NeoPhotonics Corporation
Q4 2013 Earnings Call Transcript

Published: 20 May 2014

[Operator:]

Welcome to the NeoPhotonics 2013 Fourth Quarter and Year End 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 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 operating results for the fourth quarter and full year of 2013 as well as the company’s outlook for the first and second quarters of 2014. With me today are Tim Jenks, President and CEO, and Ray Wallin, Chief Financial Officer. Tim will begin with a review of the fourth quarter, followed by Ray who will provide a financial update including results for the fourth quarter and full year of 2013 and the outlook for the first and second quarters of 2014. Tim will then conclude with a discussion of trends in the industry and growth opportunities for the company, before opening the call for questions. 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 May 19, 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, 2013, which we expect to file by the end of May 2014. Listeners who do not have a copy of our fourth 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.

[Tim Jenks:]

Thank you for joining us today. Our ongoing business activities have remained strong with solid progress in the twelve months leading up to our December quarter as we reached record annual revenue of $282.2 million, which was 15% growth over 2012. Our fourth quarter of 2013 was the highest fourth quarter revenue in the company’s history at $74.4 million, which is within our revised range of $74 million to $75 million. This is down $2.4 million from the prior quarter and up $12.4 million, or 20%, from the same period in 2012. We achieved a Non-GAAP gross margin of 27.5% with a Non-GAAP EPS loss of 6 cents per diluted share. Included in the fourth quarter results are additional G&A expenses required due to the work we have performed to strengthen our controls, restate our first and second quarters of 2013 and complete our year-end 2013 audit. Our business continues to be driven by our 100G products including those used in telecom Coherent networks, plus strength in 10G deployments supporting LTE wireless, notably in China, plus general FTTH Access market strength. Fourth quarter revenue attributable to our “Speed and Agility” product group was approximately 69% of our total revenue, and was down $1.4 million sequentially in dollar terms. Of this, revenue from our high speed products, i.e. 100G and some 40G, was $30.7 million or 41% of total revenue in the fourth quarter of 2013, which is an increase of 63% over the fourth quarter of 2012. Our “Access” product group was approximately 23% of our total revenue; which was down $0.6 million sequentially in dollar terms. For the full year, our Speed and Agility products were also 69% of total revenue, of which high speed products were 39% of total revenue, and our Access product group was again 23% of total revenue for the full year. On a year-over-year basis our high speed products were up 69% over 2012 while our Access products were down 13% verses 2012. I will now turn the call over to Ray Wallin, our Chief Financial Officer, who will provide our financial update.

[Ray Wallin:]

Thank you, Tim, and good afternoon. I will review the financial results for the fourth quarter ended December 31, 2013, the full year of 2013, and conclude with our outlook for the first and second quarters of 2014. For the fourth quarter of 2013, revenue was $74.4 million, within our outlook range, a decrease of approximately 3% from the third quarter of 2013. As Tim noted, this was well within our revised projections and the highest fourth quarter revenue in our history. We had four 10% or greater customers in the fourth quarter of 2013

[Tim Jenks:]

Thank you, Ray. We continue to work on increasing our content per port in 100G systems, and we believe the combined growth of the market for Coherent networks and the use of high speed modules on the client side can fuel NeoPhotonics growth in the quarters and years ahead. Moreover we have seen strong design win activity related to products we have recently introduced. These include

[Operator:]

Thank you. (Operator Instructions). We will take our first question from Alex Henderson with Needham & Company.

[Alex Henderson:]

Thanks. Can you start off with the comment around normalized costs associated with G&A, what would the amount of costs associated with the legal/accounting variance to get the accounting in order be in the quarter that we just reported and as well as in the guidance, how much are we absorbing here?

[Ray Wallin:]

This is Ray. So, we are absorbing right now about a 1 million to a 1.5 million per quarter.

[Alex Henderson:]

Is that in both the fourth quarter and in the first quarter?

[Ray Wallin:]

Yes.

[Alex Henderson:]

Okay, great, thanks. Second question, go ahead.

[Ray Wallin:]

That’s versus the third quarter and the one quarter last year actually, so yes, go ahead.

[Alex Henderson:]

So, just to be clear, once you have completed the auditing process and get back to normal levels, 1 million to 1.5 million falls out?

[Ray Wallin:]

Well, it won’t be the total amount because we are doing that in actually consulting expense, the additional audit fees will fall out but at the same time we are enhancing our finance organization and adding headcount. So that the level of G&A will be higher than it was. It looks a year ago but it will be lower than it has been in the last two or three quarters.

[Alex Henderson:]

So, normal growth of G&A costs but you drop out this expense but you have got the normal growth on it.

[Ray Wallin:]

That’s correct but adding some additional resource and as a permanent resource at the company because we are kind of understaffed and now we are bringing the staffing up to the required levels.

[Alex Henderson:]

So, second question, it sounds like the ITLA market has been extremely robust EMCORE at a 1.7 book-to-bill on their ITLA business in the most recent quarter. It sounds like you are seeing a sharp acceleration there, one, are you add capacity on those products? And two, how much capacity do you expect to be adding over the next several quarters in those product lines?

[Tim Jenks:]

Well, let’s see in the ITLA product line, we, in the fourth quarter we did bring a lot of the production of our ITLA in-house and in the process of doing that we actually expanded that capacity a bit. So, we are not fully at capacity, so we can continue to grow that business quite comfortably. You commented on the book-to-bill with the competitor and we saw a very similar trends in the recent quarter for not just ITLA but for other 100 gig products too. So, we would expect it to be strong going forward and I think we are pretty well positioned to respond favorably to demand.

[Alex Henderson:]

Okay. And then the gross margins are obviously the guidance here is quite low on the gross margins relatively to where you need to be. How rapidly do you think you can get that back up into the 29% to 30% plus vicinity?

[Tim Jenks:]

Well, let me, Alex, let me just comment on gross margins and then may be Ray will like to comment. But for the fourth quarter to the first quarter, the ASP decline is really the largest impact and most all of the explanation. We do have reasonably strong demand in the access space, so product mix affects it a bit, real strong in 100 gig, little bit of softness in agility products i.e. those that are not in the high speed category. But that really is a reason for our guiding in the first quarter and then Ray do you want to comment about going forward?

[Ray Wallin:]

Yes, so as Tim mentioned, we normally see the impact on gross margin from the price negotiations in the first quarter and that was, what you normally see over the course of the year, is expanding gross margin as we achieve cost reductions to make-up for those price decline. What we normally see is 1 to 2 point expansion each quarter as we go forward here, so we would be expecting to see that normal pattern in 2014. And as far as the Q2 guidance goes, it model in a range of 20% to 25%, so had a put it into midpoint there 22.5%. We haven’t actually finally closed the books for Q1 yet, so we are being little bit conservative about gross margin forecast there as well.

[Alex Henderson:]

Doesn’t sound like you are expecting at the low end of that band, any improvement in gross margin sequentially at 20% to 20% in the June guidance. And the question really is when do you get back to the 29% plus vicinity you need in order to drive meaningful profitability, is that going to happen over the course of the year or is it couple of years out, I mean what is the process that gets you there?

[Ray Wallin:]

Well, if you take my guidance of couple of points a quarter, you are very close to being there in the Q4 timeframe.

[Alex Henderson:]

Okay. I will seed the floor. Thanks.

[Operator:]

We’ll take our next question from Simon Leopold from Raymond James.

[Simon Leopold:]

Great, thank you. Sorry for there is some background noise. I am actually in a hotel lobby so could you play here everything perfectly so quick clarification fist. In the prepared remarks, you’ve mentioned increasing G&A expenses and I think you’ve said in 2Q and 3Q, I wasn’t sure if I got that down correctly, you just elaborate on that and clarify?

[Ray Wallin:]

So, you can see we’re still in the process of completing our compliance activity. During the conference call today on the fourth quarter and expect to file our K shortly certainly by the end of month, but we still have the work to complete around the compliance activities for Q1 and once we get that done then we should start seeing a reduction in our abnormal operating expenses. So we feel little bit of in Q3 but it mostly will be in Q1 and Q2 that’s little bit in Q2, but we’re hiring additional finance people and as we ramp those people up as well so you’ll see our G&A cost will be higher this year as oppose to the prior year as well. And in Q4 its low and in Q1 and Q2 it’s higher. So that’s how the way to look at, so I guess net-net time to get Q3 we should start seeing some rejection there.

[Tim Jenks:]

Yes, I think you meant Q4 rather Q3 right. The Q4 is a little bit light and that was the timing of the audit fees, Q1 and Q2 are little bit heavier and then we would be at the end of the higher run rate.

[Ray Wallin:]

And then starting to come down in Q3, Q4 by this year.

[Simon Leopold:]

Okay and then in terms of kind of some of industry trends you’ve discussed in the remarks, if you could maybe help us understand how things have changed in your view say 90 days kind of view of the metro opportunities and then kind of the China Dongguan opportunity, could you help us understand the evolution of you views? So do you feel better worse today than you did 90 days ago?

[Tim Jenks:]

So just for clarification, we didn’t do a conference call 90 days ago. We did a conference call just a month ago. So at the moment how do I feel versus 90 days ago i.e. the middle of first quarter, we saw through the course of the first quarter a potential surge in volume materializing in China because of accelerating growth in our backlog and forecasts for these products that began at the end of the fourth quarter, fourth calendar quarter. That is now manifesting as shipments and our higher forecast higher outlook as already defined for the second quarter. The backlog has continued to see strengths so I feel more optimistic than I did 90 days ago.

[Simon Leopold:]

And then since your last conference call with us some of your competitors’ peers have reported this year particular mentioned some softness in North America and Metro, do you concur with that view or do you see things specially that may do?

[Tim Jenks:]

I do concur and our first quarter forecast we’ve just provided an outlook for the first quarter which is down and we’ve provided an outlook for the second quarter which is up 10% over the first quarter, but what we reported today is actually the fourth quarter of ’13.

[Ray Wallin:]

Yes, I am focused really on the outlook commentary.

[Tim Jenks:]

On the outlook, I think compared to 90 days plus ago we thought that we’re going to see metro deployments in the third quarter and now we think will be in the fourth quarter and then really ramping in 2015.

[Simon Leopold:]

The other thing that I think this commentary also support is the gross margin being the weaker and I think all expected. I am guessing some of this is reflecting of what you’ve just described in terms of the business mix that you’ve got more China business that’s going to pressure your gross margin versus North America business. You’ve done a fair assessment?

[Ray Wallin:]

Yes, we saw in the third quarter Simon, we had 23% of our revenue and they were 30% in the fourth quarter. We see strength in China so that is true. More business in China has in effect also a bit higher access business in terms of mix also has downward pressure on margin, so volumes are strong, backlog is strong but it does have a negative impact on near-term gross margin.

[Simon Leopold:]

Okay and then one just last question I’d like to ask about R&D, we’ve spent a lot of time talking about the SG&A type expenses, your R&Ds been often clear as a tech company, we expect you to spend, but over the course of 2013 it generally ramped up. How should we think about R&D through the course of 2014?

[Tim Jenks:]

I, our R&D agenda is aggressive and it’s an important part of what we’re doing for this next generation products I’ve described, a number of the platforms that we’re working on, I don’t think you should expect -- you should not expect to see continued ramping in the R&D. I think we have got strength there in the 2014 period. I think you should expected to be relatively flat.

[Operator:]

We’ll go next to Richard Shannon from Craig-Hallum

[Richard Shannon:]

Maybe a couple of questions, also on gross margins here, Ray, I think that you have mentioned in the previous question regarding the second quarter guide number 20 to 25; can you give us a sense of even more specifically why the Rangers fairly high, and you said you haven’t closed the first quarter books yet, but what are the mix or other things that would drive the lower end to the high end of that range?

[Tim Jenks:]

Richard this is Tim, images jumping at the beginning and then Ray can come back numerically, but, for the first quarter to the second quarter were guiding of 10% on the revenue side and this is a very strong increase in volume as well. We do have, in the last Q&A, we have the mix issue, we expect continued strength in China, we expect continued strength in Access, and we do have the impact of ASP; each of those drive absolutely the amount of margins -- the mix really determines how much leverage we can get. Ray said that we do expect generally to see one to two percentage points in a quarter, higher when we get more leverage and when the product mixes frankly more a pick. And at this point in the quarter we can see that there is uncertainty on the range, normally we would guide to a four point range and we expanded it as we haven’t closed the prior quarter yet.

[Ray Wallin:]

I will hold to add to that as well that being relatively conservative in our guidance and result in a little bit wider range than we normally have, for the company.

[Richard Shannon:]

So does the one to two point improvement per quarter after the second quarter -- does that -- just to be clear that implying requiring improvement in customer in geographical and maybe even product mixed to effect that, or is that just primarily mostly your pricing driven and offset by a lower cost; how does that exactly happen then?

[Ray Wallin:]

It is the latter rather than the former. So the projections assumed are relatively constant mix. So that we are expecting there is consistent with what we see historically, you know as we drive through the year we will achieve some very significant cost reductions which would drive the higher gross margins.

[Richard Shannon:]

How do your dynamics like, more 100 gig Coherent, and just maybe -- or in the Metro in North America and CFP2 and even some improvement in the semi -- improvement; does that drive potentially a higher opportunity for gross margins about a 1.2 point per ranges that you just mentioned?

[Ray Wallin:]

Yes. It could, because the margins do have a wide range depending on what we are selling, and which part of the business we are looking at. The Neo Semi contribution gross margin is higher, and of course, you know once the fab that we are vertically integrated, we have significant operating leverage from the higher volumes as well. So the combination of driving mix through more higher margin businesses as well as operating leverage through the manufacturing organization really can drive it higher.

[Richard Shannon:]

Okay, sure enough, and let me just wrap up that into kind of a bigger picture -- a point here which is, would love to get your updated thoughts on what the breakeven point looks like here in terms of topline and gross margins and your expectations, and able to achieve that or get passed at some point in the second half this year?

[Tim Jenks:]

So, as you know, we’ve been here a short time and principally we’ve been focused on getting the company back into compliance with its reporting, such kind of focus. So we’re now going to turn our attention to getting profitable for the company, so what does that mean, of course it’s really the interplay of where we are at with our revenue and also what we do with our operating expenses. So I took it revenue north of $80 million -- $85 million, and you can pull the OpEx and reduce G&A and total operating expenses, we should be able to get there in the next few quarters.

[Operator:]

We’ll take our next question from Brian Rudolph from Deutsche Bank.

[Vijay Bhagwat:]

Hi guys, this is Vijay Bhagwat calling on behalf of Vijay Roy. So question for you Tim, as we’re headed to you know the second half, what’s your demand outlook for 100 gig and our assumption is 100 gig componentry would be one of your higher gross margin products, so I think the question really is, give us a sense of how your OEMs are telling you in terms of their 100 gig forecasts into the telco (ph) so that we get a read from you on the components side for 100 gig components heading into the back half, thanks.

[Tim Jenks:]

Well the demand forecast first of all is quite strong and as in the prepared comments the preponderance of that is long haul transport and by the end of the year we would expect to see ramping in metro as well. Now metro will continue to drive volumes for the next few years, metro also has the characteristic of continuing to put pressure on the price. So I don’t expect to see a reducing element of price pressure but I do see the strong demand, the design win activity and I think that will continue through this year and into next year based on what we see in the current and projected tenders as well as each of our customer forecasts. And there is a tremendous amount of design activity around the next generation coherent systems. So it’ll continue to drive with strong demand.

[Vijay Bhagwat:]

Yes, I think a quick follow up in this, you mentioned about strength in China especially on the axis component for LTE build out. I think the question is what would be the catalyst to, for you to guide up those margins heading into the second half. Would it be just an improved demand forecast for 100 gig or you have any new product launches on the horizon that will help you to guide up gross margins sequentially as we head into the back half or would this be the trend line, your guidance for Q2, 20% to 25% will be the trend line we should think about from modeling point of view heading into the second half. Thanks.

[Tim Jenks:]

Yes, so you know prices at this point are relatively set for the year, cost reduction is continuous for the year, I mentioned strength in a 100 gig demand and we’re starting to see that affect significantly our second quarter and beyond, the cost reduction of course affects all things throughout the year on a continuous basis. We also have differences in mix, so one of the other, the other elements in a 100 gig deployments is we have seen in our speed and agility, we talk about speed and agility but we talk about the high speed part being very-very strong. The agility part has been a bit later and a lot of that is 10 gig so we’re talking about ROADM deployments and ROADM nodes and we see that as having been a bit later than that overall speed and agility group of products is higher margin. So strength and speed and agility overall including agility would be upwardly favorable on our margins. More 100 gig is upwardly favorable on our margins and similarly strength in the ex China markets, meaning from North America, Europe and Japan.

[Vijay Bhagwat:]

A final question would be around you know the 2015 outlook, I mean before you reported consensus was expecting loss of $0.02 for calendar ’15, what’s your view qualitatively if you could on you know return to EPS profitability in calendar ’15, thank you.

[Tim Jenks:]

Is the question, what is EPS in 2015?

[Vijay Bhagwat:]

No, I think the question is around you know any color or qualitative views you can give us in terms of a timing for return to profitability, heading into calendar ’15. Would you expect to be EPS profitable in ’15; I think that’s the question.

[Tim Jenks:]

Yes, I mean again you know it’s hard to pin exact time, quarter time frame on it, as we talked about earlier we’re just getting into turning our attention to the profitability question. You know so it’s a combination of you know balancing the revenue and the revenue growth was operating expenses, G&A (ph) and total operating expenses, gross margin and so just flowing on [Indiscernible] right now, so very difficult to actually say what particular quarter we will be focusing on non-GAAP profitability but we could be assured to know we’re working feverishly to get there as quickly as we can. You know could it be as early as 4Q, I guess it’s possible with the kind of the right actions we’re taking for the company.

[Vijay Bhagwat:]

Okay, thank you.

[Operator:]

(Operator Instructions) We’ll take a follow up from Alex Henderson from Needham and Company.

[Alex Henderson:]

Yeah, just along the lines of that last one just to keep in mind it is highly probably if you’re just breaking breakeven in 4Q that you still have a loss in 1Q I assume given the pricing trajectory so what really be in 2Q, 3Q, 4Q of next year that you were to get this both sustained profitability is that the right way to think about it?

[Tim Jenks:]

I think that’s a fair to look at it.

[Alex Henderson:]

Okay. Second question really reason for the re-queue now mentioned in the Micro-ITLA at all on the call that was a fair topic and conversation the last call. Can you talk about what’s going on with the Micro-ITLA and what the timing looks like on it?

[Tim Jenks:]

Certainly, I think still and I mentioned it is one of the key products but the Micro-ITLA is we have a number of qualifications now either underway or in place. We have current qualification underway we would expect to be shipping the product in the third quarter but we would actually express ramping as a predominantly fourth quarter event because third quarter will be it will largely be immaterial in terms of revenue volume.

[Alex Henderson:]

So, given the timing of that, I assume that that’s a drag against gross margins on additional launch probably producing near neutral zero gross margins on initial volumes. Is that something that we should be using as an offset to that one to point of growth or is that already built into that assumption, how do we think about that interplay?

[Tim Jenks:]

I would say that’s already in the assumptions, Alex. The -- and in the current fiscal year volumes are relatively small little ramp in the fourth quarter but the -- I think the number that Ray expressed with respect to gross margin would already reflect impact from what we expect to have happen in Micro-ITLA. So I don’t think it would be subtractive or additive from the forecast.

[Alex Henderson:]

So as we get out into 2015 I assume the Micro-ITLA ramps production quite solidly. How do we think about the double edge sword of ramping the volume there versus cannibalization of the existing ITLAs as we go through the year, is that a net positive to gross margins and growth or is it a negative, how do we think about that?

[Tim Jenks:]

Well, let’s see, I just read into your question that you’re expecting the product is a rather negative product and I actually think it’s a very powerful and positive one the capabilities of the micro tunable laser are it’s a grid less product it has -- it’s not just a direct replacement for the ITLA with a smaller one it has higher power grid less operation and the result of that is it is a premium product and should command a good return. It’s not just a smaller cheaper replacement.

[Alex Henderson:]

So is the cost associated with Micro-ITLA fallout from the startup cost that would be solidly accretive to say a 30% gross margin in fourth ’15, is that the right way to think about it?

[Tim Jenks:]

With the startup costs fall…

[Alex Henderson:]

As the startup costs fallout as you get to volume production rates, is it reasonable to think that the Micro-ITLA would be accretive to a target of say a 30% gross margin?

[Tim Jenks:]

I would say when it’s up in volume, yes, whether that’s in the first quarter of 2015 I don’t know enough, I don’t know enough about the price and I don’t know enough about the ramp. But from a modeling perspective I think the answer is a definite yes.

[Alex Henderson:]

Great. Thanks.

[Operator:]

And with no further questions in the phone queue, I would like to turn the call back over to Tim Jenks for any additional or closing remarks.

[Tim Jenks:]

Well, thank you very much for your attention in the conference call today. I would like to thank all of you for taking the time and I would also like to thank our shareholders for their patience while we completed our restatements of Q1 and Q2 2003 financials and then finalized our Q4 2003 financials. We look forward to updating you on our progress on our next quarterly call. Have a good day.

[Operator:]

This does conclude today’s conference. We thank you for your participation.