NeoPhotonics Corporation
Q1 2018 Earnings Call Transcript

Published: 9 May 2018

[Operator:]

Welcome to the NeoPhotonics 2018 First Quarter Conference Call. This call is being webcast live on the NeoPhotonics event calendar webpage at www.neophotonics.com. This call is the property of NeoPhotonics and any recording, reproduction or transmission of this call without the express written consent of NeoPhotonics is prohibited. The webcast will be available on the event calendar page of the NeoPhotonics website. I would now like to turn the call over to Erica Mannion at Sapphire Investor Relations.

[Erica Mannion:]

Good afternoon. Thank you for joining us to discuss NeoPhotonics operating results for the first quarter of 2018, and our outlook for the second quarter of 2018. With me today are Tim Jenks, Chairman and CEO, and Beth Eby, Chief Financial Officer. Tim will begin with a review of the first quarter with a view of market conditions and new products. Beth will then provide financial results for the first quarter before providing the outlook for the second quarter of fiscal 2018. Beth will then turn it back to Tim for additional color on the market and business drivers before opening the call for questions. The company's press release and management's statements during this call 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 a 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 at the Investor Relations section of the 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, levels of sales and profitability, subsequent events, product and technology development, capital needs and availability, customer demand, inventory levels and economic and industry projections. Various factors could cause actual results to differ materially. Some of these risk factors have been set forth in our press release dated May 8, 2018 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 for joining us today. In the first quarter, NeoPhotonics delivered revenue of $68.6 million, with High Speed Products for data rates of 100G and beyond comprising 86% of our revenues, up from 84% in the fourth quarter. As we discussed on our last call, our first quarter is typically our seasonally softest due to the impact from annual price negotiations and the Chinese New Year. Even within this, we continued to see strength in our business supporting DCI and Metro in North America, and in key products supporting this trend, which we expect will continue over multiple quarters. Our largest served geographic market is China, which has been the subject of considerable attention in the media related to both sanctions and trade. First, on April 15, 2018 the U. S. Department of Commerce issued a Denial Order prohibiting Chinese telecom maker ZTE from receiving items subject to U. S. Export Administration Regulations. This order effectively bans U. S. companies from exporting certain technologies to ZTE. The impact of this order on NeoPhotonics was described in our April 17th press release. Second, recent media reports have brought back to public view that Huawei Technologies, also a Chinese telecom equipment maker, has been the subject of an inquiry about its compliance with U. S. export regulations. As Huawei is our largest customer, we pay attention to these activities. Our following comments and our outlook consider each of these issues, including the fact that there are no current restrictions on any Chinese customer other than ZTE. Moving to the first quarter, we saw a continuation of the customer trends which we discussed on our last call, mainly a more normalized demand environment in China with normalized inventory levels as our customers were waiting for new tender awards for domestic provincial tenders or in support of initial 5G wireless trials. While the mid- to long-term expectations for the market continue to have strength, due to the uncertainty around timing of new awards as well as the recent U. S. Department of Commerce actions, we have recently seen indications from our Chinese customers tempering their forecasts somewhat for the full year while beginning to make adjustments subsequent to the Denial Order. We do not see any clear indicators that cause us to forecast specific share shifts among customers. Business outside of China in Q1 was in line with normal seasonality. End use demand in North America was strong, where capex for both telecom and cloud data center applications remained robust. Our leading customers serving these end-use markets have increased their forecasted deployments for the year and signaled increased product pulls from us beginning in the coming quarter. Additionally, in Q1, while overall demand for lasers remains strong, we are seeing market share shifting as traditional EML laser applications transition to next generation 53Gbaud PAM4 solutions that enable 100G in one wavelength, while new opportunities arise for directly modulated lasers and for silicon photonics-based shorter reach applications. As I noted last quarter, we continue to see strength with our new line side 400G and 600G product offerings including strength in design wins across all three of our leading coherent components, including our ultra-narrow linewidth tunable laser, 400G and 600G micro coherent driver-modulator and coherent receiver. Systems that deliver 400G and 600G per wavelength were highlighted by many companies at the recent OFC Exposition held in San Diego, many of which rely on our next generation products. For example, our ultra-narrow linewidth lasers are a critical element in achieving these speeds because they have the narrowest linewidth and minimal phase noise for the higher order modulation schemes that are required. When more bits are encoded, there is risk of signal degradation unless very pure lasers are used. Our laser, receiver and modulator optimally work together to enable this highest performance and we are now supplying them as a full solution or as discrete elements to customers for whom the highest performance and data rates matter. These three products are now shipping and we expect to ramp volumes through 2019. At OFC we featured our DCO Coherent Module products and our new Multicast switch products, as well as our next generation advanced coherent components. Our nextgen coherent components increase integration and reduce the size of the optics in half again while featuring the high performance required for 400G and 600G per wavelength. Further, we conducted live operating demonstrations of our Coherent Optical Subassembly, or COSA, which integrates our 64GBaud coherent driver-modulator and our coherent receiver within this very compact size. Alongside this, we demonstrated our new “Nano” ultra-narrow linewidth external cavity tunable laser, which again cuts size in half while featuring industry leading linewidth and with low power consumption. In a separate demonstration, we incorporated both the COSA and the Nano laser into an operating 400G coherent OSFP module. Turning to client side and data center applications, at OFC we introduced our 53GBaud Linear Optical Component family which includes PAM4 capable optical components for 100G and 400G hyperscale data center applications, and include drivers and EML lasers in transmitters plus photodetectors and trans-impedance amplifiers in receivers. This product family provides all of the optical content necessary for single wavelength 100G PAM4 transmission, which was also demonstrated at OFC, and four wavelength 400G PAM4 transceivers, such as DD-QSFP. We also highlighted our high power, non-hermetic laser optical sources which are key innovations for use in shorter reach 100G and 400G silicon photonics based transceivers such as DR1, DR4 and FR4. This is important, as there are changes occurring in laser uses with both moves to higher baud rates and in supporting silicon photonics-based architectures. NeoPhotonics is addressing each of these needs. Similarly, our OFC demonstrations illustrate that we now offer all of the optical content for the next generation of high speed coherent and PAM4 solutions for telecom and data center markets, and supporting both pluggable modules and compact line card solutions. I will now turn the call over to Beth to provide further detail on our financial performance.

[Elizabeth Eby:]

Thank you, Tim, and good afternoon. The first quarter was within expectations, excluding the impact of our ZTE related write down. We did see a slightly lower volume and a different mix of products than expected, resulting in gross margin at the lower end of the range and inventory that was slightly higher than expectations. In the first quarter, revenue was $68.6 million, down 4% year-over-year. Quarter-over-quarter was down 11% on slightly lower volume and the full implementation of annual price reductions. China was up 9% year-over-year, down 5% from Q4, and represented 61% of our total revenue. The Americas represented 21%. Huawei Technologies, including their affiliate HiSilicon Technologies, was our largest customer, and accounted for approximately 48% of the Company’s revenue. Our next four customers after Huawei represented 36% of total revenue in Q1. As noted in our April 17th press release on the impact of the U. S. Department of Commerce Denial Order related to ZTE, we had expected up to 5% of annualized revenue from ZTE and its suppliers, which will now not be realized as planned. Further, we held certain products in inventory for ZTE that were valued at approximately $1.2 million that have written down. Each of these impacts is reflected in our results and in our outlook. Our Non-GAAP gross margin in the first quarter was 14.7%, down about 6.6 points from Q4 and below our forecast mainly due to the ZTE write down. There were four drivers of this change

[Timothy Jenks:]

Thank you, Beth. The growth drivers for our business are compelling, and complemented by our success in new product introductions, to help us drive top line growth in 2018 and our path to profitability. We remain focused on operational execution including cost containment as we leverage new products to drive higher demand for our business. While we feel confident in our competitive position in the market, we remain mindful of the timing questions regarding new tender awards and other uncertainties in China. Looking beyond the near-term, we remain enthusiastic about our mid- and long-term prospects within the optical networking space. NeoPhotonics has been focused on delivering industry leading performance components and modules. Growth in our telecom, data center and cloud markets will be driven by

[Operator:]

[Operator Instructions] We will take our first question from Simon Leopold with Raymond James.

[Simon Leopold:]

I’m a little bit confused regarding how you described the situation in China. So obviously, I understand the part about ZTE. That I get. I would have thought that other potential customers in China, whether it is FiberHome or Huawei, would look at the situation, and it would be good for you that they would want to buy more products, either stockpiling before potentially getting cut off or preparing to take business away from ZTE. So I’m – maybe I’m confused about what you said or maybe it’s a timing issue. Could you shed some light on that topic?

[Timothy Jenks:]

Sure, Simon. The situation in China has multiple aspects of it. But I think the most important is to point out, first of all, the denial order on ZTE, which is very clear and that the preclinical shipment of U.S. EAR technologies to ZTE. And the fact that with respect to media reports on Huawei, there really isn’t any new news because this actually dates back to 2016. And recent media reports did not offer any new insights. So ultimately, what’s the case is that, we, in our discussions with customers, see that they are taking time to figure out what it may – what may happen. And it’s probably more an impact as to what’s going on with respect to discussions about trade between the U.S. and China, which obviously hasn’t been yet determined.

[Simon Leopold:]

But I guess, I want to make sure my thesis is reasonable, at least just founded in logic that if ZTE is blocked from purchasing your products and can’t get them from other suppliers, shouldn’t that mean that your business with other Chinese vendors, OEMs, should improve as the share shifts among the OEMs in China? Is that an unreasonable thought, in terms of what should happen longer term?

[Timothy Jenks:]

That’s certainly is one possible outcome that could happen.

[Simon Leopold:]

What are others? What are, sort of – I guess, I want to make sure – because to me that seems very obvious. I feel like maybe I’m missing a scenario you are envisioning? Or a risk I’m not appreciating?

[Timothy Jenks:]

Well, I think with respect to the media reports on Huawei, there is an upside and a downside. And so you have to consider both. And in the case of ZTE, you similarly have to consider that it stays in place to its duration or that potentially there is another resolution that may be subject to current discussions between the U.S. and China. And while we are aware of each of these things, we don’t have clear indications from our customers as to what could happen. And then last one is simply that the ZTE ban could result in deployment schedules in China slowing down, over time. This would be really from the carriers, if they have plans that fundamentally dependent on the group of telecom network equipment providers that have existed. And now there is a change, then they could simply slow down their deployment schedules, and that’s not yet known.

[Simon Leopold:]

Okay. And then I just wanted to ask a modeling question, if I might. In the past, you’ve sort of provided us with a bridge to the gross margin recovery, and I think we’ve been assuming that recovery near breakeven levels means mid-20s gross margin. I want to make sure that that’s correct. And I want to get an understanding of what gets you there? Is it simply the return of volume? Or if there are other aspects we should know about?

[Elizabeth Eby:]

So the – we absolutely still have the model that breakeven revenues mid-80s breakeven and gross margins, mid-to high 20s with a current maybe a little higher spending levels as we get some profit-dependent spending in there. But then we still believe that we can get to those gross margin levels with the combination of return to volume and known cost reductions that we’re working on, that I have spoken to a few times, in general, of course. And then the elimination of some of these onetime events that have been hitting in the last few quarters.

[Simon Leopold:]

Great, thank you for taking my questions.

[Timothy Jenks:]

Thanks, Simon.

[Elizabeth Eby:]

Thanks, Simon.

[Operator:]

And we’ll take our next question from Alex Henderson from Needham.

[Alex Henderson:]

Great. So I wanted to talk a little bit about the question Simon asked first. So it seems to me that borrowing a Huawei band, which I think is highly improbable in any reasonable time frame. That, at a minimum, the environment that would be impacted by the ZTE ban would be network deployments that generally involve ZTE gear. And since a lot of that coherent gear is not compatible with Huawei gear, I would assume that they would shift funding from a build in those networks to builds that are in networks that they can get to a need to deploy on. Is it a reasonable to think that there is a need for the capacity, and therefore, they’re going to continue to spend to put that capacity in place, given their own – the service providers' effective needs?

[Timothy Jenks:]

No, Alex, I think the – each of those possibilities are reasonable. It’s certainly the case that, as I said in the prepared remarks, that we expect their need for bandwidth will continue. They still have the long-term plans for build-outs, including ultimately the 5G wireless. But in the current – in the three weeks that have passed since the time of the denial order and then with just media reports related to Huawei, there aren’t any clear indicators yet from customers. We – as I said in the prepared remarks, we do see people, the customers, trying to look at their alternatives subsequent to the denial order, but they’re not yet clear plan. So I think that each of the scenarios or the things you talked about are possible. But I don’t think it’s possible for us to commit one way or the other until we get a clear view from customers.

[Alex Henderson:]

Fair enough. Second question I had for you is on the gross margin side. Obviously, the big part of the pressure on your gross margins has been the decision to work down inventories to 90 days. You are a little bit behind on that schedule. Can you give us a sense of when you think you will be able to achieve that market? Will it be during the second quarter, and therefore, that impact falls out? And what do you think the dollar or the percentage impact to gross margins from that particular issue is in the second quarter guide?

[Elizabeth Eby:]

What we’re seeing now, Alex, is a little more complicated story around gross margin, where some of our factories will get to be loaded in Q2 and some of them will continue to be underloaded. As I said in the prepared remarks, it’s looking like EML demand may be a little bit light, which had caused Japan to be continue to be substantially underloaded. So we do expect to get to that 90 days. Every time I look at it, it seems to push out a little bit. It was supposed to be in Q2. Now it’s looking like it’s going to be Q3, before we get down to 90 days.

[Alex Henderson:]

Does that negatively impact your outlook for 3Q reaching profitability then? I would think that if you’re still working on inventory, you’d have some margin pressure that you had in prior expected – in the third quarter when I think you had expected to be fully out of it? And then the second piece of that is, if the EMLs are having difficulty, when does the – what’s the route cause of that? And when does that rebound or doesn’t? Is that something that you expect to be more of an impaired environment for an extended period of time or short period of time?

[Elizabeth Eby:]

So let me go to the first part of the question, which is, it does hit our gross margin by a point or two compared to what I expected a few months ago. But it’s not nearly as big as it was at the end of the last year, where we just had the breaks on just about everything. Now it’s a little more nuanced story.

[Alex Henderson:]

I'm sorry, you mean to say a point or two in the third quarter or in the out-quarter? I'm not sure which period you're referring to?

[Elizabeth Eby:]

In Q2.

[Alex Henderson:]

A point or two in Q2 and something substantially less than that in 3 Q, I assume?

[Elizabeth Eby:]

Tough to say. EMLs and the Japan factory, it’s fairly – it’s going to depend on what comes back, and I can talk to the volume and the revenue when the current quarter is soft, but we are well prepared for upside. Tim can talk to a little bit more about the market demand – dynamics of what’s going on with EML.

[Timothy Jenks:]

Yes. So there are couple of things to consider in – the loading is certainly – it will be addressed, certainly, as China customers decide on their path forward because if, ultimately, share does shift, it could be beneficial to Neo. And as a result, it could make a meaningful difference in loading. So as both, you and previously Simon, asked with respect to going forward, we have been actively prepping for demand in the 53 gigabaud EML. And so the rate of uptick there, which we expect really to be a 2019 event, is a reason for our prepared remarks are suggesting that, that EML loading for the legacy 28 GB will be lighter for 2018. But ultimately, we make a range of products there, not just EMLs but the overall effect on lasers matters.

[Alex Henderson:]

One last question, and I’ll cede the floor. Can you just give us an update on Multi-Cast?

[Erica Mannion:]

Sure. Multi-Cast Switches, we’ve now got several different versions in the marketplace. These are products that are being qualified with additional customers and our customers selling them to an expanded base of end-users, and so demand continues to grow. And we would expect to see a steady upward trend on deployments of Multi-Cast Switch over the next several quarters.

[Alex Henderson:]

Yeah, I'll see that. Thank you.

[Timothy Jenks:]

Thank you, Alex.

[Operator:]

And we will take our next question from Richard Shannon from Craig-Hallum.

[Richard Shannon:]

Hi Tim and Eby. Thanks for taking my questions as well. Maybe I’ll start with a really simple question on your guide for second quarter on sales here. I wonder if you can give us any qualitative or quantitative thought process on the growth here quarter-on-quarter from China relative to the rest of the world? And if you want to discuss the U.S. demand in there as well that would be great, please?

[Timothy Jenks:]

Are you saying from second quarter to third quarter?

[Richard Shannon:]

First quarter and second.

[Timothy Jenks:]

Okay.

[Richard Shannon:]

In your guidance.

[Timothy Jenks:]

Yes. So we do see that for our second quarter, we’ve seen pretty strong demand in our Americas region, particularly North America. As I said in the prepared remarks, we do have indicators from some customers that they expect volumes to be a bit higher. For that, I think, that’s reasonably good. I think Beth said in her remarks that the Americas in the first quarter were 21% of revenue, and so we would expect some more traction in the second quarter. Now with respect to China, I think, there are upside and downside scenarios. Certainly, if one expects that Huawei will continue on their existing plans and the denial order stays in place, then I would expect the net-net of that could be beneficial to us and share shifts to others. But again, we don’t have clear indicators of that yet directly from customers.

[Richard Shannon:]

Okay. That’s helpful. I probably should ask this question first. But what’s the percentage of sales in the first quarter coming from Ciena?

[Elizabeth Eby:]

19%.

[Richard Shannon:]

19%. All right. Perfect. Tim, it sounds like on the topic of China here, it sounds like a lot of uncertainty. I know last quarter you talked about port count numbers coming from both Huawei and China, in general. Have your customers given you updated numbers on that in the last few weeks since the news about Huawei and ZTE broken? Or do you just not have any trust in what those – what they are giving you right now?

[Timothy Jenks:]

Well, actually, we’ve had lots of customer discussions, but it’s pretty difficult at the moment to state what conclusions are. There aren’t any clear share shifts. We have talked to all the customers. We do expect that there will be changes, and there are potential directions that it can go. So certainly, with the four leading systems companies in China, one would logically assume that if one is less able to shift, i.e., ZTE, then you would expect the others to pick up share and potentially to pick up in some relative proportion, but that ignores the important nuances of whether the equipment is interoperable; as Alex had mentioned, whether or not the telcos actually slowed down their plan, and all of the myriad details. So at the moment, we have really the same port count forecast that we had in our last conference call with no clear differences, and therefore, no conclusive information to the contrary.

[Richard Shannon:]

Okay. That’s helpful. Last question for me. I got in the call a little bit late due to another reporting company here and I missed the discussion about the 28 gigabaud, I think, it was EML lasers and the demand issues there. Can you go through that again and help me understand what’s the situation?

[Timothy Jenks:]

Yes. Well, just briefly is that we reported, I think, in our last call that in Japan, we are having some output challenges. Those have largely been remedied, but we do essentially see some changes in the laser business. There are changes between the types of lasers being used and the increase in silicon photonics-based transceivers as well. For us, specifically we are talking about EML lasers. EML being the electroabsorptively modulated lasers. They’re high-performance lasers, and they’re really used in the most demanding applications. So our focus has moved to using these for 400-gig per wavelength PAM4 applications. And it’s really – you’re trying to take advantage of the linearity dynamic range and the power of an EML. We’re able to do 53-gigabaud laser, so that’s 100 GB per single wavelength. And we expect that, that will be in good growth by 2019. But for 2018, there is a bit of a low on the legacy 28 GB. So that’s what we were explaining.

[Richard Shannon:]

Got it, okay. I think, you will take my other questions offline. So that’s all from me. Thanks guys.

[Operator:]

And we will take our next question from Tim Savageaux from Northland Capital Markets.

[Elizabeth Eby:]

Hi, Tim.

[Timothy Jenks:]

Tim, can you start, again. We weren’t hearing you at the beginning. Go ahead.

[Tim Savageaux:]

Can you hear me now?

[Timothy Jenks:]

Yes, we can hear you now.

[Tim Savageaux:]

Great. Don’t know what happened there. The question is about guidance for the second quarter in light of your previous disclosure about both direct and indirect ZTE exposure, which – and I’m not sure – precisely what time frame you’re estimating, I’ll assume for the year or kind of on a run-rate basis to have up to 5%, something, may be 3% to 5% exposure? I mean to the extent that you’re kind of able to grow through that in Q2, I wonder if you could talk – and you’ve already spoken to some of that, in terms of Americas' strength. But I mean, is that the way we should look at it as a certain – I don’t know, low to mid-single digits impact that you’re kind of sustaining in Q2 and growing elsewhere? And to the extent, you can point to specific areas that’s enabling you to do that? That would be helpful.

[Timothy Jenks:]

Sure. So part one really is, in our press release related to the ZTE denial order, we did describe that the revenue that we had expected from ZTE would be in low single digits growing through the year and perhaps be 5% of annual total revenue, and we do not expect that, that will happen and are planning accordingly. That has been taken into account into our outlook. We’ve talked about Huawei situation in China. North America has been strong there. North America demand really does come from data center interconnect as well as metro applications. And we expect that, that will most likely be strong through the year. And so to some extent, we’ve incorporated that in our outlook for the second quarter. Our visibility beyond that is pretty limited, but we do see strong demand generally from North America, which, as I said, earlier was 21% in the first quarter.

[Elizabeth Eby:]

And to add on Tim, while we have not yet incorporated any share shifts toward Huawei, but they were always planning on growing helpfully this year.

[Tim Savageaux:]

Got it. And I mean, it looks like that North Americas' number was also up nearly 20% year-over-year. I don’t know if that’s a meaningful number quarter-to-quarter. But if you have any sort of comments on kind of overall growth potential there? And I guess that heads into my second question, which is, you kind of described a scenario where – and kind of overall growth potential there? And I guess that heads into my second question, which is, you kind of described a scenario where – and kind of excluding ZTE for the moment, even post that maybe there are some navel-gazing in China about what the outcome might be in some slowness. At the same time, you described some acceleration in forecasts amongst some of your DCI and metro customers. So I guess, net-net, where do you come out on that relative to how you’re looking at things, say, at OFC or before?

[Timothy Jenks:]

So in the case of – let me divide that in two parts

[Tim Savageaux:]

Got it. And final question for me, you mentioned and you provided some color on Ciena, but your next 4 customers were 36% in the aggregate. Given some of the growth you’re seeing there outside of China, I wonder if you might provide any more color on what might be happening among that kind of next four type group? And maybe I’ll call out specifically the potential – and I know they were – Alcatel-Lucent was a 10% customer back in the day. I’m not sure where that stands, but they seemed to have picked up some share even in China, much less the rest of the world. So maybe you could spend a minute talking about your other OEM customers on down that top 5 list? And what sort of applications and growth potential you see there?

[Timothy Jenks:]

Well, we do sell to really all of the top 12 to 15 network equipment companies. And so I think that the overall rate of growth over the last several years in the market that they collectively serve, the rate of growth has been quite modest. And so to the extent that one is gaining share over another, there is a plus and a minus. Certainly, we do feel that our two largest customers, which you rightly point out, are Huawei and Ciena, have both done reasonably well with respect to their global share. And we are fortunate to be able to business partners for both of those companies. We also have other exposures in the China market, certainly, beyond Huawei. We have both direct sales to ZTE, also sales to ZTE supply chain partners. We also sell to FiberHome. We also sell to Alcatel Shanghai Bell. And so to the extent that the other Chinese customers, other than ZTE, pick up share, we think that, that could over time be a net benefit for NeoPhotonics. But again, it’s early days and predicting how that will shake out is difficult to do. I hope that helps.

[Tim Savageaux:]

It helps thanks.

[Operator:]

[Operator Instructions] And we’ll take our next question from Jun Zhang from Rosenblatt.

[Jun Zhang:]

So the first question is about the Japan, the fab situation. So could you have – when do you a production ramp in Q3? And what kind of advantage you have to help NeoPhotonics to gain share back from competitors? And also, I think with the current increase in price competition in hyperscale market, is EML still a competitive solution compared with other low- cost laser? And what are the key markets your target for the EML lasers when you start ramp the production?

[Timothy Jenks:]

Sure. Jun, with respect to EML lasers in particular, are one of several different type of lasers that we sell. Our largest group of lasers, of course, are tunable lasers that go into coherent circuits. We also sell EML lasers, which have a number of applications. We also sell different types of DFB and DFB arrays, which support shorter-reach applications to include silicon photonics-based transceivers. So this is the DR1, DR4, FR4 applications. So we are addressing different types of laser applications with our laser product portfolio. For – because the EML products are generally higher performance, they are used in more demanding applications. I think I said earlier, the attributes they have, very linear performance. They’ve got very good dynamic range and power. So essentially they tend to be used in the higher- speed applications. And so we have a range of products and products solutions at 52 gigabaud, which move toward being able to combine 50-gigabaud data rate with PAM4 allows you to have 100 gigabits on a single wavelength. So that can be in a single wavelength at 100 GB, it can be 4x 100 for 400 GB, et cetera. And so these are forthcoming applications, where some of the new lasers are being designed in.

[Jun Zhang:]

Okay. Got it. And second question is about China demand. So do you expect that China to be up or perhaps sequentially in Q2? And also, without uncertainty about the trade situation, do you still expect China business continue growing in the second half of this year?

[Timothy Jenks:]

Well, that’s the big question, Jun. I think as we talked about on our last conference call, we – based on the high-speed port count deployment estimates from each of our customers, the volume growth rate for 2018 was in the range of 10% plus above the volume of deployments in 2017. So you could start with the assumption that the business would be up. But if you offset that by price, you get closer to flat. And then, if you believe that some things may be delayed, which I described as customers tempering their forecasts, it may be flat to slightly down. So that’s the possibility in China for 100 GB plus coherent. Now there are other applications that are absolutely growing in their high-speed port growth. Certainly, in the North America case and metro and DCI, we’re certainly seeing port count growth, deployment growth. And so there’s also the scenario where China makes changes to stay on schedule with their deployment, and that together with port growth in North America could be a positive scenario, but it remains to be seen. So I hope that addresses your question.

[Jun Zhang:]

Yes, thanks. And last question is that, could you talk a little bit about any interest from the client base on your line size margin? I think they’ve launched line size margin at OFC, which is competing with Acacia line size margin? And also, do you think that the line size margin you’re offering to the client is compatible with Acacia’s line size margin? Thanks.

[Timothy Jenks:]

So couple parts to that. We have – we’re referring to DCO, so- called Digital Coherent Optics modules. We did showcase some of these at OFC, although we introduced them last year. And we have a number of qualified customers today. Volumes are relatively light because it’s early days. And I think it’s not a surprise that a lot of the DCO modules are used in China. And so the ZTE denial order, I think, does have some meaningful impact on what the overall consumption of DCO modules will be. With respect to interoperability, they are operable. It’s a function of hard and soft decision error correction. And they generally are operable in the shorter reaches, less interoperable in the longer reaches.

[Jun Zhang:]

Okay. Got it, thanks a lot.

[Operator:]

[Operator Instructions] And we will take Alex Henderson from Needham.

[Alex Henderson:]

Great, thanks. I was hoping if you could give us some sense of what you think is happening in North American/European environments, relative to the mix of spend between metro deployments and long-haul background deployments. If we look at the CapEx numbers, there’s a lot of search providers, they’re not growing a lot. And yet we’re hearing very strong indications of demand growth in some of these metro environments. But are they taking from the long haul to fund that? How would you say that balance looks between those? Are you seeing still growth in long haul? Or is long haul flattening or declining?

[Timothy Jenks:]

Well, let’s see. Overall – I’ll start with CapEx. Because, generally speaking, CapEx recently has been pretty strong in the west. We’ve seen the principal carriers, Verizon and AT&T, coming above what we had as estimates. Then if we move to the hyperscale data centers, certainly, Facebook is strong. We’ve seen the Google CapEx numbers now eclipse Verizon, really, for the first time. And so generally speaking, there is a strong CapEx environment. There is the ability to distinguish across the market and customer-to-customer on what is the spend on long haul versus metro. It’s a – I probably can’t give you a good answer on that, Alex, because the best information we would have would similarly be from published reports that aggregate that information. I can’t shed much light on it.

[Alex Henderson:]

Alright, thanks.

[Operator:]

And there are no further questions. I’d like to turn the call back over to Tim Jenks.

[Timothy Jenks:]

Thank you very much. I want to thank you, everyone, for your time and interest in NeoPhotonics. We look forward to updating you on our progress in the near future. Have a good evening.

[Operator:]

That concludes today’s conference. Thank you for your participation. You may now disconnect.