NeoPhotonics' (NPTN) CEO Tim Jenks on Q4 2013 Results - Earnings Call Transcript

NeoPhotonics Corporation (NYSE:NPTN)

Q4 2013 Earnings Conference Call

May 19, 2014 04:30 PM ET

Executives

Erica Mannion - IR

Tim Jenks - President and CEO

Ray Wallin - CFO

Analysts

Alex Henderson - Needham & Company

Simon Leopold - Raymond James

Richard Shannon - Craig-Hallum Capital Group LLC

Vijay Bhagwat - Deutsche Bank

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:

Alcatel-Lucent at approximately 13%; compared to 17% in the third quarter

Ciena comprised approximately 16%; compared to 13% in the third quarter

Finisar comprised approximately 11%; which was below 10% in the third quarter, and

Huawei Technologies comprised approximately 30% of our total revenue compared to 23% in the prior quarter

Geographically, our revenue mix for the fourth quarter was 23% in the Americas compared to 23% in the prior quarter, 47% in China compared to 42% in the third quarter, 9% in Japan which is the same as the prior quarter, and 21% in the rest of the world compared to 26% in the third quarter. Note that we track shipment destination rather than end use destination as we talk about geographies.

GAAP gross margin for the fourth quarter of 2013 was 26.4%, an expansion of over 2.7 percentage points sequentially from the 23.7% reported for the third quarter of 2013. Non-GAAP gross margin for the fourth quarter was 27.5%, at the high end of our projection of 25.0% to 28.0%, and was flat versus the previous quarter’s Non-GAAP gross margin of 27.5%.

SG&A spending for the fourth quarter was $11.9 million, or 16.0% of revenues, down from $12.5 million, or 16.3% of revenues, in the third quarter. Of this, G&A expenses from the fourth quarter were $8.2 million, or 11.0% of revenue, down from $8.9 million, or 11.6% of revenue in the prior quarter, primarily due to timing of audit and accounting fees incurred. We anticipate incurring higher G&A expenses through the first and second quarters of 2014 as we continue to enhance our internal controls.

Research and Development expenses were $12.8 million, or 17.3% of revenue, up from $12.2 million, or 15.9% of revenue in the prior quarter. We continue to make significant investments in 100G product development.

Operating loss for the fourth quarter was $5.6 million, or 7.5% of revenue, compared to an operating loss of $8.5 million, or 11.1% of revenue for the third quarter of 2013. The effective tax rate for the quarter was 8.1%, as the company made a provision for taxes related to NeoPhotonics Semiconductor in Japan, and for our operations in China.

GAAP net loss for the fourth quarter of 2013 was $4.5 million, compared with a net loss of $9.4 million in the third quarter of 2013. Diluted loss per share for the fourth quarter of 2013 was 14 cents which is lower than the loss of 30 cents per share in the prior quarter and compares to diluted loss of 10 cents per share in the fourth quarter of 2012.

Non-GAAP net loss from continuing operations for the fourth quarter of 2013 was $1.8 million, improved from the net loss of $3.2 million in the third quarter of 2013. Non-GAAP diluted loss per share from continuing operations for the fourth quarter of 2013 was 6 cents as compared to a loss of 10 cents per share in the preceding quarter, and is up from diluted loss per share from continuing operations of 1 cent per latest press release in the year ago period. Adjusted EBITDA was an income of $3.0 million, an increase from income of $1.9 million in the third quarter and was down from $3.5 million in the fourth quarter of 2012.

Now turning to the balance sheet: Cash, cash equivalents and short term investments were $75.0 million at the end of the fourth quarter, compared to $70.6 million at the end of the third quarter and $101.2 million at the end of 2012 and prior to our acquiring NeoPhotonics Semiconductor. Total debt at December 31, 2013 was $44.2 million, a decrease of approximately $0.7 million from the third quarter of 2013.

Accounts receivable balances decreased by $14.4 million in the fourth quarter to $64.5 million, and days sales outstanding were 87 days at the end of the fourth quarter compared to 89 days at the end of the third quarter.

Net inventory increased approximately $1.2 million during the fourth quarter to $64.9 million while days of inventory on hand increased to 106 days from 94 days in the third quarter due to our building inventory for higher expected shipments in the next several quarters.

Capital expenditures totaled $5.2 million in the fourth quarter due to our current period capital expenditure programs as well as our completing certain programs initiated during prior periods. We expect capital expenditures to generally be in the range of $3.0 million to $5.0 million per quarter in the next two quarters. Fourth quarter depreciation and amortization was $5.5 million, compared to $5.6 million in the third quarter of 2013.

Now, I will provide an overview of our financial results for the full year of 2013.

NeoPhotonics delivered record annual revenue for fiscal year 2013. Total revenue was $282.2 million, an increase of $36.8 million, or 15%, over 2012. On a year-over-year basis, our revenue growth was primarily attributable to growth in our high speed products. In 2013, revenue from our high speed products grew 69% over 2012.

Gross margin for 2013 was 23.1%, down from 25.0% in 2012. Loss from continuing operations for 2013 was $34.3 million, which was up from a loss of $17.7 million from continuing operations in 2012.

Non-GAAP gross margin for 2013 was 26.0%, down from 27.0% in 2012. Non-GAAP gross margin for 2013 excludes the same items mentioned in the quarterly discussion and was totaled approximately $8.2 million for 2013.

Non-GAAP loss from continuing operations for 2013 was $14.2 million, an increase from a non-GAAP loss from continuing operations of $4.7 million in 2012. Non-GAAP loss from continuing operations for 2013 excludes the items previously noted in the quarterly discussion, which totaled approximately $20.1 million in 2013, and are detailed in today’s press release available on our website. Adjusted EBITDA for 2013 was $4.4 million, a decrease over 2012 Adjusted EBITDA of $9.5 million per latest press release.

For the full year we had three 10% or greater customers: Alcatel-Lucent was approximately 14 % of total revenue; Ciena comprised approximately 16% of total revenue, and Huawei Technologies comprised approximately 27% of our total revenue. Our top 10 customers comprised approximately 86% of our total revenue for the year.

Geographically for the full year our revenue mix was 26% in the Americas, 43% in China, 9% in Japan and 22% in the rest of the world.

Now, I will provide a summary of our updated outlook for the first quarter of 2014.

Recall that the first quarter revenue is seasonally low historically due to pricing negotiations completed before year end, plus seasonal impact on our Access business and the effective shortening of the quarter with holidays including Chinese New Year.

We anticipate revenue for the first quarter ending March 31, 2014 to be in the range of $67.5 to $68.5 million, in line with our prior outlook and consistent with price declines and their impact in the first quarter of each year;

Non-GAAP gross margin will be in the range of 20% to 23%;

Diluted loss per share from operations in the range of 38 cents to 42 cents, and on a Non-GAAP basis will be in the range of a loss of 28 to 32 cents per diluted share;

The share count assumption used to estimate the first quarter is approximately 31.5 million diluted shares.

Now, moving to the second quarter of 2014:

We anticipate revenue for the second quarter ending June 30, 2014 to be in the range of $73 to $78 million;

We expect the second quarter Non-GAAP gross margin will expand again following the seasonal low in the first quarter, such that Non-GAAP gross margin will be in the range of 20% to 25%.

Looking at the full year 2014, we continue to believe demand is favorable for NeoPhotonics products, with continued potential in high speed and Coherent products in 100G and fiber-to-the-home and LTE wireless backhaul deployments around the world. This is indicated by our outlook of +10% growth for Q2 over Q1 of 2014.

With that, I will turn the call back to Tim.

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:

A new “micro-ITLA” narrow line width tunable laser which leverages our core PIC array laser technology; Two new types of coherent receivers, including one focused on demanding long haul transport and one focused on compact Metro applications; A new coherent transmitter that integrates both narrow line width tunable laser and four Mach-Zehnder modulator elements in a dual polarization QPSK modulator configuration; A new 100G client-side module in the CFP2 form factor that includes numerous internally-produced components; Several new, lower power and higher performance laser and driver devices for 10G and 100G applications from our NeoPhotonics Semiconductor subsidiary; A new Multicast Switch for Coherent optical networks that expands the flexibility of a node to enable any port to provide colorless, directionless and contention less operation; and a GPON Optical Line Terminal that incorporates embedded Optical Time Domain Reflectometry for monitoring the fiber infrastructure in which it operates.

We have increased product capacity for each of our new 100G products and we have captured significant market share for the products sold into these markets. We believe that our key investments in next gen products are aligned with industry trends that include:

Moving to 100G data rates and beyond, Expanding coherent applications to Metro deployments; Connecting data centers to telecom networks with 100G links; Enabling coherent switching; Providing new Access network innovations that enhance network reliability, cost and efficiency, and, increasing Access network speeds to 10G data rates and above.

During our last call I noted that we had seen strong demand conditions in China and a resulting strong uptick in our direct backlog. We have seen strong backlog growth since that time and we are forecasting revenue growth in Q2 and we expect strength continuing in Q3. In addition to very strong demand for our 100G products, our 10G transceivers, used in wireless backhaul and OTN networks in China and elsewhere, have shown strong year-on-year growth, and in 2014 our Access transceivers are also seeing strong demand.

We have been fortunate to have added considerable capacity during the last year, including our opening a factory in Dongguan, China, as the totality of current demand is the strongest we have yet experienced. In the case of China and 100G deployments, expected tender awards from China Telecom and China Mobile total over approximately 20,000 100G lines through successive award cycles. Each line can account for $5K-$7K of optical components, when including each of the required tunable lasers, coherent receivers, modulators, mixers, taps and such optical devices, meaning an increase in market demand of more than $100 million in the current year for China alone.

Now, our business has fixed costs, such as a sophisticated and highly trained engineering staff, device fabrication facilities and the infrastructure to support it. As such, in times of accelerating business growth our business model can show leverage. Current demand, plus the new products that I have described that are just beginning to launch to production, can provide the upward tension in operations that I have described. We operate our own plants for manufacturing, such that higher volumes can drive both additional revenue as well as higher product gross margins. This is because incremental volumes of our products can be produced at marginal costs that can be appreciably lower, contributing to operating leverage and accelerating gross margin growth and our path to increasing profitability.

Now I would like to talk about several key industry trends that we expect to impact NeoPhotonics’ business going forward.

First, 100G Coherent long haul transport system shipments have been the mainstay of 100G. We expect we will begin to see systems specifically designed for Metro deployments beginning 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, which includes both our optical components and transceiver products, is a relatively small portion of the datacom market, but it is fast-growing and will take share over time as enterprise computing and consumer Internet applications continue to consolidate into large cloud-scale datacenters.

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.

Now I would like to talk about our vision for the next two years.

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 micro tunable laser and our integrated coherent transmitter, which we announced last quarter. These factors mean that 100G will continue to increase in volume and share of our business. The acquisitions we completed in 2013 and 2011 together significantly enhanced our development of advanced high speed solutions, and we are rapidly bringing these important capabilities to market in the form of our new products  including some of the products I have described that integrate the broad technology capabilities we have brought into NeoPhotonics.

As I have noted on prior calls we are gradually phasing out certain products whose growth and profitability prospects are limited. This has a near term impact of dampening our total growth rate, but when completed we expect to be in a position to increase our level of profitability and additionally increase our growth rate in 2015.

And finally, as Ray noted, we are focused on G&A and total operating costs, which we expect to decline to normalized levels as we complete current audit procedures and internal control improvements.

This concludes our formal comments and now I would like to ask the operator to open up the line for questions. Operator…

Question-and-Answer Session

Operator

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

Alex Henderson - Needham & Company

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 - Needham & Company

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

Ray Wallin

Yes.

Alex Henderson - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

Okay. I will seed the floor. Thanks.

Operator

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

Simon Leopold - Raymond James

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 - Raymond James

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 - Raymond James

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 - Raymond James

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 - Raymond James

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 - Craig-Hallum Capital Group LLC

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 - Craig-Hallum Capital Group LLC

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 - Craig-Hallum Capital Group LLC

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 - Craig-Hallum Capital Group LLC

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 - Deutsche Bank

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 - Deutsche Bank

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 - Deutsche Bank

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 - Deutsche Bank

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 - Deutsche Bank

Okay, thank you.

Operator

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

Alex Henderson - Needham and Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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 - Needham & Company

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.

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