactly what’s happened is that 400G components get constrained where there is demand that can’t wait till Q3. They are taking older products and the older products have lower margins.

[Simon Leopold:]

Great. No, I appreciate that insight. That’s helpful. Thank you for taking the questions.

[Operator:]

Thank you. And at this time this concludes our question and answer session. I'll turn it back to Tim Jenks for closing remarks.

[Timothy Jenks:]

Thank you, Todd. Thank you for joining our call today and for your interest in NeoPhotonics. The core trends of the industry play into our strengths in 2021 and subsequent years. I am very proud of our team for what they've achieved and we do look forward to updating you in the future. Have a good evening.

[Operator:]

Thank you ladies and gentlemen. And this concludes today’s teleconference. You may now disconnect.