NeoPhotonics Corporation
Q4 2016 Earnings Call Transcript

Published: 15 Mar 2017

[Operator:]

Welcome to the NeoPhotonics 2016 Fourth 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. You may listen to a webcast replay of this call by visitingthe event calendar page of the NeoPhotonics website. I would now like to turn the call over to Erica Mannion at Sapphire Investor Relations, Investor Relations for NeoPhotonics.

[Erica Mannion:]

Good afternoon. Thank you for joining us to discuss NeoPhotonics operating results for the full year of 2016, the fourth quarter of 2016 and outlook for the first quarter of 2017. With me today are Tim Jenks, Chairman and CEO, and Ray Wallin, Chief Financial Officer. Tim will begin with brief comments on the fourth quarter and then discuss market dynamics currently impacting the first quarter. Ray will then provide financial results for the fourth quarter and the outlook for the first quarter of fiscal 2017 before turning it back to Tim to provide further detail on recent business developments before for opening the call for questions. 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, 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 March 14, 2017 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. 2016 was a strong year for NeoPhotonics, with overall year over year revenue growth of 21% to $411 million and High Speed product revenue growth of 42% year over year. We had a strong finish to the year with our all-time record revenue in Q4 at $110 million, representing growth of 23% over the prior year period. That said, given the softness we are seeing in Q1, I would like to begin my comments today with the recent developments that are impacting these estimates. In December, we announced the sale of our Low Speed Transceiver Product assets and provided an updated outlook on Q4. At that time we were seeing a healthy forecast and backlog for the first quarter. We also articulated some issues we were having with yield and supply chain on certain products, and we reflected those issues in our revised fourth quarter guidance. However, since then we have seen meaningful changes in near term demand, especially in recent weeks in China where we have major customers. Recall that China has been pursuing certain telecom national backbone deployments as it anticipates transitioning to increased metro and provincial deployments of 100G coherent networks in a subsequent deployment phase. Generally this is referred to as moving from so-called “Phase 11” to subsequent phases, so-called “Phase 12” and beyond. That said, we are unaware of any large tenders for phases beyond Phase 11 yet released, so such deployments remain future anticipated events. As a result, we are right now at the tail end of Phase 11 and before Phases 12 or 13, etc. Recall also that a significant amount of our shipments are from VMI – that is, from inventory that we may have already shipped, but that we do not recognize as revenue until our customer pulls it for use and provides us notification. In the last month or more, we have seen declines in planned “pulls” from leading Chinese customers. And due to VMI, we may realize this impact earlier, and it is may be more pronounced, than with those having limited VMI exposure. The current demand level represents a delay relative to our customers’ beginning of quarter expectations about the timing of their ramp, and transitioning from the current deployment to the next deployment phase, and for which they had begun to build inventory. This situation is similar to what we saw in the lull in the second half of 2015, just before the so-called Phase 11 deployments surged. However, our customers and our contacts within carriers in China tell us they anticipate significant growth in 100G ports in China in 2017 relative to 2016, albeit heavily loaded in the second half and extending into 2018. As a result of these forecast changes, we are providing an outlook for Q1 with revenue that is well below our Q4 results even after adjusting for Low Speed Transceiver Product sales, as we closed the sale of those product lines on January 14. I will ask Ray to provide details on our results for Q4 and our outlook for Q1; then I will return to provide more commentary on what we see going forward.

[Raymond Wallin:]

Thank you, Tim, and good afternoon. Sales for the fourth quarter totaled $109.8 million. Sales of our High Speed Products were $78.5 million or 72% of revenue and Network Products and Solutions represented $31.3 million or 28% of revenue. Revenue excluding Low Speed Transceiver products for the fourth quarter was $97.0 million, a 52% increase from the prior year period and up 8% from the third quarter. Our overall Non-GAAP gross margin was 30%, down from 32% in the fourth quarter of 2015, and up from 28% in the prior quarter. Total Non-GAAP operating expense for the quarter was $26.6 million, an increase of 17% versus the prior year period and up 8% sequentially. Non-GAAP operating income for the fourth quarter was $6.3 million, or 6% of revenue; flat with the prior year period, but up 62% from the prior quarter. Non-GAAP net income in the fourth quarter was $6.3 million or 6% of revenue, compared to 8% of revenue in the prior year period and 3% of revenue in the prior quarter. Based on a fully diluted share count of 47.1 million shares, this translates to earnings per share of $0.13. For the fourth quarter, Adjusted EBITDA was $12.5 million, or 11% of revenue. For the full year of 2016, revenue was $411.4 million, a 21% increase from the prior year. Our full year Non-GAAP gross margin was 30%, and we delivered record Non-GAAP net income of $23.0 million for the year. Non-GAAP EPS was 50 cents per share and we achieved a record Adjusted EBITDA of $45.1 million, or 11% of revenue. I will close out my discussion of the fourth quarter income statement with a review of our GAAP results. Fourth quarter gross margin was 28%, flat with the prior year period and up 1.7 percentage points sequentially. Operating expense was $29.2 million, or 13% versus the prior year period and down 14% compared to the third quarter of 2016. Operating income was $1.8 million for the fourth quarter, which included approximately $0.6 million of amortization of acquisition-related intangibles, $2.6 million of stock-based compensation expenses and $1.2 million of costs related to the sale of our Low Speed Transceiver product assets. Net income was $2.0 million for the quarter, up from net income of $0.4 million in the prior year period and up from a loss of $7.2 million in the prior quarter. Geographically, our revenue mix for the fourth quarter was 18% in the Americas, compared to 19% in the third quarter. China was 65% in the fourth quarter compared to 61% in the prior quarter; Japan was 4% compared to 5% in the prior quarter; and the rest of the world was 13% compared to 15% in the prior quarter. Note that these figures are based on shipment destination, not the end use destination. We had two, 10% or greater customers in the fourth quarter of 2016

[Timothy Jenks:]

Thank you, Ray. The softness in our first quarter outlook directly reflects the views we have from customers on the quarter and their needs, and while we are disappointed with the change in outlook over the last several weeks, we feel confident this is simply a delay in the timing of deployments, with demand returning once tenders are announced. Further, we have several key new product introductions which will expand our market opportunity, and position us to benefit from accelerating deployments both in the west and in China in 2017. As I noted earlier, we believe that demand for 100G and beyond products will be stronger in 2017 than in 2016, though later in calendar 2017. We have been expanding capacity and investing in our new product developments and technology in line with this view. Now, end market demand for our 100G and beyond products remained robust throughout 2016, with China deployments kicking off a wave of growth beginning back in the fourth quarter of 2015, followed by acceleration in Metro and DCI deployments that continued through the year and including a strong fourth quarter. While our performance in 2016 was good, it was constrained by our capacity versus demand. We believe actions taken during the year to expand production capacities, reduce supply chain bottlenecks and increase manufacturing yields will set the stage for a more robust year in 2017, that will result from anticipated tenders moving to deployment. And again, the timing anticipated here is Q2 and beyond, which we can well support in light of the production volumes we achieved in Q4 as well as our ongoing yield improvements and capacity gains. The mid and long term market drivers for our business remain compelling. China remains committed, through the China Broadband 2020 initiative, to continue build out of the national backbone network and expanded buildouts of 100G provincial and metro networks. Our OEM customers in China tell us they expect these actions to markedly increase the number of 100G ports in China in 2017 over 2016, but now with the preponderance of the deployments in the second half of the year. In North America, we continue to see strong demand, with continued metro strength at Verizon, growing DCI deployments and new announcements for AT&T to begin initial 400G installations. Shifting to products and as noted in our recent press releases, we have announced a number of exciting new products which will further help accelerate our growth and market leadership in 2017 and beyond. In the Coherent module market, we announced sampling of our Coherent CFP-DCO module based on our ClearLight™ coherent platform, which is capable of achieving single wavelength 100 and 200 Gbps transmission, and joining our ClearlightTM CFP2-ACO solutions. Most recently, we announced a new modulator product, capable of higher order modulation at 64 Gbaud in a micro form factor, and with integrated drivers, designed for use in CFP2 and smaller coherent module applications and providing data rates of 400G and faster. We believe that the overall growth in ports, the move to increasing 400G links, plus our new module and modulator additions, as well as strength in our component customers’ modules, will continue to provide strength to our overall coherent share. Our new 8x16 Multi-Cast Switch is designed for deployment in China as well as in the west, and should begin to enter volume production in late 2017 as a part of the next China deployment phase. Inside the datacenter, we announced our low power consumption 28Gbaud EML laser with integrated driver, for client side 100G, 200G PAM4 and 400G PAM4 applications. We followed-up with sampling our new long reach 400G CFP8 module, based on our 28 Gbaud EML lasers using PAM4 transmission. To reiterate, we see the demand conditions of the first quarter as temporary, and we expect to see a return to sequential growth with further acceleration later in the year through a combination of the next phase of deployments in China as well as new revenue streams from our new product introductions. NeoPhotonics will showcase and demonstrate many of our new product advancements at the Optical Fiber Communication Conference in Los Angeles, California from March 21 to March 23. This concludes our formal comments and now I would like to ask the operator Denise to open up the line for questions.

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question from Jorge Rivas with Craig-Hallum Capital Group.

[Jorge Rivas:]

Thanks for taking my question guys. First, I wanted to just get your take on what have you seen as far as like provincial – the provincial activity in China. I understand the Phase 12 is being delayed, but we would expect this on – now such a decline since there were some provincial activity at the same time the carriers were having wavelengths who you already deploy equipment, so can you update us on that front please?

[Timothy Jenks:]

Yes. Sure. There are a number of things going on, but I think let's start with the expectation of moving from Phase 11 to Phase 12 and Phase 13. We use those terms where the Phase 11 that had a lot of deployment in the national backbone network and so the expectation is now to move to increasing provincial deployments and increasing Metro. But as we understand it and it depends by carrier, but China Mobile being the largest and then also China Telecom and China Unicom, the expectation is that the next phase would be meaningful increases in the number of ports being deployed in the national backbone and then following that with increases in the provincial backbone. Now it's important to note that in the national backbone deployment, there's pretty good visibility. Carriers have good knowledge of that and they can tell you what and when, in the provincial arena, certainly large carrier like China Mobile those numbers are actually done in the provinces. So there's less central visibility to what the specific numbers will be. But our customer forecasts due continue to show in the range of 20% to 30% increases 2017 over 2016. At the same time, that's actually down a bit from what we knew in December. So in December the numbers were higher than that and we also know that the timing of these things tend to follow People's Congress meeting. So this year the People's Congress meeting started on March 5 tends to run for about two weeks and then several weeks after that is generally when the investment levels are announced and then tenders follow. So that really has – the People's Congress has just happened and there have not yet been announcements on either the investment level or on the deployment timing. However, there were a number of things noted in news releases on the People's Congress where people had been talking about the level of investment – needed continued investment in the network and the strength of that and the commitment to that going forward. Does that answer your question Jorge?

[Jorge Rivas:]

Yes, partially I just want to know if you saw any positive activity from the last call to now and into your guidance from provinces. I understand it's a decentralized process, but there's about 30 provinces as far as we know. So we were under the impression that they have more independence asked to build up with their own networks?

[Timothy Jenks:]

Yes and that's true and so the specifics provincial deployments are ones where visibility, we don't have forward-looking visibility on that at the moment. So I can't really tell you, but I do know the total number of the estimated numbers of ports as I indicated are up in the range of – from about 120,000 ports last year to about 150,000 ports for example for the biggest customers.

[Jorge Rivas:]

Okay. And then one last question from me, so I believe the yield issues had an impact of about $6 million last quarter, any chance you can quantify that for the first quarter guide?

[Timothy Jenks:]

No really, but it's the same or a bit smaller, it's in that range.

[Jorge Rivas:]

Okay, all right. Thank you, guys. That’s all from me.

[Operator:]

We'll take our next question from Alex Henderson with Needham & Company. Please go ahead.

[Alex Henderson:]

Thanks. So obviously with this extremely weak guide for the 1Q, the slope in for the full- year is looking awfully challenged or is it the other alternative view would be that you just pending up demand into the back half? Given what you've said, would you recommend investors and analysts think about lower numbers in the first half and maybe still maintaining the back half of the year or would you suggest that in fact we should be using a lower slope and a lower ramp off of much lower base and therefore a much lower number for each of the four quarters?

[Raymond Wallin:]

Well let's see the – as I responded to the last question, the timing for tenders matters a lot, but typically what we've seen is decisions would follow the People's Congress by a few weeks. So if that were following the normal pattern, we would see such announcements that in the second quarter now. What our customers have told us and this is from a couple of different customers is that they expect the balance of business to be kind of first half, second half they expect it to be in the range of [40-60 or even 35-65] first half, second half depending on the tender announcement time. So I think the slope is steeper than we previously expected. We also have seen some impact with existing inventory because customers were taking a higher volume of shipments in the fourth quarter in the first half of the first quarter and then really around the timing of early to mid February that slowed down appreciably. And as a result, I think we're expecting that there maybe couple months of inventory available. So they are very poised to ramp quickly with the inventory that they have for us that that matters because essentially with VMI, we've already made the shipments. But I think it is a steeper slope for the year probably lower than previously thought, but a steeper slope.

[Alex Henderson:]

Can you tell us what the percentage of sales in 4Q that was 100 gig and what you think in the guide percent of March quarter would look like at 100 gig?

[Raymond Wallin:]

Okay. So the answer is in the fourth quarter, Alex the number was 72%, but in the fourth quarter that 72% included our low speed transceiver asset revenues. And so in the first quarter that transaction closed on January 14. So we will only have revenue for those products until the January 14. So ultimately, I think we will be in the 80% to 85% range in the first quarter because we have to make that adjustment for those departed low speed products.

[Alex Henderson:]

Another question if I could, as I'm looking at the gross margins in the quarter as well as the guide for the March quarter. I understand that the yield issues are impacting revenues by $6 million, but what is it impacting the margins?

[Raymond Wallin:]

Well, our guidance guiding from 28% to 31% is about one to two margin points lower than it would have been if we didn't have the lower forecast. So the fact that we have – it's much less about lower yield, it's much more about the lower output. So with the midpoint of guidance it's 70%, the dominant factor is just the volume.

[Alex Henderson:]

Okay. As we look at the new products that you've been launching, is there a timeline for when those could materially impact the topline and contribute to growth?

[Raymond Wallin:]

Well, sure. Couple of different things. The products that we actually announced last year and designed in for example into a number of different modules DCO and ACO, certainly the DCO products would have a meaningful impact as the provincial networks ramp in China. Other products we mentioned in particular the Multicast Switch that's really a second half event. So we are shipping Multicast Switch in North America, but I referred specifically to our 8/16 configuration that is designed specifically with the China network in mind, so that would really expect to start in the third quarter and ramp pretty heavily by the fourth quarter, so all of the products that I spoke to can contribute to second half revenue. Now the newest one, the one that I said most recently announced is our new modulator, 64 gigabaud modulator. That product I would not expect to have significant revenue in 2017. I would expect that to be ramping late in the year, so contributing in 2018.

[Alex Henderson:]

Okay. If I could ask two more questions. Do you think it’s because of the late timing in 2017 on China ramp that causes a fairly solid splash into the first half of 2018 and that we continued growth in 2018 or do you think that this is kind of a one-time pop in the back half of the year and then we roll-off. And then second, do you think your margins as we get through all the yield issues and get the production ramp going and volumes up to speed will get up into the mid 30's or do you think we're stuck in this lower 30 range?

[Timothy Jenks:]

So on the first part of the question, Alex the – again the vernacular difference is slightly by carrier, but referring to the largest in China Mobile, let me refer to both of Phase 12 and Phase 13. Where Phase 12 is generally referring to increasing volumes going into the national backbone and that's decidedly a 2017 event. And if tenders are announced in April that ramping can actually be pretty significant by the third quarter. And then Phase 13 which is really much more about the provincial networks. That one continues to roll into 2018 for sure. That would be an extension on prior awards and that would continue to grow in 2018. Now with respect to margins, in selling our low speed products as we talked about on the last call, we expected that to contribute to one or two margin point increase in overall margin and we do expect that as our volume goes back to the level that it was and say the fourth quarter than we would expect margins to tick up by a couple of percentage points. So whether or not it gets to the mid 30's, I think it will go couple points above where it is right now.

[Alex Henderson:]

Thanks.

[Raymond Wallin:]

Hey Alex. Ray here. So if we kind of wrap all the absorption and yield problems together, we're probably talking somewhere two to four points of margin relative to our guidance.

[Alex Henderson:]

Okay. Thank you.

[Operator:]

Our next question comes from Troy Jensen with Piper Jaffray. Please go ahead.

[Troy Jensen:]

Hi there. Thanks for taking my question Tim and Ray. I guess maybe along when question here, but can you talk about where are the inventory problems specifically had a broad-based kind of very focused. In addition to that, we've heard that Huawei is shifting from using a discrete component architecture to make the line cards to using pluggable modules. I am just curious if you guys have lost share maybe in the new designs with pluggables are lower?

[Timothy Jenks:]

Yes. Okay. So generally speaking the national backbone is using a preponderance of line cards and the provincial will increase the use of pluggables. Certainly we have shipped – we're selling into the pluggable modules quite a bit both with – well certainly our largest customer Huawei is an important module customer and merchant module suppliers as well and so what we see as we see significant increases in shipments really in the fourth quarter and first quarter that really go to those modules. That said, we believe that there has not been a huge amount of shipment of those modules from the OEM's. So this is in fact part of the revenue out that we've given Troy in that. We had a fair amount of shipment in the fourth quarter and then going through the first half of the first quarter for the modules in particular for DCO modules. These are a couple of different products and then as tenders have not been announced, we have seen the customers put on the brakes and then we believe that they are still holding significant amount of inventory for those modules in stock. And so when the tenders are announced, we would expect that to open up, but until they're announced we would expect it to be a little bit slow and that is for reason. So we don't see it – we see it there's a bit of a mix change because the products that we sell on line cards and the products we sell in modules are in fact different products and different versions of lasers, different versions of receivers et cetera. But we know exactly what the volumes are and we know what the mix difference is. So in that sense, I think broadly speaking with respect to share over the current time period. We've seen increases in some products such as lasers, exceed the rate of growth of ports in the industry and receivers we had very strong share and there are some cases where we've gone for example from a sole supplier into one of two and there has been some modest share loss as the volumes have continued to either be flat or up. But overall net-net incoherent components, we think we’re actually either constant or gaining slightly in share overall.

[Troy Jensen:]

All right. And just one other question for me, obviously the Multicast Switch opportunity in China is going to get pushed out with this so assume, but can you just talked about where you are with Verizon in the Multicast opportunity?

[Timothy Jenks:]

So with Verizon – Verizon is deploying so-called CDC networks or [around the] select networks that use Multicast Switches and we're continuing to ship in the Verizon they have two principal suppliers of these products. We're really tied into the Cisco supply chain here and I think we're major supplier with strong demand going into that that deployment. We would see as the deployments in China start using the similar architecture for example in the China Mobile network, which we understand decision has been made that we understand that China Telecom is still considering it, but these are these would be important offers to the overall TAM that we're serving and the size of that business going forward.

[Troy Jensen:]

All right, understood. How about – maybe just a last one for Ray. Can you help us out with the tax rate and then other income that we should be thinking about this year?

[Raymond Wallin:]

This is based on what we know today and we're looking at about a 25% tax rate for the Company overall for 2017.

[Troy Jensen:]

Okay. Thank you, good luck guys.

[Raymond Wallin:]

Thanks Troy.

[Operator:]

We’ll take our next question from Paul Silverstein with Cowen and Company.

[Unidentified Analyst:]

Hi, this is [indiscernible] for Paul. A couple of questions, on the new Metro RFB, should we be assuming that you already qualified for those new pluggable modules or do you have to go through a cycle of qualification once those RFB were issued in your OEM customers know what they’ll be shipping in?

[Timothy Jenks:]

Are you referring to pluggable modules in China?

[Unidentified Analyst:]

Yes, somewhere you had mentioned that the Phase 12 opportunity is mostly going to be a pluggable module, so.

[Timothy Jenks:]

So actually I think I said that Phase 12 would be principally line cards going into backbone in Phase 13, but increase the amount of the pluggable modules that go into provincial networks and that's not a black and white statement. But the deployments that our national backbone have majority line cards, okay. We sell into both. We sell actually pretty strongly into both with receivers and lasers. And so we have been shipping since the fourth quarter into the module builds and we have seen a slowdown of that in the first quarter. We understand that to be inventory related, but we are continuing to sell both into the modules and the line cards and so it is not a future design win that we're waiting for. We are actually designed and we are a significant supplier and as the volume happens, we enjoy that business.

[Unidentified Analyst:]

Got it. One more question if I may. You also cited pricing pressure or pricing resets. How much of pricing was a factor in your guidance as well.

[Timothy Jenks:]

Well, pricing, the typical range of pricing is usually in the 10% to 15% range. I think we're in the low end of that this year, but it's in that neighborhood.

[Unidentified Analyst:]

Okay. And lastly if I could, inventory build how many months are we talking about?

[Raymond Wallin:]

I think the answer has to be in the range of one to three months. They certainly – I don't think they have a quarter's worth, but they have more than a month. So it's in that range. And it depends by customer also generally I'm referring to really our largest customers.

[Unidentified Analyst:]

Got it. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Hi, good afternoon.

[Timothy Jenks:]

Hi, Tim.

[Tim Savageaux:]

Mostly some follow-up questions on what we’ve been discussing thus far. First on the magnitude of the Q1 shortfall relative to say where you were in Q4 or you may have been expected to be in Q1, so obviously we have to account for the low speed transceiver, the traction of that business and so of that remaining delta kind of putting everything together that you mentioned in terms of the four factors. In my close and saying it's about 60% kind of China issues and 40% yield and seasonality if you will or. And I anticipate that you had pretty good visibility to whatever yield in the seasonality or pricing issues that you may have seen through the quarter as opposed to a more recent and unexpected development on the China front, is that a fair way to look at it as well?

[Timothy Jenks:]

As I think Ray indicated, the biggest impact here has been the relatively near-term decline in the China numbers. So yes, we had good knowledge of the impact obviously of the sales of low speed transceivers and we've good knowledge of the pricing. We've made a lot of progress on the yield and supply chain, but there's still work to do, but the largest impact is China and that's relatively recent and again that's also related to VMI in other words to very extent that that product has been shipped in VMI, but we have reasonable understanding from our customers what they expect to take in the quarter, it is relatively late in the quarter, and I hope that – does that address your question?

[Tim Savageaux:]

I think so, yes. And then on the module versus discrete front, I wondered if you can sort of discuss your decision to launch the DCO module kind of at all in the context of – sensibly you're selling into both internally produced DCO modules at the likes of the Huawei or also third-party or merchant DCOs. With your own platform here I guess kind of pursuing the same strategy with ACO, I wonder if you can discuss the dynamics of being in the module business yourself versus selling components into modules, the impacts on topline and whether that does indeed impact your relative share on the components side, which is you're likely to have higher content in your own stuff in third-party stuff or internally manufactured module and would that be the…?

[Timothy Jenks:]

We actually look at elements that are related to customers, elements that are related to markets, and elements that are related to performance. We tend to pursue those applications that are at the highest speed in the longest distance and our components reflect higher performance, we have the highest bandwidth receivers. We’ve announced 64 gigabaud modulator. We have announced the – we have ultra-narrow linewidth tunable lasers and so ultimately our products are very well suited for the longer reaches and for the highest data rates. This is sometimes serving different customers than existing suppliers and different markets. So in China, it’s often different customers than internal production of DCOs and in the West it's often different market. So less so in the Telecom space and more so in the DCI space, so we view this as extending our technology and reach into those applications that need the highest data rates and longest reaches.

[Tim Savageaux:]

Okay. I wanted to follow-up on that quickly and you could still deliver those component level advantages and other guys modules I guess, what I was trying to get to was these sort of business rational or being in the module market yourself versus trying to go best-in-class in sockets…

[Raymond Wallin:]

Well by going best-in-class also then you can be selling all of the components instead of one of the component, so that also matters.

[Tim Savageaux:]

Right, exactly. In some sense I mean the move to modules in general for a more component focus supplier is a bit of a headwind and I think you're trying to address that for your own module introductions on both DCO and ACO?

[Raymond Wallin:]

That's correct. And DCO and ACO particularly in the longer reach and higher performance and ultimately we see this across the entire industry essentially the market size expands with those new applications and we also see that we'll be selling modules on a continuous basis as you know some of the certain Chinese customers actually will be supplying their own modules and as a result we are supplying them with the components.

[Tim Savageaux:]

Right. Understood. Okay, final question for me. It has to do with the kind of sloop and growth and baseline type discussion before, but if you look at I think tell me if this is correct, appropriately look at the baseline organically as your topline minus the low speed transceiver business something in the range of $350 million. I would start – I think you’d indicated previously that 2017 would be a stronger year than 2016 even factoring in that headwind obviously with the Q1 guide I wouldn't expect that to be the case, but if you want to pick your milestone do you think the company can grow or stay flat with the previous year's revenue given the both exit from access or low speed transceivers or to what extent do you think you'll see growth off of that 350?

[Raymond Wallin:]

I think the answer to that Tim is really born in the whole discussion about what happens in China. We have expectations from customers where as I indicated it might be one-third and two-third, first half versus second half. And I should note that we did $411 million in 2016 included in that was low speed revenues which was $63 million. And so the products continuing and the Company would have revenue in 2016 they generated a contribution of $348 million of revenue in 2016. And so essentially the question you're asking is do we expect that we'll have growth on that product set of 20% or more really and I think that is really answered by the timing of the Chinese tenders and the magnitude of the Chinese tenders because that matters to our overall outlook pretty significantly. We see in the first quarter that our guidance is – our outlook is soft because of the fact that those tenders haven't happened yet by the same token I would expect that – if the tenders come out as expected or anticipated then I would expect a meaningful rebound. So those are the variables that we see.

[Tim Savageaux:]

Got it. Thanks.

[Operator:]

And we will take a follow-up question from Alex Henderson from Needham & Company. Please go ahead.

[Alex Henderson:]

Yes, just along the same lines, so that $63 million can you just play that across the four quarters just so that everybody has the same baseline? And why you are thinking about that? The other question was can you give us some sense of what your CapEx numbers are in the fourth quarter and what do you expected to be as we go over the course of the year?

[Timothy Jenks:]

Yes, so the CapEx I think in Ray’s comments, he said that the CapEx was total of $50 million and for 2016, and then for 2017 we would expect a lower number, but in the 8% to 10% range for quarter. Ray, do you want to talk about that?

[Raymond Wallin:]

Yes, I think you're probably looking at for 2017 right now on $30 million to $40 million range for CapEx. It was $51.7 million in 2016 and it was $21.7 million in the fourth quarter of 2016?

[Timothy Jenks:]

Okay, and then your first question was how can we spread the $63 million and the answer is, it was about $22 million in the first quarter followed by $16 million, followed by $13 million, followed by $13 million. Now those you would say add up to $64 million, but we'll just rounding here it’s approximately…

[Alex Henderson:]

And can you talk a little bit about the OpEx level that you’re expecting in 1Q, a little bit about display are you expecting R&D to step up, does G&A in sales and marketing change at all as a result of the divestiture. Can you give us some of the benchmarks around those Ray?

[Raymond Wallin:]

Sure for the March quarter, on a non-GAAP basis total operating expenses are being guided to about $29 million to $31 million. And so I think that would be – I think it relative to the exit of the low speed transceiver assets, but don’t see much change as a result of that because we continuing to operate it.

[Timothy Jenks:]

I really for two quarters.

[Raymond Wallin:]

For two quarters, so we're keeping the expenses there. So if you kind of look at the Q1, we were 23.4% OpEx and we – 24.2% OpEx and then when we get into 2017, it's going to be higher because of the lower revenue, but the dollars are as I said.

[Alex Henderson:]

Right, so is that $16 million or so in the R&D line? Is that what I should be thinking?

[Raymond Wallin:]

Let me take a quick look at this. Yes it could be right around $15.5 million to $16 million-ish.

[Alex Henderson:]

So conceptually as we're looking at producing a pretty solid loss here in the first quarter, are you planning on taking some actions to straighten the ship out and get the profitability back up to towards double-digits at some point or how long – what's the shape of the business model as we think about your objectives in terms of operating income?

[Timothy Jenks:]

Yes, so there are two things to think about there Alex, the first one is that as noted the big dependency here is Chinese tenders and the decrease in the topline is not a decrease in production. It's a decrease in recognized revenue because of shipments into VMI and so – and then the second thing is the manufacturing the low speed transceiver products, which takes six months. So there won't be meaningful decreases until those products that exit our plan, which is in six months.

[Alex Henderson:]

I'm a little confused by that, wouldn't that show up in the cost of goods sold line not in the OpEx line now?

[Timothy Jenks:]

Mostly, yes, mostly yes, but not entirely. There's some SG&A and there's some R&D that's just a small bit residual, which is assisting with it, but for the most part it is in costs of goods sold. But essentially we do view it as temporary in terms of the impact on revenue and so we would expect that I think you should expect that a normalized number in our income statement would be in place by the third quarter, it may not be in place by the second quarter because of the timing and the various things that we've just been talking about.

[Alex Henderson:]

Okay and I think, I follow-up that answer. So is it your thought that some point in the next couple three, four quarters that you'll be back in a 10% or is it going to a struggle to achieve double-digits?

[Raymond Wallin:]

Yes, I think Alex as we look at it today is very possible that we would be back there in the second half of 2017. We're looking at these events as relatively temporary and therefore don't see a need to adjust expenses that much to compensate for it.

[Timothy Jenks:]

I think the real question though is the timing of the tenders.

[Raymond Wallin:]

Yes.

[Timothy Jenks:]

The timing of the tenders and you have the volume that's one scenario, if you don't have the tenders in the volume you have another scenario.

[Raymond Wallin:]

You have another scenario.

[Timothy Jenks:]

So the baseline is that we have the tenders, we have the volume. But in all cases, I think you should expect us to be there in the second half.

[Alex Henderson:]

Just to round out the longer term question, are you still thinking 2018 is – China is a 20% plus growth volume year or you thinking that that's a lower number or something different?

[Raymond Wallin:]

In 2018, I have to say on the fact that we're providing the guidance for the first quarter that we're providing in the fact that we don't have the Phase 12 and Phase 13’s announced yet. My crystal ball on 2018 is a little bit foggy.

[Alex Henderson:]

Yes. I understand, but you do talk about the program?

[Raymond Wallin:]

Yes. Based on the forecast that we have from carriers there is continuing growth in the number of port deployments that are planned and so whether that is close to 20 or over 20 it's certainly approaching that range. So we're optimistic, but that remains to be seen in what the government announces and what the carriers announce. Now it is notable that in one of the opening speeches in the People's Congress discussion was that there were comments made about 2016 having underfunded telecom investment in China, so this is government comments and opening speeches. So with comments related to underfunding there is a motivation to do more to catch up to make sure that they deliver to their plans. So that gives us a cautious level of optimism, but again we have to see with the tenders.

[Alex Henderson:]

Very helpful. Thank you.

[Operator:]

Our next question, it comes from Dave Kang with B. Riley.

[David Kang:]

Thank you. Good afternoon. Just a clarification on the Huawei first, I thought you said Huawei was 53% customer, was it for fourth quarter or for the year?

[Raymond Wallin:]

That was for the fourth quarter.

[David Kang:]

Got it. Okay. And then just wanted to also clarify on your gross margin comments, so what is your normalized gross margin say $90 million to $100 million per quarter without the yield issue and post upon divestiture?

[Raymond Wallin:]

Dave, Ray here. So it would be 1% to 2% following the sale. However, if you normalize for these yield and other issues, as we said previously it's two to four points of impact from that, so just to aggregate those two.

[David Kang:]

Got it. And then I thought you talked about something of a supplier issue, can you elaborate what that is?

[Timothy Jenks:]

Well we have two things that we talked about it in December, but the first thing is we had some yield impact in one fab that if that continues into the first quarter. In the December call I talked about the fact that the throughput time and fabs can be multiple months and so corrective actions take time to play out. We are seeing our yield curves normalize and so we do know that there have been meaningful improvements in yields. The other thing is that we have significantly ramped certain products and that has put some constraints on component purchases that we do. So when we significantly ramp a product, we've managed to strain some of our component supplier, which is slowing our rate of growth for those products. I think that’s basically working though the system really started in the fourth quarter going on in the first quarter that’s working through the system right now. And generally speaking these impact a narrow range of products and principally laser products. And laser products or something with the increasing ports and the increasing applications from the fact that we were supplying into long-haul, long-haul then goes to three or four extra volume when you move to Metro, add on top of that the DCI, add on top of that the deployments in China that the demand overall for lasers of various types has been very, very strong. And so that does – that has put a little bit of constraint on some suppliers.

[David Kang:]

Okay. And just to be clear as it sounds like the yield issue is at the first quarter, the second quarter issue to be behind the company correct?

[Timothy Jenks:]

Well, I talked about it in the fourth quarter, so it's a fourth quarter and first quarter issue…

[David Kang:]

Right, right but the second quarter I mean it shouldn’t be an issue in the second quarter?

[Timothy Jenks:]

There maybe some residual in the second quarter, but it's not material over time.

[David Kang:]

Okay. Got it. And then just a couple more I guess I want to ask about Phase 12 tenders too, so in the previous call you talked about maybe the gap between tenders and the ramp is about one to two quarters. What do you think right now, is it more like one quarter or maybe two quarters?

[Timothy Jenks:]

So I don't have any better information now than I had then on terms of the timing because – two parts of it, so what I said last time, if we go back to 2015 it was four to five months after announcing the tenders that you see significant production volumes as a result of those tenders. That resulted in tenders announced in the second quarter of 2015 with quite a surge beginning in the fourth quarter of 2015. So that's our relevant example now. I think at this point in time based on where we sit and what we see, we see more available inventory right now that we saw then. So that lends itself to a shorter time being possible, but we sell a few products. We're not the entire supply chain. We're not the entire system, but just from where we sit, there is the possibility of a compressed timeframe, but I don't know that to be in the plan from the OEMs or the carriers.

[David Kang:]

Got it, thank you.

[Operator:]

Our next question comes from Richard Shannon with Craig-Hallum.

[Timothy Jenks:]

Hi, Richard.

[Richard Shannon:]

Hi, Tim and Ray. Thanks for taking my questions. I jumped on the call rather late, so [indiscernible] been on for about 20 minutes. So I might ask you questions that you've been covered already, but maybe just two from me. First of all, it sounds like you've had in terms of your first quarter guidance VMI with some of your larger customers has been an impact here and sounds like a lot of it's coming from China. Anyway that you could give us a sense of how much you expect from Huawei or from China coming the first quarter relative to the fourth quarter?

[Timothy Jenks:]

So on a percentage basis certainly we – Ray talked about the fact that in the fourth quarter we had very, very strong demand from Huawei. Huawei was 53% of total shipments in the fourth quarter and given what I've talked about inventory and slowdowns and delays, we do not expect to repeat of that performance and essentially as the drop is mostly in China. And China is mostly with the few customers. We would expect their respective percentages to be lower. For us, when we think about China, I tend to think about four customers in particular Huawei, Fiberhome, ZTE, and Alcatel Shanghai build part of Nokia. And in the current situation, we see the highest vendor managed inventory levels are really related to the first two and so to an extent those are the biggest impacts.

[Richard Shannon:]

Okay.

[Timothy Jenks:]

Just to hit it on, on your question, no question that Huawei to this impact because Huawei is having the revenue.

[Richard Shannon:]

Right. Okay. And maybe Tim, I’ll ask a question maybe in a different way, which is you look at your first quarter revenues here. How would you characterize your gross either sequentially or maybe year-on-year or maybe is a better number to look at excluding China?

[Timothy Jenks:]

Well, I think for the overall year, we see the non-China business is running very much on plan. It's only the China business that has a lower impact on the first quarter. Now the seasonality that we see every year, we do see seasonality, the seasonality is not just a China impact because of price negotiations in the fourth quarter and the fact that the production cycle in the first quarter is for us where we have a 12-week quarter because of China New Year celebration if you will, that factory shutdown for a week. Those things are normal, but essentially our other customers are generally unplanned and a little impact. Really no impact on can.

[Richard Shannon:]

Okay. I’ll take all of my – rest of my questions offline. Thanks for the time guys.

[Timothy Jenks:]

You’re welcome. End of Q&A

[Operator:]

It appears there are no further questions at this time. Mr. Tim Jenks, I’d like to turn the conference over to you for any additional or closing remarks.

[Timothy Jenks:]

Thank you very much Denise. I appreciate the time and interest of everyone this afternoon and I hope you will tune into our next quarter's call. Have a good evening.

[Operator:]

That does conclude today's presentation. Ladies and gentlemen, thank you for your participation. You may now disconnect.