NeoPhotonics Corporation
Q3 2013 Earnings Call Transcript

Published: 10 Apr 2014

[Operator:]

Welcome to the NeoPhotonics conference call to discuss the Company’s restated first and second quarter 2013 financial results and third quarter 2013 financial results, plus the company’s outlook for the fourth quarter of 2013 and first quarter of 2014. 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 expressed written consent of NeoPhotonics is prohibited. You may listen to a webcast replay of this call by visiting the 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 restated first and second quarter 2013 financial results and third quarter 2013 financial results. With me today are Tim Jenks, President and CEO, and Ray Wallin, Chief Financial Officer. Tim will begin with a review of the third quarter, followed by Ray who will provide a financial update including results for the third quarter of 2013 the outlooks for the fourth quarter of 2013 and the first quarter of 2014. Comparisons to prior quarters will be unaudited restated Q1 and Q2 results for 2013. Tim will then conclude with a discussion of trends in the industry and growth opportunities for the company, before opening the call for questions. We will begin today’s call with the legal disclaimers and safe harbor statement. All material contained in the webcast is the sole property and copyright of NeoPhotonics Corporation, with all rights reserved. Certain statements in this conference call, which are not historical facts, may be considered forward-looking statements that involve risk and uncertainties. Forward-looking statements include statements regarding future business results, future levels of sales and profitability, subsequent events, product and technology development, future customer demand, inventory levels and economic and industry projections. Various factors could cause actual results to differ materially from what is set forth in such forward-looking statements. Some of the factors that could affect the Company’s results have been set forth in our press release dated April 9, 2014 and will also be described in detail in the Company’s SEC filings, including but not limited to, our Annual Report on Form 10-K for the year ended December 31, 2012 and revised Quarterly Reports on Forms 10-Q/A for Q1 and Q2 of 2013 and Form 10-Q for Q3 of 2013, when filed later today. Listeners who do not have a copy of our third quarter 2013 earnings press release may obtain a copy of the press release by visiting the Company’s web site. Now, I will turn the call over to CEO, Tim Jenks.

[Timothy S. Jenks:]

Thank you for joining us today. On November 13, 2013 we announced that we would be delayed in filing our Form 10-Q and we hosted a Q3 update call to provide the information we could at that time. We have completed the necessary work to restate our Q1 and Q2of 2013 and at this time we are providing results for the third quarter of 2013. Before I discuss our business results, I want to call your attention to recent management and board additions. In February we announced that Dr. Rajiv Ramaswami joined our Board of Directors. Dr. Ramaswami serves as Broadcom's Executive Vice President and General Manager of the Infrastructure & Networking Group. And he was previously Vice President and General Manager of the Cloud Services and Switching Technology Group at Cisco Systems. We believe that he will be a strong addition to our Board of Directors. Also, I want to note that Ray Wallin joined NeoPhotonics as Senior Vice President and Chief Financial Officer in December 2013, succeeding our former interim CFO, Cal Hoagland. Ray comes to NeoPhotonics with more than 30 years of experience in the high technology, industry most recently as Chief Financial Officer of Micrel, Incorporated. Ray has held senior financial management positions at several high growth semiconductor manufacturing companies and has extensive experience with both public and private companies including proven expertise in building a sound financial infrastructure within these companies. Cal Hoagland has remained with NeoPhotonics as a consultant through our transition and restatement process, as he will continue with us until we file our annual report on Form 10-K with the Securities and Exchange Commission. Now, moving onto our business and financial results, beginning with our third quarter of 2013. Our ongoing business activities have remained strong. We have made solid progress in the last twelve months leading up to our September quarter. Our third quarter of 2013reflected the highest revenue in the company’s history at $76.8 million. We achieved a Non-GAAP gross margin of 27.5% and we achieved a Non-GAAPEPS loss of 10 cents per diluted share. Included in the third quarter results are additional G&A expenses required due to the work we have performed on restatements. These details will be discussed later in this call. Our business continues to be driven by our 100G products including those used in telecom Coherent networks, plus contributions from NeoPhotonics Semiconductor, notably also for 100G products. Revenue from our high speed products, which is predominantly 100G, was$28.4 million or 37% of total revenue in the third quarter of 2013, which is an increase of 31%overthe third quarter of 2012. Revenue attributable to our “Access” product group was approximately 23% of our total revenue; which was up $2.8million sequentially in dollar terms, reflecting normal seasonal strength in our third quarter. It is worth noting that for the nine months ending September 30, our Access product group is at $48.2 million in revenue, which is down 15.4% from the corresponding nine month period one year earlier. While we have introduced several advancements, notably in OLT modules, over the past few years, the range of PON deployments globally is relatively steady. Combining steady volumes with decreasing prices and new entrants in the PON business, especially in China, makes us less optimistic on the prospects for this product group’s growth going forward. Across our 100G portfolio we have multiple new products in the pipeline that will go to production in 2014. These include our micro narrow line-width tunable laser for Coherent systems, two new Integrated Coherent Receivers, or ICRs, including a compact one for higher port densities and one for high dynamic range, plus a new CFP2 100G transceiver module product that incorporates numerous internally produced components. We believe that each of these products will make important contributions to our strength in 100G. At the recent OFC trade show held in San Francisco we introduced a new Integrated Coherent Transmitter (or ICT) that is designed to reduce the size of the transmitter optics for a 100G coherent transport link by a factor of four compared to current approaches. The device combines a narrow line-width tunable laser with a dual polarization QPSK modulator in a single compact package. The modulator section utilizes PIC Integration to combine multiple elements onto a single chip and consists of four indium phosphide based Mach-Zehnder modulators plus multiple other important functionalities. This is a key new product addition as it completes our suite of leading 100G solutions while expanding our Total Addressable Market with the addition of state-of-the-art transmitter and modulator solutions. I will now turn the call over to Ray Wallin, our Chief Financial Officer, who will provide a financial update including financial results for the third quarter of 2013 and the outlooks for the fourth quarter of 2013 and the first quarter of 2014.

[Clyde Raymond Wallin:]

Thank you, Tim, and good afternoon. First of all, let me say that I am very pleased to be part of the NeoPhotonics team as Chief Financial Officer. I believe that this is an exciting time at NeoPhotonics as the company is well positioned to maintain a leadership position in the accelerating global adoption of 100G. My near-term goals are to get the company current with its SEC reporting requirements, to strengthen and grow our team by hiring additional permanent financial professionals and to significantly improve our internal financial and business controls to remediate our material weaknesses and move towards achieving profitability. In addition to me joining the Company in December 2013, we previously added a Vice President and Worldwide Controller, and recently added a Senior Worldwide Operations Controller. We are currently supplementing this team with interim financial professionals as we continue to build up our finance organization. As was discussed on our Q3 2013 business update call in November 2013, the Company delayed filing its September 30, 2013 Form 10-Q to address a purchase price accounting issue related to our acquisition of NeoPhotonics Semiconductor in Japan duringQ1 2013 and to allow our previously announced new auditor, Deloitte and Touche, to review our financials for each of Q1, Q2 and Q3 2013. In our November call, we noted we would be restating our Q1 and Q2 2013 financial statements for a matter related to our Q1 2013 acquisition of NeoPhotonics Semiconductor in Japan. Concurrently, we reflected measurement period adjustments to the purchase price allocation which is reflected in the revised Q1 and Q2 filings. Separate from our restatement work and as part of the SEC’s periodic review process, we received a comment letter from the SEC regarding our 2012 Form 10-K relating to the Rusnano private placement that was completed in April 2012. As a result of the SEC comments, we have enhanced our disclosures in this area. The net changes to our financials for Q1 and Q2 are complete, and are shown in tables within our amended 10-Qs which will be filed with the SEC today. Let me note the adjustments for the P&L

[Timothy S. Jenks:]

Thank you, Ray. We continue to work on increasing our content per port in 100G systems, and we believe that our percent of revenue in the 100G business is one of the highest in the market for vendors of optical modules and subsystems. Notably, recent tender awards in China are driving further demand growth for these products, which increases our confidence, at least through Q1 and Q2 of 2014. In addition to our 100G products, our 10G transceivers continued to show strong year-on-year growth, although down in the third quarter from a record second quarter. Our backlog for these products remains strong through the current period. Many of our 10G products are used in wireless backhaul and OTN networks in China and elsewhere, and we expect to see continued volume growth for 10G products in 2014 as well. Now I would like to talk about demand conditions. China historically has been our largest market, and Huawei Technologies our largest customer. The China market in the first three quarters of 2013was slower than previously expected; this continued in the fourth quarter as only late in the fourth quarter did we see an increasing backlog for wire-line deployments. Moving into the first quarter we have seen further growth in our backlog in China, reflecting increases in these important wire-line deployments. Per our guidance, while we see strength in 1Qof 2014 we are not seeing a strong uptick in revenue from the backlog; but we do expect it to be beneficial to our top line while creating more leverage in our operating model in Q2 of 2014. We saw strong contributions to revenue from our NeoPhotonics Semiconductor business in 2013, reflecting to some extent the deployment rate of 100G modules which utilize our components. While this has been a strong contributor in 2013, we expect that this will flatten or even decline slightly in 2014,due to current actions to move from the CFP to the CFP2 form factor; that is, until such time as the industry’s demand for CFP2 modules picks up following current sampling and qualification actions. We expect to be supplying lasers and drivers to several manufacturers of CFP2 modules, and this is very positive. However, in the next few quarters we may see some system manufacturers slow their consumption of CFPs as they wait for CFP2 modules to be available in volume. Now I would like to talk about several key industry trends that we expect to impact NeoPhotonics’ business going forward. First, as I noted in our last business update, 100G Coherent system shipments to date are system platforms designed for long haul transport though some have been deployed in Metro environments. Based on customer conversations we expect we will begin to see systems specifically designed for Metro deployments begin to ship in the latter part of 2014 and early 2015. This is important, as Metro deployments could result in 3X volume increases versus long haul over the following two years. We believe we are well positioned for this growth in terms of product offerings, design wins and manufacturing capacity, as well as our having important next-generation product developments underway that focus on 100G and beyond. Second, we see the broad expansion of cloud computing with massively scaled datacenters with related infrastructure updates as beneficial to NeoPhotonics’ business over time, as we supply key elements of high-speed connections within and between datacenters. 100G links are being deployed as high-bandwidth connections between Internet routers within datacenters and central offices within telecom transport networks. 100G, which includes both our optical components and transceiver products, is still a relatively small portion of the datacom market, but it is the fastest-growing portion and will take share over time as enterprise computing and consumer Internet applications continue to consolidate into large cloud-scale datacenters requiring higher bandwidth connections. Third, the rollout of next-generation 4G LTE and 100G OTN networks, particularly in China, is driving demand for optical transceivers for backhaul links. This is currently the main market driver for 10G single mode transceiver volume growth. We are leveraged to this trend with our 10G 10km and 40km single mode transceivers, for which we are a market leader, and we expect to see continued growth in these applications and products over time. Now I would like to talk about our vision for the next two years. We expect that 100G transmission technology, which is a basis for future network design, will drive multi-year investment cycles for those companies associated with this emerging paradigm. Our product portfolio addresses these high speed requirements in both carrier telecom and enterprise/datacenter markets, and we expect to continue to be a strong player as the market expands over time. We view 2014 as a transformative year for NeoPhotonics. We are investing heavily in new product platforms, including our advances in Coherent receivers and high speed switching that I have talked about on prior calls, plus advances to Coherent transmission approaches including our “micro ITLA”, or ultra-small form factor integrated tunable laser assembly, which we announced in 2013. 100G will continue to increase in volume and overall share of our business, and this is directly beneficial to NeoPhotonics as we are a leader in 100G optical solutions. In 2011 and in 2013 we completed two M&A transactions which together significantly enhanced our capability to develop and deploy advanced high speed solutions. These businesses are now fully integrated in NeoPhotonics and are strong contributors to our ongoing revenue streams. At the same time we are gradually phasing out certain products whose growth and profitability prospects are limited. As a result of growth in 2014 and 2015 from 100G,and with the culling of lower margin products and a focus on controlling overall costs, we expect to be in a position to increase our level of profitability and additionally increase our growth rate in 2015. In terms of key milestones over the next year you should expect to see

[Operator:]

Thank you. (Operator Instructions) We’ll go first to Simon Leopold with Raymond James.

[Simon Leopold:]

Great, thanks a lot. A couple of things, I wanted to try to follow up on. one is, just in your opening remarks, you gave us some of the numbers on the Speed and Agility. I didn’t get those down. if you could just repeat the metrics on sales and growth trends at the beginning of the prepared remarks?

[Clyde Raymond Wallin:]

Certainly, thanks for the question, Simon. In the remarks, what I indicated is that let’s see revenue to the access products was approximately 23% of the total, this was up $2.8 million. Revenue from high-speed products was $28.4 million or a 30% of total revenue that was up 31% and let’s see…

[Simon Leopold:]

I think it was right before the comment on access?

[Clyde Raymond Wallin:]

Well, the Speed and Agility was 69% of the total.

[Simon Leopold:]

69%. Okay. And then getting to the timing in terms of getting in compliance, a couple of questions out of that one is, the March quarters I guess essentially complete. I’m just wondering do you plan, intend, hope to have another update call in the not-too-distant future to give us a greater level of detail on the March quarter. Can we get some estimate of timing of when we’d be able to get that detail? And then related to that, if I’m reading the press release correctly, it sounds like, it’s saying we would expect to get a 10-K filing before October 2014. I’m wondering if you could give us a – maybe a tighter window of when we might be able to get a 10-K.

[Timothy S. Jenks:]

Yes. Thanks, Simon. this is Tim. So we have been doing a lot of work around obviously, our Q1 and Q2 and Q3, but also our Q4 and the K and 1Q. So these have all been going on and there is – I think Ray ought to comment on the particular details there, but you should expect that we’re working on all of those in parallel with the intent of getting amount as soon as we can.

[Clyde Raymond Wallin:]

Yes.

[Timothy S. Jenks:]

Ray?

[Clyde Raymond Wallin:]

So over the next several weeks, we expect to finalize our fourth quarter numbers, and then we’ll file our K certainly thereafter and finalize those, we’re in the final stages of completing the audit with Deloitte & Touche. And so as that work is completed, we’ll continue preparing the K. So over the next several weeks, we will hope to get that filed with the SEC. And then from there, we’ll turn our attention to completing the Q1 numbers and they should follow shortly thereafter there.

[Simon Leopold:]

So should we think about that as being within the next 90 days?

[Clyde Raymond Wallin:]

Absolutely, yes.

[Simon Leopold:]

Okay.

[Clyde Raymond Wallin:]

Yes. And 90 days of more than generous timeframe. And I was thinking the next 30 to 45 days.

[Simon Leopold:]

Okay. That’s exactly the kind of answer I’m looking for at that level of details, that’s very helpful to understand that. And then Tim, since you last kind of ramp through the trends in the market for 100-g, it’s – I’m not sure, if I’m hearing it correctly, but it’s my sense that things have maybe flit out a little bit from how you felt, let’s say, six months ago in terms of 100-g where the metro ramp you’re looking talking about late 2014 or early 2015 is a driver. Can you sort of compare or contrast your view of that marketplace today versus how you felt six months ago?

[Clyde Raymond Wallin:]

How about if I comment, how I felt four months ago in November, I think the answer Simon is, yes. I feel the metro market has flit a bit to the right. Let me say first about 100-gig overall. 100-gig overall is fairly strong. In particular, in China, we’ve seen a fair amount of growth in the backlog and we expect that to be as I’ve made in my prepared comments, we expect to see benefit from that in the second quarter. we did see some growth in the first quarter, but mostly reflecting in the backlog. So we would expect the second and third quarter to benefit globally, but in particular, in China for a 100-gig. Specifically, in the metro market, in November, I commented on that and we thought that that was going to be largely a second half meaning third quarter beginning. We probably see that out one, two maybe two quarters. I think it will still start in the second half in the third quarter and fourth quarter, but the ramp maybe a bit slower. And then ramp up going into 2015.

[Simon Leopold:]

And then on the access business, you sound a little bit more cautious in tone sort of similar thoughts you can offer in terms of how your view on that business for 2014 has evolved?

[Clyde Raymond Wallin:]

Well, there are two parts of that. That business continues to be a strong volume business. but as I noted in my comments, strong volumes that are relatively steady, if prices decline in their new entrance, then we’re not optimistic on the growth prospects for that business. It’s a steady business, but it’s more competitive. And so we have to be therefore more selective on the things that we do. And I would expect that theme to be consistent through 2014.

[Simon Leopold:]

But do you think revenue was down in 2014 versus 2013 for the access business?

[Clyde Raymond Wallin:]

I think it may be down a little bit. What I noted in the comments is that actually over the first nine months of 2014, we saw a decline by just about 16%. And there aren’t large increases in the deployment volumes. And therefore I would expect comparing apples-to-apples; we would see some decline in total revenue for the year probably declines in that single-digit percent.

[Simon Leopold:]

Great, thank you for the answers.

[Clyde Raymond Wallin:]

You bet. Thanks, Simon.

[Operator:]

(Operator Instructions) We’ll go next to Richard Shannon with Craig-Hallum.

[Richard Shannon:]

Good afternoon Tim, Ray, how are you doing?

[Timothy S. Jenks:]

Good, Richard. thank you.

[Clyde Raymond Wallin:]

Good.

[Richard Shannon:]

Great. Good to be here, good to be able to talk a few finally. I guess just a few questions from me hope to see here. You talked a new ICR receiver product at OFC and as I recall from our conversation significantly higher ASP there. Can you refresh our memory on how much content that does add to you and then when could we start to see the benefit from that?

[Timothy S. Jenks:]

Yes. Actually, just for clarification. We had announced two different ICR products, and in my prepared comments, I talked about both of them. But the more recent addition was actually not a new ICR, but it was a new transmitter. And the transmitter what we call ICT, the transmitter includes the combination of both tunable laser functionality and modulator functionality. And therefore, on a competitive basis, it’s a new product for us entering the transmission side and adding the modulator functionality. And so the total transmitter is a higher ASP than a tunable laser alone. And so that we would expect those products to have a little impact in the first half of this year. Generally speaking, these products take from the time of announcement there often 12 months to see, some level of material impact on the revenue increase. So while we’ll be shipping those in the latter half of the year, I would expect to see their benefit to be more in early 2015, first quarter 2015.

[Richard Shannon:]

Okay, perfect. Another question, Tim, in your prepared remarks, you had alluded to a little bit more competition on the 100-gig side, presumably more – presumably on the lasers. Curious about what the impact will be, I don’t know if you can quantify in terms of maybe share, specifically products that have your lasers in it. But also as you start ramping up metro haul, what kind of initial share might you see in that metro space as well and any comments you can share on that would be great?

[Timothy S. Jenks:]

Just for clarity. I think you said tunable lasers, do you mean tunable lasers or do you mean 100-gig lasers or do you want me to comment on both?

[Richard Shannon:]

100-gig. 100-gig lasers specifically.

[Timothy S. Jenks:]

Okay. So generally speaking, there are two approaches for 100-gig lasers that the lasers themselves are not actually native 100-gig, but you can combine four lanes of 25-gig or 10 lanes of 10-gig. and so what we see, as we see modules client side modules that are at a 100-gig, can be 100-gig by the 4x25 approach or the 10x10 approach. And essentially, the form factor here is changing rather than the competitive environment. So that’s the form factor changing from the current CFP form factor to the newer next generation CFP2. We see that line cards from customers that use the newer CFP2 will be rolling out midyear. So, between now and mid-2014, so between now and then, we’re not expecting any significant rise in the CFP2, the current generation rather we expect that as the line cards go into production in the second half, then we’ll see a pick-up, because of the CFP2.

[Richard Shannon:]

Okay, great. And I guess just one last question maybe to follow up on from, I think was Simon earlier. Are you prepared to offer any thoughts on what kind of overall growth, sales growth you might see this year and could we enter into non-GAAP profitability in the second half of the year at any point?

[Timothy S. Jenks:]

Well, let’s see an answer to your first question, I’m not yet prepared to say what the total growth will be. We have limited visibility on the second half. We do have strong backlog growth. we are looking for strong second quarter. We do expect the second and third quarter notably in China to be strong. for the full year, we don’t yet know, as Ray indicated though over next several weeks will probably have two more opportunities stock and conference calls and we’ll know more about that during that time. I think that profitability, the numbers that Ray reported we have – we’ve been spending about $1 million a quarter extra on our accounting work over the last couple of quarters. And I think those are not necessarily continuing expenses, we don’t expect them to be. It’s possible therefore with the higher volumes for the second and third quarter that we could reach potentially profitability. but I would say on a full-year basis, I wouldn’t expect that this year, maybe we’ll see it a quarter, but we won’t see it for the year that would – I’d be having look toward next year.

[Richard Shannon:]

Okay, that is fair. I think that’s all from me. I think I’ll jump out of line and requeue. But thank you very much guys.

[Timothy S. Jenks:]

Thank you, Richard.

[Operator:]

(Operator Instructions) And we’ll hear now from Dave Kang with B. Riley.

[Dave Kang:]

Yes, thank you. Good afternoon. So you talked about some kind of a little production initially occurred. is that ITLA, and can you quantify the situation and where are we now?

[Timothy S. Jenks:]

So I talked about production issues in November, but not today. We did in the first half of 2013, we were ramping certain 100-gig modules, and we had some yield issues that was thought several months ago. So that’s not an issue, I also Ray did note in his comments that we had transferred our tunable laser products in-house from a CM2 in-house and that was completed during the fourth quarter.

[Dave Kang:]

Okay, all right. and then it sounds like that you are adding capacity and can you just talk about the current capacity situation, I mean do you have ample capacity to meet growing demands and for which particular products are you ramping capacity?

[Timothy S. Jenks:]

Well, the focus of our capacity additions not surprisingly is 100-gig space. These, broadly speaking, include both receivers and transmitters and tunable lasers for the 100-gig coherent systems, as well as our capacity for the modules, the CFP and CFP2 type modules and their components. So we have been adding capacity, we’re…

[Dave Kang:]

Okay.

[Timothy S. Jenks:]

potentially, we’re doing our best as stay ahead of demand and have available capacity for continued expansion.

[Dave Kang:]

Got it. And can you just talk about the price adjustments you guys may include, was it better or worse or kind of in line?

[Timothy S. Jenks:]

Typically in last couple of years, we’ve talked about price decreases on an annual basis of the 10% to 15% on an annual basis. You could call that 3% or 4% on a quarterly basis, but it really happens mostly in the fourth quarter. We were in that range yet again, so not much difference than normal.

[Dave Kang:]

Okay. And lastly, you mentioned there with our growing backlog, especially with China’s strength being used. Do you expect second quarter, as well as third quarter to be strong? so I was wondering if you can provide any color I mean, excuse me, should we expect maybe a stronger seasonality in second quarter than normal?

[Timothy S. Jenks:]

I would say that in general, we see the first quarter to be our seasonal low and Ray made some comments about that. I would expect that to be the case this year. We’ve provided revenue guidance for the first quarter and we would expect to have a strong second quarter as an up-tick versus first quarter. I would state however, in comparison to last year, 2013. In 2013, one quarter, we did not have the revenue of NeoPhotonics Semiconductor and in second quarter, we did. So even though we’ll have a strong up-tick in our second quarter versus our first quarter, if you just look directly versus last year, it might not appear to be as large, but…

[Dave Kang:]

But if you can normalize that if you strip out that portion?

[Timothy S. Jenks:]

And I would expect it to be a strong, a normal increase maybe slightly above normal, because of that.

[Dave Kang:]

Got it.

[Timothy S. Jenks:]

The strength of the backlog.

[Dave Kang:]

Got it, all right. Thank you.

[Timothy S. Jenks:]

Thanks, Dave.

[Operator:]

And we have no further questions at this time. Mr. Jenks, I’ll turn things back to you for closing remarks.

[Timothy S. Jenks:]

Okay, thank you, Kellianne. In closing I would like to thank everyone for taking time to join our call today. I would also like to thank our shareholders for their patience while we completed the restatement of our Q1 and Q2 2013 financials and then finalized our Q3 2013 financials. We look forward to updating you on our progress on our next quarterly call. Have a good day. Bye-bye.

[Operator:]

And that will conclude today’s conference. again, thank you all for joining us.